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BUY: Renew Holdings (RNWH)
Operating profit is up 18 per cent on the back of strong organic growth, writes Michael Fahy.
Renew Holdings chief executive Paul Scott said the 10 per cent increase in organic revenue and 18 per cent gain in operating profit delivered during difficult market conditions provided “evidence of the resilience in the [business] model that I’ve talked about for years”.
Although the company hasn’t had things go completely its own way — wage pressures remain elevated, for instance — it does look to be in a better place than many of its contractor competitors. Although the government continues to assign a £600bn figure for infrastructure commitments over the next five years, that amount was frozen in cash terms in last year’s Autumn Statement. This inevitably means there isn’t enough money to do everything, and some schemes meant to be completed during the current five-year phase of the Roads Investment Strategy ending in 2025 have been pushed back.
Delays to new schemes mean a greater priority is placed on the maintenance of existing assets, which is where Renew makes its money — on road, rail, water and power networks.
“We’re actually seeing clients talk very confidently about increased focus and spending,” Scott said.
Renew has increased its headcount by around 10 per cent over the course of the year, as past acquisitions have provided the opportunity to expand into new areas — Scott cites winning South West Water as a client as an example. An operating cash inflow of £55mn meant net cash (excluding leases) increased by £15.5mn to £35.7mn, despite the company paying £14.6mn for the remaining half of the Enisca water business that it did not already own.
Although its share price has experienced some turbulence over the past couple of years, results have been steadily impressive — as witnessed in the doubling of its earnings per share over the past five years.
Recent gains mean Renew’s shares have broken through the 800p barrier for the first time since hitting their all-time high of 889p in September 2021. They now trade at 13 times FactSet consensus forecasts, above their five-year average of 12 times. Yet Berenberg analysts upgraded their earnings forecasts by 5 per cent for this financial year and 9 per cent for next, citing “confidence in Renew’s ability to deliver through-the-cycle resilience”. With the company also having the firepower to do more deals — it has bought TIS Cumbria, a small nuclear specialist, for £4.9mn since the year-end — other upgrades could follow.
HOLD: Focusrite (TUNE)
The audio recording hardware and software company has been affected by the tricky macro conditions, writes Arthur Sants.
Focusrite sells hardware and software for music production. Many people say they can’t live without music, but it appears that a large chunk can live without the most up-to-date recording equipment.
In the year to August, content creation revenue dropped by 9.7 per cent to £137mn, a 15.3 per cent fall in organic terms. Content creation makes up three-quarters of the company’s revenue and spans both amateurs and professionals. During the pandemic, many people needed to upgrade their equipment as they switched to streaming from home, but now their equipment is updated they have pulled back on spending.
These struggles were partly offset by the audio reproduction business, where revenue grew 30 per cent — a 20 per cent organic increase. This division focuses on producing audio for crowds, so has benefited from the return of live concerts and the backlog of demand for live events.
There are some green shoots of recovery. Focusrite returned to growth in the second half of the year.
A concern is that Focusrite has not shown much pricing power. Administrative costs increased by about 10 per cent but it couldn’t offset much of this with price rises, probably because audio recording equipment is a luxury product for lots of people. However, Focusrite is still trading on a seemingly high valuation of 12 times its forward earnings, according to FactSet consensus.
Broker Peel Hunt is impressed by the 32 new products released in the year. This belief is backed up by an impressive historical return on equity of over 20 per cent. However, we would like to see growth return before updating our view.
HOLD: Pennon (PNN)
The owner of South West Water faces many political and infrastructure issues affecting its underlying profitability, writes Julian Hofmann.
It has been 30 years since there was a significant round of spending on water infrastructure, and it was clear from its interim results that Pennon is having to increase capital expenditure hugely to keep on top of the depreciation of its physical infrastructure.
Doing so at a time of heightened inflation only adds to the burden, and it was no surprise that reported profits almost disappeared during the half. In this context, attempting to cite adjusted cash profit figures, which exclude both depreciation and amortisation, for a business with £4.2bn of physical assets is a largely pointless exercise.
The need to create cash headroom was evident, with management time taken up with refinancing a substantial part of the company’s balance sheet — since the March 31 year end Pennon has refinanced or taken on debt facilities of £710mn. And its capital expenditure programme, which is running at approximately 1.5 times ahead of depreciation, is generating a significant cash requirement; wages rose by 21 per cent to £60.3mn, while consumables and materials were 17 per cent higher at £18.6mn. Total capital investment soared by 87 per cent to £266mn as Pennon ramped up its renovation programme.
It is fair to say that the market is applying a “political discount” to water company shares, given their unpopularity with voters, along with regulatory inquiries that could yet impose stiff penalties for pollution offences.
Along with other companies, Pennon’s profitability, indeed its future structure and ownership, is in the gift of whoever forms the next government. Until there is clarity on these points, we keep our recommendation steady despite the inflation-linked income appeal of the shares.
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