TClarke’s forecast profit recovery is underrated

Building services contractor TClarke (CTO:117p) has reported a 41 per cent increase in its order book in the second half, more than doubling in value to a record £1.1bn since the start of the year. In addition, the group has more than £1bn of quotations in the tender process with potential clients. This provides strong visibility of revenue for the next two financial years and is supportive of house broker Cavendish’s revenue estimates of £600mn (2024) and £650mn (2025), up from £500mn forecast in 2023.

The boom in data centres and smart buildings have been key growth drivers. The segment delivered 31 per cent of first-half revenue and accounts for a third of the £1.1bn contracted order book, up from a 20 per cent share at the start of this year. Work on major engineering projects is another boom area, accounting for £489mn of the order book, up from £225mn in December 2022. For instance, TClarke is working on major UK government-funded healthcare infrastructure projects, such as the National Rehabilitation Centre near Loughborough, one of 40 new hospitals to be built by 2030. It is also enjoying ongoing success in the education sector, too.

The booming order book notwithstanding, the turbulent conditions in the construction sector are impacting several market participants. This prompted the board to make the strategic decision to enter early contract agreements and change some supply chain partners mid-contract to protect completion dates. These actions have incurred one-off costs of up to £3.2mn, which explains why operating profit guidance has been lowered from £12.2mn to £9mn-£10mn for the 2023 financial year, down from £11.5mn in 2022. On this basis, analysts now expect a 30 per cent decline in current year pre-tax profit to £7.2mn, and 35 per cent lower earnings per share (EPS) of 12.7p.

That said, the actions protect the business, and with the benefit of a greater proportion of higher-margin work on data centres and smart buildings, as well as more complex projects, analysts forecast a strong rebound in TClarke’s profitability in 2024. The house broker expects operating profit to double from £9mn to £18.6mn (2024) based on operating margin improving from 1.8 to 3.1 per cent, slightly above the group’s 3 per cent target. On this basis, EPS is projected to rebound by 90 per cent to 24.1p, implying the shares trade on forward price/earnings (PE) ratio of 4.9.

Well-funded to deliver step up in revenue and profitability

The £62mn market capitalisation group remains well funded. In fact, the directors expect closing year-end net cash of £15mn, or £6mn higher than Cavendish’s previous forecast. In addition, the group has access to £30mn of low-cost bank facilities with NatWest to fund working capital as revenue scales up, as well as £65mn of bonding facilities that are used for a third of contracts, a key differentiator from rivals in the bidding process.

The recovery in 2024 profitability and the absence of this year’s one-off costs should also drive a marked improvement in free cash flow (FCF). Analysts expect FCF to more than treble to £7.6mn next year, implying a FCF yield of 12.2 per cent. That’s good news for the progressive dividend policy. Indeed, analysts expect the payout per share to be raised by 10 per cent to 5.9p (2023) and 6.5p (2024), which underpins dividend yields of 5 and 5.5 per cent, respectively.

The low earnings multiple, chunky dividend yield and structural growth drivers in TClarke’s key end markets more than compensate for the reversal in this year’s profits, albeit the share price has dipped below the 122p placing price when TClarke raised £10.7mn in an oversubscribed equity raise (‘TClarke’s order book goes from strength to strength’, 14 July 2023). That said, the holding is still 56 per cent in profit since I initiated coverage (Alpha Research: ‘Profit from a buoyant earnings cycle’, 7 December 2018), during which time the FTSE Aim All-Share Total Return index has shed 15 per cent of its value. Once the dust settles, and investors focus on next year's earnings recovery, expect the share price to recover. Buy.

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