In the autumn, I made the case that Aim-traded shares in Bilby (BILB:72p), a provider of gas heating appliance installation and maintenance services to residential and commercial properties, were worth buying, at 85p, ahead of this week’s interim results ('Bilby’s de-rating a buying opportunity', 24 October 2018).
Institutional investors Ruffer and Northern Trust thought so too, having both purchased 8 per cent stakes in the company the previous month at 100p a share from founder and departing chairman Phil Copolo, and his son, Leigh Copolo, who was previously operations director. Miton Group was clearly of the same opinion, having raised its stake from 15.1 to 19.8 per cent at the same time.
I was also assured that there was continuity in the boardroom. Finance director David Ellingham took on the job as chief executive, having led the IPO of Bilby and overseen its ‘buy-to-build’ strategy which led to a trebling of operating profit to £6m on revenue up fivefold to £78m since 31 March 2015. Adjusted EPS had more than doubled from 5.6p to 12.3p in the same three-year period. I also liked the fact that Lee Venables, managing director of Bilby’s largest subsidiary, Purdy, a Waltham Abbey-based provider of maintenance services to 150,000 properties throughout London, the Home Counties and south-east England, had taken a seat on the board. Purdy’s local authority and housing association clients include Homes for Haringey, and London Borough of Enfield.
It also made sense for Chris Webster, the founder of DCB, a provider of building, refurbishment and maintenance services to housing associations and local authorities throughout Kent, Sussex, Essex and London, to take on responsibility for overseeing building services work. DCB was acquired by Bilby in 2016 to expand the range of services that the company can offer, and tap into the business opportunity in servicing the needs of housing associations and local authorities in its core London and southeast England markets.
A few weeks after my article was published, Bilby appointed a replacement for Mr Ellingham’s previous role as finance director, Clive Lovett. He previously held finance roles at publishing groups St Ives, Informa (INF), and IBC Business Publishing. It wasn’t the only development as last month Bilby’s board also appointed Canaccord Genuity as its new nominated adviser and joint broker alongside Stanford Capital Partners to replace Northland Capital. And a few weeks later, so after Bilby’s 30 September 2018 half-year end, the company made a small acquisition of electrical services company R.Dunham.
A small strategic acquisition
The initial consideration paid by Bilby for R.Dunham was £750,000 and the company also issued the vendors with 250,000 new ordinary shares. In addition, there is a cash earn-out of £500,000 subject to R. Dunham earning not less than £500,000 of pre-tax profits for the 2018 financial year, and there is an additional cash payment to be made which is capped at £150,000 in relation to R. Dunham’s tax losses carried forward. Bilby has also repaid a director loan of £250,000. The maximum £1.87m consideration payable for R. Dunham seems reasonable to me in relation to the profitability and adjusted net assets of £800,000 (after taking into account the repayment of the director loan) of the company. Reassuringly, having led the business, Mark Dunham has committed to stay on under the ownership of Bilby.
Strategically, the acquisition makes sense as R. Dunham’s long-established client base (the company was founded in 2002) is complementary to that of Bilby. Its customers include Sanctuary Housing, the London Boroughs of Barking and Havering and Poplar HARCA. The opportunity for Bilby is to cross-sell a wider range of services from its other businesses to clients of R. Dunham in order to exploit a trend in the market whereby large scale organisations are increasingly seeking out a single source supplier for a range of facility management services. I am comfortable with the acquisition.
However, what I wasn’t anticipating was a shortfall in Bilby’s first half profits. Neither was the market as Bilby’s share price fell 20 per cent to 72.5p yesterday.
Interim results fall short, but expect growth for full year
Canaccord Genuity and Stanford Capital Partners have yet to publish any research and Bilby’s previous nominated adviser and house broker Northland Capital have terminated coverage. Northland had though been previously forecasting a near 14 per cent rise in pre-tax profit to £6.6m to produce adjusted EPS of 13.1p in the 12 months to end March 2019. This was based on cash profits of £7.1m. So, given that Bilby’s cash profits and pre-tax profits of £6.3m and £5.8m, respectively, in the 2017/18 financial year were split evenly across both halves, shareholders were expecting growth in the first half to end September 2018.
