Investors’ Chronicle: Ashtead, Babcock, Stagecoach

BUY: Ashtead (AHT)

The equipment rental company is expanding fast after cutting costs during lockdown, writes Jemma Slingo.

Ashtead has enjoyed an excellent start to the year. The equipment rental company, which trades under the name Sunbelt Rentals, has raised its full-year guidance after first-half operating profits shot up by over a third and group revenue neared $3.9bn (£2.9bn).

The bulk of Ashtead’s earnings come from the US, where it has more than 900 stores. As a result, the group has changed its presentational currency from sterling to the dollar to allow for “greater transparency” and reduce exchange rate volatility. As such, rental-only revenue in the US rose by 16 per cent to $2.3bn, while its general tool business grew by 13 per cent from the depressed activity levels the previous year.

The UK business also reported strong growth, with revenue rising 35 per cent to £368m. However, future months could prove less buoyant as a third of this revenue stemmed from the Department of Health’s Covid response efforts. Ashtead supports about 500 testing sites at the moment, but its workload is expected to “reduce significantly” in spring 2022.

The group has no plans to shrink, however. During lockdown, Ashtead shrewdly reduced its operating costs and eliminated discretionary spending in all its markets. This resulted in a stronger balance sheet, putting the group in a good position to grow as demand ratchets up. Now the money tap has been turned firmly back on. Gross capital expenditure for the first half was $1.18bn, up from $438m in 2020, and the company has added 58 locations across North America.

Ashtead also invested $428m in 10 bolt-on acquisitions in the period, a bid to expand its footprint and diversify its end markets. Impressively, however, its ratio of net debt to Ebitda has fallen to 1.5 times on a constant currency basis, down from 1.7 times in 2020, though this is likely to have ticked up since October, given a further $320m has been spent on small deals.

Ashtead’s expansion plans could well pay off. The US market is still fragmented and relatively untapped, with many smaller independent operators for Ashtead to acquire.

Peel Hunt has increased its pre-tax profit estimate for full-year 2022 from $1.73bn to $1.78bn, boosting earnings per share from 288¢ to 296¢. Ashtead expects group rental revenue to increase by 18-20 per cent year-on-year, up from 13-16 per cent.

SELL: Babcock (BAB)

Margin improves due to fewer Covid disruptions but company suffers big cash outflow, writes Michael Fahy.

Defence contractor Babcock is making progress in repairing its balance sheet, having sold three businesses worth £400m in recent months.

Net debt reduced marginally to £1.39bn during the period, but will fall further once the proceeds of recent sales are accounted for. Debt excluding operating leases stood at £938m at the end of September, or 2.8 times Babcock’s cash profit. The £290m sale of engineering consultancy Fraser Nash to US industry giant KBR in October effectively reduces this figure to 2.1 times and the company’s near-term target is to cut this below 2 times.

Restatements made this year to last year’s figures to more accurately assess contract profitability — which includes a £761m prior-year goodwill writedown — make some comparisons meaningless, but the company said on an underlying basis its operating profit rose 36 per cent to £115m as its margin increased to 5.2 per cent, up from 4.1 per cent, as several business units faced fewer Covid-related disruptions.

Chief executive David Lockwood, who was appointed last year to lead a turnround of the business, is clearly taking some difficult decisions.

For example, there was a £160m free cash outflow as Babcock stepped up efforts to repay creditors and the company increased capital expenditure by 51 per cent to £72.1m to fund new work.

He also has some laudable goals, such as simplifying Babcock’s structure and making environmental, social and governance (ESG) a key part of the company’s strategy — although it is difficult to imagine some investors will ever consider a defence contractor to be an “ethical” business.

But the task of fixing Babcock is far from over. The company is spending £40m on restructuring over the course of the year and more asset sales are likely in the second half. Until a clearer picture emerges of the business’s long-term future, it’s one to avoid.

HOLD: Stagecoach (SGC)

Despite the benefits of state support and improving journey numbers, the transport group faces a difficult future, writes Jemma Slingo.

Covid-19 blew a hole in Stagecoach’s profits. But over the past six months the transport group has seen revenue grow by 27 per cent, while total operating profit has almost doubled to £45.2m. This is largely due to a rise in passenger numbers, driven by the return of schools and universities. Passenger journeys have now reached 70 per cent of 2019 levels, while commercial sales are over 80 per cent.

A full bounceback is unlikely to arrive soon, however. Management anticipates it will take “some time” for demand for its regional bus services to return to pre-pandemic levels, even if its London bus service is enjoying revenue growth and stable profits. Storm Arwen and changing virus guidance has also hit recent demand.

The government is still helping to keep services running. The Department for Transport, for example, has put in place a £226.5m bus recovery grant to cover the period from September 2021 into 2022. Similarly, in Scotland, the grant payments for continuing bus services have now been extended to the end of March 2022.

State support could turn sour, however. In Manchester, for example, bus services are due to be brought under public control, reversing the privatisation of the bus industry that started under the Thatcher government. Stagecoach warned that the change could impact its share of the Manchester bus market, as well as its profit margins (before Covid, Manchester contributed a hefty £128m of the group’s consolidated annual revenue and a higher than average operating profit margin). Stagecoach has launched a legal challenge against the proposed reforms, but the impact on deleveraging efforts is a real worry.

The group’s future is mired in uncertainty, therefore, even if green initiatives push people away from cars and on to public transport in the longer term. FactSet consensus estimates give earnings per share of 4.4p for the year to April 2022, rising to 11.19p the following year.