The company, Bilby (BILB:75p), was established as a holding company to acquire P&R Installation, a Sidcup-based firm employing 80 staff and founded by deputy executive chairman Phillip Copolo almost 40 years ago. P&R is an award winning provider of gas heating appliance installation and maintenance services to residential and commercial properties, primarily servicing the gas heating and general building needs of 1.25m local authority and housing association properties across London and South East England.
The business has expanded its activities in recent years to incorporate a broader range of domestic and commercial plumbing, electrical and general building repair works. By offering a high level of service, P&R has developed long standing relationships with its customers including the Guinness Partnership, London & Quadrant, Gallions and the Royal Borough of Greenwich.
It's a lucrative market to be operating in given that demand for housing is outstripping supply in Southern England, so much so that there are 800,000 people now living in London who are on the social housing waiting list. In turn, this is putting added pressure on local authorities and housing associations to maintain and improve their current housing stock, as well as build new homes to meet the needs of a growing population. Indeed, the Office of National Statistics forecasts that between 2013 and 2012 there will be an additional 473,000 new households across Greater London. This can only put even greater pressure on the need to increase the social housing stock and maintenance budgets too.
Profiting from regulatory requirements on landlords
Legislation is also playing its part as local authorities have to adhere to The Decent Homes Standard which was set up by central government 15 years ago and updated in 2006 to include the implementation of the Housing Health and Safety Rating System. As a result of the requirement of landlords to meet this standard, the majority of work carried out by P&R is compulsory responsive repairs.
It's a significant market to be targeting because even though the Mayor of London secured £821m in the 2011-2015 spending round for London boroughs to improve the condition of 45,000 homes in the capital, the Greater London Authority (GLA) estimate that London still has 11 of the 12 local authorities in the country where more than 10 per cent of dwellings do not meet The Decent Homes Standard. The 2013 Comprehensive Spending Review announced a further £160m would be made available in 2015-2016 for the national Decent Homes Backlog Programme, targeted on areas with the largest number of non-decent homes. In recognition of the condition of London's local authority owned stock, the GLA now plans to invest up to £145m to bring a further 9,500 homes up to the Decent Homes Standard.
The company is also benefiting from The Right to Repair Scheme, legislation introduced by the last Conservative government in 1994 to enable tenants to have urgent, minor repairs which would affect health or safety, completed quickly and at no cost to them. The scheme sets out a list of repairs which are required to be completed within a certain time limit. The repair must cost less than £250 to carry out, with the tenant entitled to compensation if the repair is not completed within the specified time period. Qualifying repairs include: unsafe power, lighting sockets or electrical fittings; blocked flues to fires or boilers; leaking roofs; blocked sinks, baths or basins; leaking or flooding from pipes, tanks or cisterns; and loose or broken banisters or handrails.
Although the Right to Repair Scheme covers relatively small jobs, the true cause of the problems will often only be discovered once P&R is on-site. In many cases this has led to a substantial amount of additional work for P&R. But even if this work is significantly more expensive due to government legislation, it is deemed compulsory and therefore must still be carried out.
Solid recurring revenue
Of course, the bread and butter for the company is gas installation and maintenance services, and in particular the requirement for landlords to comply with the Gas Safety Regulations. P&R has 42 qualified engineers able to carry out such work, servicing the needs of over 100,000 domestic and commercial dwellings across London and South East England. But it's worth flagging up that many of these are now multi-trade building contracts which explains why there was a near 50:50 split between gas and general maintenance services work in the nine month trading period to end October 2014, compared to a 72:28 split skewed towards gas work in the previous financial year. In addition to the 80 staff on its payroll, P&R employs 42 sub-contractors specifically to help carry out building maintenance work.
These long-term rolling contracts provide a solid income stream. That's because P&R has eight contracts in place on 14 distinct projects from its top four customers and these account for three quarters of its total turnover. As a result of the rolling nature of these contracts, P&R has a high recurring revenue base; in the last financial year over 92 per cent of revenue was derived from customers who had been clients in the prior financial year. This stable source of income not only offers strong visibility for future earnings, but it also means that profits are ramping up strongly as new contracts and the business is scaled up.
Strong profit growth profile
Bilby's listing document reveals that P&R's revenues rose by 29 per cent to £9.7m in a two-year period to end January 2014 and the business maintained this momentum in the nine months to end October 2014 when turnover increased by 14.5 per cent to £8.7m year-on-year. And with the increased work being spread over a relatively fixed-cost base, the effect of rising sales is boosting operating margins, so much so that pre-tax profits for that nine month period shot up by £500,000 to £1.21m on the same period in 2013. The operating margin increased from 9.6 per cent to 14.1 per cent. Admittedly, the margin is above that earned by other publicly quoted competitors like Mears (MER:427p), Mitie (MTO:292p) and Morgan Sindall (MGNS: 808p), but this reflects Bilby's lean management structure, a disciplined approach to tendering, and a geographic focus on southern England that has enabled careful management of the cost base from a centralised location.
And following an upbeat pre-close trading statement, we can expect more of the same when Bilby releases its maiden results next month. Support services analyst Andy Smith at house broker and nominated advisor Charles Stanley Securities predicts that the company will report pre-tax profits of £1.96m on sales of £13.9m in the 14-month period to 31 March 2015. On this basis, expect adjusted EPS of 5.46p and a maiden dividend of 2.4p a share even though the company only listed in early March this year.