This has not materialised. Bilby’s first half underlying pre-tax profit of £2.43m was £450,000 shy of that reported in the same six-period of 2017 on revenues down from £38.6m to £36.4m. All of the revenue shortfall came from its gas service business and primarily reflects delays in a number of installation programmes. The company has also terminated its low margin building services contract with Amey under which it provides services to Ministry of Defence properties as flagged up previously.
However, the key point to note is that guidance from the directors is to expect Bilby’s full-year revenues and cash profits to still be higher than the £78.8m and £6.3m reported in the financial year to end March 2018. So, having just reported a £472,000 decline in first half cash profit to £2.678m, down from £3.15m in the same period of 2017, guidance from the directors is that the company will make at least £3.62m of cash profit in the second half which is well ahead of the £3.15m reported in the second half last year.
One reason why Bilby’s senior management team expects to make up the first half profits shortfall is because they have merged some of the company’s services and this is already producing annualised cost savings of £772,000 through headcount reductions. They are evaluating the divisional operations and this may lead to additional savings in the second half.
The second reason is that Bilby has a strong order book worth £270m in revenue, a bull point my investment thesis. Clearly, there is execution and timing risk in delivering these contracts, otherwise some of the aforementioned gas service contracts wouldn’t have been delayed. But this shouldn’t detract from the fact that the company continues to win new business and retains a strong position in the London market where it has contracts with 15 of the capital’s 33 Boroughs, comprising a social housing stock of almost 400,000 dwellings. Bilby also has arrangements for maintaining 125,000 local authority homes in Kent, Essex, Surrey and Hertfordshire.
Local authorities and housing associations are under growing pressure to maintain and improve their current housing stock in light of increasing demand for high quality affordable homes. This is positive for demand for Bilby’s services as are government standards and legislation, such as the Decent Homes Standard and Right to Repair Scheme. Importantly, Bilby is maintaining pricing power as highlighted by a slightly rise in the company’s gross margin from 22.4 to 22.7 per cent in the latest six month trading period. These factors, and the fact that the board say that their company “has started the second half strongly”, adds weight to Bilby making good the first half profit shortfall.
The final contributor to a strong second half trading performance is the profit contribution from the post half year-end acquisition of R.Dunham.
A low valuation
Based on an issued share capital of 40.54m shares, Bilby now has a market capitalisation of £29.2m. It also had net debt of £7.9m on its balance sheet at 30 September 2018 to give balance sheet gearing of 46 per cent. True, it has since used debt facilities to make the £750,000 cash payment to the vendors of R.Dunham, and pay off the £250,000 director loan, and if Bilby achieves £3.6m plus of second half cash profits then one would expect operating cash flow to cover this sum. I would point out that Bilby is compliant with all financial covenants on its borrowings, and one would expect it to continue to be so.
This means that Bilby has an enterprise value of £37m. Based on the company achieving full-year cash profits of £6.3m at the very minimum – that was last year’s outcome and guidance is still for growth for the financial year to end March 2019, but clearly not as high as the £7.1m cash profit estimate Northland had made prior to terminating coverage – then it’s still realistic to expect an underlying operating profit of £6m for the 12 months to end March 2019, split £2.55m for the first half and £3.45m for the second half. On this basis, the company is effectively being valued on 6 times operating profit to enterprise value, or on a standard price/earning (PE) ratio of 6 based on a normalised corporation tax charge.
It's worth noting too that the interim dividend of 0.5p a share was maintained, and the board declared a final dividend of 2p a share in the previous financial year, so the rolling 12-month dividend yield is 3.5 per cent.
Ultimately, the question is whether Bilby can make up the first half shortfall and deliver growth on its record performance it achieved in the 2018 financial year? I think it can after taking into account the contribution from the acquisition of R. Dunham, the cost savings that have already been realised, and the fact that the directors confirm the business has started the second half of the year strongly. I would also flag up that the company has secured a number of contracts since the half-year end which will delivered in the 2019/20 financial year.
Moreover, I note that chairman Sangita Shah and non-executive director David Johnson purchased 28,104 and 25,000 shares, respectively, yesterday adding weight to the board's expectations of the company making good the first half profit shortfall. Buy.
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