Since former FTSE giant Carillion (CLLN) entered liquidation in January, investors have been sceptical about the outsourcing sector. Just a few weeks after the collapse of Carillion, Capita (CPI) suspended its dividend, announced a rights issue and warned on profits. Fund manager Neil Woodford commented: “Capita represents many of the things that this market loathes at the moment – it is exposed to the UK economy, it has a recent record of disappointment, it is an outsourcer.”
We feel the same applies ro Interserve (IRV), which represents another high-risk prospect in this troubled sector that could deliver nasty surprises even with its shares trading at their current derisory earnings multiple.
Low PE
Recent signs of improvement
High receivables
Heavily shorted
Gearing level increasing
High exceptionals
Late last year Interserve delayed the compliance test date for its loan covenants after revealing there was a “realistic prospect” it would fail if it went ahead at the end of December, as initially intended.
True, the group's shares have seen an uptick in performance in recent months after the company agreed additional short-term funding and delayed the covenant test date by three months to the end of March. It also announced in early January that it expected operating profit for 2018 to be ahead of current market expectations. Seen in isolation, this sounds like a company on the mend. It's of less comfort, though, considering brokers have more than halved current-year earnings forecasts over the past 12 months, based on Bloomberg consensus estimates, and that upcoming full-year results will contain a slew of exceptional charges.
Nerves over Interserve’s potential to tank further are rife in the wider market. Following Capita’s disastrous announcement at the end of last month, Interserve’s share price dropped sharply as investors assumed it would be the next to run into trouble. It is among the most heavily shorted companies in the UK, with 7.6 per cent of shares being short sold. The level of shorting spiked up in August last year and has remained high ever since.
The quality of the group's profits are questionable based on the rising disconnect between the headline numbers issued by the group and the warts-and-all statutory figures it is required to publish (see chart below). Numbers will be weighed on this year by the group's exit from its energy-from-waste business. Having originally made a £70m provision for associated losses, this number was revised up by £90m in February last year and then another £35m in October.
Another concern with the accounts is that, alongside Capita, Interserve had the highest levels of receivables as a proportion of revenues in the sector, which may indicate an inflated risk of liquidity problems, while separate Panmure Gordon analysis showed it had the second highest median accrual rates in the sector between 2006 and 2015. Both of these could be signs of potential balance sheet strain.
INTERSERVE (IRV) | ||||
ORD PRICE: | 81p | MARKET VALUE: | £118m | |
TOUCH: | 80.9-81.4p | 12M HIGH / LOW: | 359p | 53p |
FORWARD DIVIDEND YIELD: | NIL | FORWARD PE RATIO: | 3 | |
NET ASSET VALUE: | 248p* | NET DEBT: | 107% |
Year to 31 Dec | Turnover (£bn) | Pre-tax profit (£m) | Earnings per share (p) | Dividend per share (p) |
2014 | 3.01 | 106 | 58.0 | 23.0 |
2015 | 3.37 | 118 | 69.9 | 24.3 |
2016 | 3.47 | 107 | 61.3 | 8.1 |
2017** | 3.50 | 45.5 | 26.6 | nil |
2018** | 3.42 | 55.0 | 31.4 | nil |
% change | -2 | +21 | +18 | na |
Normal market size: | 3,000 | |||
Matched bargain trading | ||||
Beta: | 2.49 | |||
*Includes intangible assets of £504m, or 346p a share **Numis estimates, adjusted profit and EPS figures |