Moreover, with over 90 per cent of Mr Smith's revenue forecast of £16.3m already secured for the financial year to end March 2016, then we can also expect yet another step change in profits. Charley Stanley forecasts increased pre-tax profits of £2.37m, EPS of 6.48p and a payout per share of 3.15p for fiscal 2016. On this basis, the shares are only trading on a forward PE ratio of 11.5, and offer an attractive prospective dividend yield of 4.2 per cent. It's worth pointing out that Bilby raised new funds of £1.8m in a placing at the time of the flotation, so after factoring this in Mr Smith predicts that net cash is currently around £3.69m, or 12.5p a share, based on 29.3m shares in issue. So on a cash adjusted basis, the shares are only being rated on 9.6 times earnings estimates for the 12 months to end March 2016.
Estimates well underpinned
Those revenues and profit estimates look well underpinned to me because since the beginning of the year the company has won material work with two new clients; a contract with Basildon Borough Council worth £1m, and a framework agreement worth £2.5m with Haringey Council. Bilby has also extended its reach within the NHS, winning its first Building and Engineering Maintenance contract and negotiations are on-going to significantly extend the 'Damp Works' contract with the Royal Borough of Greenwich - currently, revenues are expected to be £900,000 for the first three months of the new financial year from this contract, according to Mr Smith. In addition, Bilby has won regular short-term contracts of up to £500,000.
It's also worth flagging up that with the benefit of an Aim-quotation, and a cash-rich balance sheet, the board plans to supplement the strong organic growth being generated by the business by making strategic acquisitions in order to scale up operations and access larger tender contract opportunities which require pre-qualification revenue requirements. I understand the board have identified a selection of acquisition opportunities as part of this 'Buy-and-Build' strategy. All potential bid targets must meet strict acquisition criteria based on: service savings, revenue size, geographic focus, the management team, operating margins, cash flows and forward order book. So, even without any more contract wins, a hardly likely scenario given the recent spate of successful tenders, there should be scope for upside to Charles Stanley's profit estimates if Bilby's board wisely invests its cash in bolt-on purchases.
Assessing the risks
Of course, no investment is without risk. The obvious one is if Bilby loses any of its four major clients who account for three quarters of its revenues. That said these clients have long-standing relationships with the company, and there is nothing to suggest this will happen. The fact that the company has been winning significant new local authority contracts is evidence enough of its success and standing in the segment of the support services market.
It's worth flagging up too that the company currently performs sub-contract work for Mears and Morgan Sindall Property Services, large service providers that have become increasingly reliant on sub-contractors to fulfil contracts with housing providers. In the event of Bilby landing a larger scale contract itself, it intends to continue certain sub-contact work for some of these providers, but this also means that the business risk rises due to the reduced proportion in the mix of relatively low-risk sub-contracted work.
The business is also dependent on UK government policy with regard to expenditure on improving social housing. Frankly, I can't see this changing during the course of the current fixed-term parliament under the Conservative Party. Acquisition risk is another issue to consider since there is no guarantee that bolt-on deals will succeed and they may even require further equity to be issued.
The general economic cycle is worth taking into consideration too as the business is exposed to adverse movements in interest rates, increased competition, changes in regulation, and budgets for spending on social housing maintenance and refurbishment. Despite the robust nature of the order book and pipeline of new business, there is no guarantee that these orders and expected orders will be converted into sales. That said, with 90 per cent plus recurring revenues, I see this as a low risk.
Finally, it's worth pointing out that Bilby only has a free float of 24 per cent due to the substantial shareholdings of the management team. Executive chairman Philip Copolo owns 52 per cent of the equity, managing director Darren Dunnett and finance director David Ellingham both own 8.5 per cent each, and Leigh Copolo, the managing director of P&R, owns 5.1 per cent. In addition, Miton Asset Management has a 5.9 per cent shareholding and Amati Global Investors owns 7.3 per cent. Although this guarantees that the board's interests are in line with external shareholders especially with regards to the progressive dividend policy, and creating shareholder value, the limited free float means that liquidity in the shares is lower than normal and they are likely to be more volatile.
Target price
Having taken all these risk factors into account, I still feel that a cash adjusted forward PE ratio of sub-10 represents an attractive entry point for a company delivering such strong profit growth and operating in a buoyant niche of the support services industry. In fact, social housing providers in Bilby's geographic regions spent over £2.5bn on the repair, maintenance and supervision of their housing stock in the last fiscal year, so it's a huge market place to tap into for a fast growing smaller player.
Furthermore, both Morgan Sindall and Mears are rated on 13 times forward earnings, and there is a valid case to be made that higher-growth and higher-margin Bilby should command a higher rating. Based on a fair value earnings multiple of 13 times fiscal 2016 earnings, after taking into account cash on the balance sheet, I have arrived at a 12-month target price of 100p. Offering 33 per cent potential upside, I rate Bilby's shares a decent income buy.
Please note that the electronic market size is 3,000 shares and it is possible to deal between the spread on lower bargain sizes. Splitting your orders into smaller bargains is likely to be the most cost effective way to build up a decent position in this £22m market cap company.
Please note that I published an article with all the share recommendations I have made this year at the end of last month. I have published three other investment columns this week all of which are available on my IC homepage...
■ Simon Thompson's book Stock Picking for Profit can be purchased online at www.ypdbooks.com, or by telephoning YPDBooks on 01904 431 213 and is being sold through no other source. It is priced at £14.99, plus £2.95 postage and packaging. Simon has published an article outlining the content: 'Secrets to successful stockpicking'
