- Underlying pre-tax profit rises 55 per cent to £32.7mn on annual revenue of £178mn
- Adjusted fully diluted EPS up 46 per cent to 100p
- Full-year dividend rises 6 per cent to 20.4p
Following a robust pre-close trading update in early June when analysts pushed through their eighth profit upgrade in the past 12 months, Hargreaves Services (HSP:526p), a diversified industrial services group and brownfield land developer, has delivered eye-catching annual results.
Surging commodity prices explain the bumper profit growth as German metals trading subsidiary, HRMS, a key supplier of specialist raw materials to European customers in the steel, smelting, ferroalloy, limestone, and ceramic industries, doubled its net profit to £32.5mn on 84 per cent higher revenue. Hargreaves holds an 86 per cent share of the business, so booked a £27.3mn post tax profit from the subsidiary in its latest accounts.
High zinc and pig iron prices have been a key driver. That’s because HRMS owns a 94.9 per cent stake in DK Recycling, a German company that produces 285,000 tonnes of high-quality pig iron and 6,000 tonnes of zinc by recycling waste material from the steel industry. DK contributed 43 per cent of HRMS net profit in the 12-month period even though it accounted for only a quarter of its revenue, a performance underpinned by €10.5mn (£9mn) of operational improvements (sales mix, procurement processes and general cost reductions) since DK’s acquisition for a bargain basement €1 only three years ago. The point is that even in a weaker commodity price environment, DK should deliver healthy profits.
In addition, Hargreaves chief executive Gordon Banham pointed out during our results call that although HRMS continues to trade well, even if its trading volumes drop off in the second half of the 2022/23 financial year then they will still be above historical levels given the additional contribution from DK, HRMS’ new carbon pulverisation plant and from third-parties.
Importantly, HRMS mitigates against its exposure to commodity prices by hedging forward sales positions and doesn’t enter open trading positions, so purchases of commodities are back to back with secured sales. Also, DK is a net energy contributor with surplus output sold back to the German Grid, and only small quantities of gas are used in the production process, so is far less exposed to the possibility of gas supply shortages. In any case, HRMS is considering the installation of a liquid gas tank to mitigate against that risk. Singer Capital Markets is predicting a net profit contribution of £16.5mn from HRMS in the new financial year, a conservative looking estimate given the operational improvements at DK and current trading volumes at HRMS.
It’s worth noting that the group’s land promotion and services businesses will make up some of the expected profit shortfall from HRMS this year. In fact, Singer expect operating profits from the two activities to almost double to £8.8mn. Land director David Anderson points out that a 9.5-acre parcel of land covering 130 plots at the Blindwells development, East of Edinburgh, has received “more interest than any other previously”, suggesting no let-up in housebuilders’ buying activity. The land is being marketed at £0.9-0.95mn per acre. In February 2022, Hargreaves agreed to sell a 4.6-acre (77 plot) land parcel at the site to Ogilvie Homes for £3.6mn with completion likely in September. There are another 120 acres remaining to be sold over the next nine years within the first Phase of Blindwells, suggesting scope to deliver over £100mn of further land sales.
Anderson also points out that Hargreaves renewable energy portfolio has agreements in place with wind farm developers to lease out land that will produce 580MWs of power, or more than two per cent of the UK’s total installed wind power capacity. The leases could generate £2mn of annual rental income for Hargreaves by the end of 2024. In addition, the group is set to receive £0.42mn of index linked rental income when the construction of a new waste plant at its 1,049-acre Westfield site in Fife completes in three years’ time. Hargreaves acts solely as landlord, so doesn’t undertake any construction work or ownership of the energy generating assets.
The group’s major earthmoving contract on HS2 is ramping up, too. It commenced last year and should deliver £40mn of revenue on a trading margin of 5 per cent, says finance director John Samuel. He also notes that a £12mn loan made to HRMS has been repaid since the 2022 financial year-end, the key reason why group net cash (excluding finance leases on HS2 equipment) dipped from £28.3mn to £13.8mn. As HRMS’ record inventories – £147mn at 31 May 2022 – unwind, then there is scope for more cash to be redistributed back to Hargreaves.
For the year ahead, analysts at Singer expect the group to deliver annual pre-tax profit of £25.3mn on revenue of £200mn. On this basis, expect earnings per share (EPS) to dip from 100p to 71.7p, but a slightly higher annual dividend of 21p to be declared. This implies the shares are rated on a modest forward price/earnings (PE) ratio of 7.3 and offer an attractive prospective dividend yield of 4 per cent. They are also priced well below book value of 563p even though land assets are conservatively valued in the accounts.
Hargreaves' share price has risen 155 per cent since I initiated coverage, at 206p (Alpha Report: ‘A high yielder offering significant hidden value’, 19 March 2020), and the board has paid out 23.8p a share of dividends, too, excluding a 17.6p payment to be paid in October (ex-dividend: 22 September). However, the share price has pulled back 12 per cent since my last update (‘Slick performers’, 3 May 2022) due to investor caution on HRMS prospects even though analysts’ maintained forecasts for the division look conservative. Buy.
Simon Thompson was named Journalist of the Year at the 2022 Small Cap Awards.
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