Shares digital

Connaught (CNT) – 375.25p, stop loss 300p

SHARES SUMMARY

Connaught is a growing giant in the support services industry. The well-run business continues to expand and serves multi-billion pound markets that shouldn’t be too affected by an slowdown.

Business:

Social housing and compliance services

Vital stats:

Market value: £458 million

Historic PE: 35.6

Prospective PE 2008: 21.8

Prospective PE 2009: 17.3

Sector PE (next 12 months): 13.7

1-month relative strength: 10.7%

1-year relative strength: 34.6%

Yield 2008: 0.7%

NMS: 1,250

Spread: 0.4%

In uncertain times, investors should seek companies with good earnings visibility, growing sales and exposure to markets driven by regulation and legislation. Connaught delivers on all accounts.

The company’s activities are split into social housing and compliance, markets which have a combined value in excess of £15 billion. It repairs and maintains buildings for local authorities and social landlords. A third of its business is compliance-related, such as checking gas systems and advising on health and safety.

Pre-tax profit is forecast to nearly double this year to £30.5 million, underpinned by strong markets and earnings-enhancing acquisitions.

Connaught claims social housing is the only area of government expenditure with an income stream, arguing that there is less chance for spending cuts. Rental payments help to fund repair and maintenance and capital refurbishment, namely Connaught’s business.

Local authorities are under pressure to drive cost efficiencies across their property portfolio, so there is a growing emphasis on working with fewer suppliers. Connaught is well placed in this situation to pick up long-term, multi-service contracts, because of its broad skill set and expertise.

There are minimal risks to the social housing arm. Admittedly, local authorities are starting to spread capital refurbishment over longer periods which delays some work, but chief executive Mark Davies said this doesn’t present too much of a problem. Connaught’s reputation is on the line if it doesn’t deliver quality services on time and to budget, but its achievements to date suggests it takes this risk very seriously and won’t allow staff to slip up.

The compliance division is driven by legislation and regulation. Businesses are under pressure to comply with health and safety laws, as both the company and directors can be prosecuted for negligence. Insurance providers are also refusing to underwrite corporate policies if companies don’t comply, claims Davies.

In the past year, Connaught has expanded compliance from mainly gas to include water, electrical, occupational health and fire safety. Future acquisitions should build on these skills rather than expand social housing, but they are unlikely to be as big as last September’s £91 million purchase of National Britannia. This large addition increased group borrowings with net debt of £70 million forecast this year. With interest cover at around seven times, it is still in a comfortable position.

The company has achieved 30% annual EPS growth for the past three years. This should increase to 40% for 2008, justifying its high rating. Connaught has outperformed the FTSE All-Share index by 11% in the past month and 26% in the past six months. Last October, it said 85% of 2009 revenue had already been secured. This figure is likely to be much higher today.

The group’s strong earnings visibility makes it highly attractive to private equity companies, yet a takeover may not come easily. ‘Connaught will be a very big stock in five years time,’ says KBC Peel Hunt analyst Andrew Nussey. ‘Investors know this and are holding shares for the long term, which means a private equity takeover may not succeed unless there is a significant bid premium.’

Analyst Ed Wright of house broker Altium reckons the share price will hit 425p by January 2009, implying 13% upside on the current position. Connaught is bidding for £3 billion of potential new work. Wright claims that if Connaught maintains its trend of winning one in three contracts, it could snap up £1 billion of new work before further opportunities emerge. An insignificant 1% yield means that investors should buy this stock for medium to long-term price gains rather than short-term trading.

by: Dan Coatsworth