Join our community of smart investors

Red flags at Mitie

The facilities management group has one too many risks challenging its recovery efforts
November 9, 2017

Investors in support services groups have been no strangers to high-profile share price collapses in recent months. Carillion's (CLLN) shares experienced a stunning drop following a slew of warnings over profit and debt and significant changes to the management team. Interserve (IRV) has struggled with ongoing troubles exiting its energy-from-waste business, and last month warned it was in real danger of breaching its banking covenants. While Mitie (MTO) has already served up its share of disappointments, we feel there's clear risk of more bad news and investors should steer clear of the stock during these nervous times given its worryingly high debt, declines in profit and two concurrent investigations from financial regulators into historic announcements.

IC TIP: Sell at 238p
Tip style
Sell
Risk rating
High
Timescale
Medium Term
Bull points

Cost-cutting measures ongoing
Looking to close DB pension scheme

Bear points

High debt
Heavily shorted
Ongoing investigations into business
Changes to accounting rules

Mitie is a leading provider of facilities management services, offering everything from cleaning to catering to security. We last turned bearish on the group in late 2015, in part due to a worryingly high level of exceptional items – often a sign of trouble for support services companies – and growing debt. Last year, the group was able to meet the covenants on its £147m net debt, which require it to stay within three times cash profits but, worryingly, it needed to agree a waiver with lenders to exclude certain non-cash items from the calculation. Indeed, the group's warts-and-all numbers reported a cash loss for the period of £31m, with the £11.1m cash profit from continuing operations decimated by losses from discontinued parts of the business. 

In an effort to get its house in order, the group has been carrying out an extensive cost-cutting and restructuring programme, alongside an accounting review. The property services arm is up for sale and a defined-benefit pension scheme is expected to be closed soon. However, progress has not been entirely smooth, with management recently revising up from £15m to £24m expected current-year costs associated with making savings of £40m by 2020. Meanwhile, disposals, restructuring and impairment of goodwill exacted a heavy toll on last year's numbers with the bill for so-called "other items" coming in at £154m.

A new accounting rule, with the unmemorable title IFRS 15, also has the potential to cause nasty surprises. IFRS 15 changes the way companies report on income from long-term contracts and their set-up costs. Early adoption of the standard – which officially comes into force for accounting periods beginning in or after January 2018 – has already led outsourcer Capita (CPI) to revise its adjusted 2016 operating profit to £335m from £481m, prompting a 6 per cent share price drop. Analysts at Liberum have attempted to identify companies most at risk from the change by screening all 642 FTSE All-Share constituents for long-term receivables (items recorded in the profit-and-loss account but not yet actually collected) as a percentage of revenue. Mitie was 16th highest on the list, buddying up against the aforementioned Capita at 14th.

As the troubles at Interserve have hit the share price, it has vied with Mitie for the dubious title of second most-shorted outsourcer in the UK. At time of writing, Mitie trailed Interserve with 6.9 per cent to 7 per cent of shares shorted. Adding to the uncertainty, the FCA is investigating Mitie and its ex-auditor, Deloitte, for past exchange announcements. 

MITIE (MTO)    
ORD PRICE:238pMARKET VALUE:£871m
TOUCH:238-238.5p12-MONTH HIGH:314pLOW: 165p
FORWARD DIVIDEND YIELD:2.6%FORWARD PE RATIO:12
NET ASSET VALUE:24p*NET DEBT:164%
Year to 31 MarTurnover (£bn)Pre-tax profit (£m)Earnings per share (p)Dividend per share (p)
20152.2711424.211.7
20162.1379.516.112.1
20172.1466.715.74.0
2018**2.2271.816.24.0
2019**2.2884.719.16.3
% change+3+18+18+58
Normal market size:7,500   
Matched bargain trading    
Beta:0.24   
*Includes intangible assets of £397m, or 109p a share **Numis forecasts, adjusted profit and EPS figures