Benefiting from increased government and utility sector spending on energy efficiency schemes, Eaga (EAGA) is one company with substantial growth prospects this year, underpinned by a strong cash position and no debt. But the 20% rise in interim profit reported last week did not convince the market a contract and cost issue earlier this year was an isolated incident.

At 141p, the shares of the support service group have still to recover fully from last April’s patchy trading update, which revealed unexpected problems with the social housing business. The market reacted as if Eaga had issued a profit warning, though it had not, and the shares fell 25% in a day, from 178.5p to 133.5p. By June they were at 93.8p. After a small summer rally negative sentiment returned when the financial results appeared in September.

‘We had a consensus number of £40 million earnings before interest tax and amortisation (EBITA) performance and we delivered £38 million, so a 5% downgrade. It wasn’t a huge number in the context of the business but the market reacted badly. They thought it was the first of three (profit warnings), with things getting very much worse,’ says finance director Ian McLeod. ‘As it happens, we were comfortable it was a blip that would reverse and we would move on, as we have done.’

Eaga had underestimated the mobilisation costs of certain contracts. There were delays in replacing heating systems, and costs of fuel and copper (used in its heating work) had increased, putting pressure on margins. McLeod says the company has since exited one of the affected social housing contracts and restructured parts of the business, insisting a recovery is well under way.

Warm Front

Last week’s (29 January) financial results are the second time Eaga has published figures proving its trading strength since April’s problems. Full-year results in September showed a perfectly acceptable performance, yet the share price only came out of its slump after a trading update in December. The real catalyst should have been three months earlier, when the government announced a £1 billion green-related fiscal stimulus. Gordon Brown pledged to help families on middle and modest incomes to cut energy bills through a package of measures. Within this was an extra £74 million funding for Warm Front, a scheme administered by Eaga to help eradicate fuel poverty.

Its contract to administer Warm Front until May 2010 has a possible two-year extension. The scheme includes grants up to £2,700 for new heating systems and insulation. This fiscal year and next should each see the government spend around £400 million on Warm Front.

The contract is clearly important to Eaga’s revenues, so the market is slightly worried failure to win the extension could damage profits. McLeod refuses to state how much Warm Front contributes to Eaga’s earnings, but the latest financial results show the managed services division, of which Warm Front is a key component, accounted for 17% of half-year EBITA.

‘We’ve always said we would expect the government to extend our Warm Front contract’ says McLeod. ‘If you look at the latest funding for the programme, as opposed to our contract, it goes into 2011, so read into that what you want.’

The Daily Mirror last week claimed the Warm Front scheme had been dogged by complaints over poor service by Eaga and its sub-contractors. The article, which presented itself as a cutting-edge investigation, cited examples of rushed jobs and people in bungalows charged for scaffolding use. It claimed energy minister Joan Ruddock would take action to improve service standards. ‘Complaint rates are less than 0.5% and we have 250,000 homes a year on the scheme, so I think there is a lack of balance in that article. It’s quite malicious,’ says Ross Armstrong, Eaga’s director of corporate and government affairs.

Certain progress

Eaga is less reliant on Warm Front now than when it floated on the London Main Market in June 2007. The company has expanded its installation business and diversified into social housing, where it delivers round-the-clock repair and maintenance work under framework contracts for local authorities and housing associations. It now works with all six of the major utility companies in the UK for the carbon emissions reduction target (CERT) a regulatory requirement to help consumers reduce energy bills. This also benefits from Gordon Brown’s £1 billion home energy-saving programme, with utility companies told to invest an extra £910 million on top of the £2.8 billion already required. The government argues this is a ‘better, simpler way’ of wiping out fuel poverty than imposing a windfall tax on utility profits.

‘As part of the CERT work, we are Scottish Power’s agent for all of its CERT commitment,’ says McLeod. ‘That is a huge vote of confidence in Eaga to give us all of its regulatory target, as the potential penalties on it, if it doesn’t deliver, are significant.’

In 2006 Eaga lost the contract to administer the Scottish version of Warm Front to British Gas but claims it is still actively involved through sub-contracting. The finance director claims if the same happens in England, then Eaga’s army of skilled installation workers could retain the ground work even if there is a new administrator.

Eaga is well placed to make new acquisitions and accelerate its diversification. It has £15.7 million cash and an untouched £35 million debt facility. McLeod says he will increase this borrowing capacity when it is up for renewal later this year, which implies he has grand plans that require more funds than the company currently has. Not so, it seems. ‘Two years ago, everyone said get leverage on your balance sheet, it’s great and generates lots of shareholder value. It’s not the same place today,’ he says. ‘We’ve always been relatively conservative with our approach to the balance sheet. Any acquisition for us must be a platform for organic growth. We’ve largely done this with our installation business. Opportunities elsewhere may now come along at relatively short notice. We will look at anything complementary to our business that fits with the environment, carbon reduction and social policy

space in which we operate. But we will

be cautious.’

Commercial director Drew Johnson suggests Eaga may boost its role in business process outsourcing (BPO), a thriving part of support services currently occupied by the likes of Capita (CPI), Mouchel (MCHL) and Serco (SRP). Yet he insists Eaga will not become the next Capita, instead offering a broader range of work. ‘We are positioned to offer an end-to-end service,’ he says, insisting Eaga has a broader range than its competitors. ‘Capita focuses on the front-end work, Connaught (CNT) and Mears (MER) are at the back end. In the middle, there’s Homeserve (HSV). We provide all of these services.’

The similarities with Homeserve are interesting. Both offer warranties on boilers but Eaga does not rely on consumers choosing whether to protect their equipment. Its clients must have warranties under social housing law, thus giving it recurring revenue compared with Homeserve, which recently reported a downturn in warranties as consumers scaled back what they deemed to be unnecessary spending.

Green goals

Most of Eaga’s work for consumers is driven by government or utility-funded grants. ‘We’re not out in the consumer marketplace knocking on people’s doors desperately trying to get business,’ says McLeod. This may change if Eaga chooses to sell its ShowerSmart device directly in the retail market. ShowerSmart saves water and is funded by utility companies as part of the CERT obligations. Eaga does not manufacture the product but it has a UK distribution licence. ‘As the product is subsidised from other areas, we are hedged in terms of our exposure,’ says Drew Johnson, admitting Eaga ‘may’ sell ShowerSmart via retail outlets.

Toward the end of 2009, Eaga should begin to see its first income from CESP, the Community Energy Saving Programme. This will involve helping energy-generating companies put a range of efficiencies into the community from renewable technologies to external wall insulation. The work will be lower volume but higher value than CERT projects. The company says it is also seeing the first notable contracts come through from its Canadian operation, a low-key business that has been running for five years. It is also pushing for more work in India where it has a presence.

Against this backdrop of green services, Eaga has other capabilities. It has a £500 million contract from the BBC to help households with the transition from analogue to digital television. It also has a thriving advice business where it handled 40,000 benefit entitlement cheques and 6,000 cases in the past half-year under a community legal advice contract. Eaga has been operating in this area for the past ten years.

Although it wants to extend its range of skills, Eaga’s reputation will continue to be judged on green activities. Given the government’s renewed focus on environmental activities, playing the ‘green card’ could prove wise for Eaga. McLeod remains confident September’s £1 billion fiscal stimulus will not be a one-off event. He concludes: ‘I think the government is keen to put more money into this area if it can find it. Funding is tight but the will is there.’ n