The struggle by service provider Mears (MER) to grow domiciliary care revenue has prompted analysts to call for the division to be sold. Yet speaking to Shares, chief executive officer (CEO) David Miles categorically states that Mears 'is not a seller'. In light of the topline challenges within care; and operating losses within its Mechanical and Electrical (M&E) business and the newly-acquired Morrison service group; is there reason to be worried about Mears?
The answer is simply no. On paper this may look like a troubled business, yet Mears has proved time and time again that it is able to navigate through difficult markets and emerge triumphant. It stayed at the top of its game when rivals Connaught and Rok collapsed. It branched into the care industry almost seamlessly and continues to grow operating profit margins in this business line, despite only marginal revenue gains.
Today's full-year results haven't moved the share price – it sits at 373p. After a strong run in the past year, some analysts reckon it could be time to take profits. Others in the City remain 'buyers' including Liberum Capital.
It is perhaps more interesting to note that the shares have not fallen today, given that analysts have downgraded their forecasts. House broker Investec, for example, has slashed 2013 earnings per share by 10.4% and 8.6% off 2014's estimates, predominantly because of changes to accounting rules, but retains a 'buy' rating with a 400p price target.
The robustness of the share price in light of these downgrades shows that much of its shareholder base are in the stock for the long-term and therefore do not trade in and out of the stock on financial results or trading updates. It has risen 82% since we said to buy at 205.5p in our Griller interview (see Shares, 8 Dec '11).
Pre-tax profit, excluding Morrison, grew by 7% to £33.6 million in 2012. When you add Morrison into the accounts, pre-tax profit only increased by 1% to £31.7 million.
Mears acquired Morrison in November 2012 for £24 million. It knew the business was loss-making at the time and that several of its contracts were on the verge of going into default. Yet the deal was strategically-sound as Mears now owns its most significant competitor. It strengthens the ability for the group to secure larger tenders.
The acquisition announcement (8 Nov '12) stated that the deal would start to enhance Mears' earnings from 2013 but not provide a significant uplift until 2014. So the £2.3 million operating loss reported in today's results is not a surprise. After all, these figures only represent 54 days of ownership under Mears.
Under Miles' leadership, Mears is now hard at work sprucing up Morrison. It is addressing the contract problems which centre upon the quality of work and getting the jobs done on time. The CEO says it will take between 6 months and a year to get Morrison's operations sorted. He reckons it will take three years to get Morrison's margins up to the same level as Mears.
The M&E division has been problematic for some time. It is a highly competitive industry and everyone is fighting on price to secure work. Mears reported a £1.6 million operating loss in 'Other Services', which is predominantly the M&E division. This compares with a £1.3 million operating profit in 2011.
It needs to decide whether M&E has a future within the Mears stable. The cut-off point for this decision will be 31 December 2013. By then, Miles says he will either have communicated plans for the future of the business or removed it from the group. He hopes someone will buy the business – or at least cherry pick some parts – otherwise it will have to be shut down.
The care business is also suffering from a price war among service providers. The end market is rich with opportunities that cannot be realised. This is due to a UK-wide shortage of care workers. 'There's more work than there is qualified staff,' says the CEO, adding that Mears will stick with the business, expecting a few tough years ahead but potentially seeing brighter prospects from 2016/2017 which is when it expects the government to implement changes in the care market. 'We look after the house (through social housing maintenance) and we look after the person in the house,' adds Miles.
Care operating profit margins increased by 30 basis points to 8.3% yet the revenue only increased by 4% to £112.6 million. In comparison, Social Housing (excluding Morrison) grew the topline by 10.8% to £459.7 million.
Although the shares will probably take a breather on the back of today's results, there is reason to remain optimistic. The core business of social housing maintenance is trading well with strong earnings visibility. Mears converted 118% of profit to cash and raised the dividend by 7% to 8p, continuing its good track record of increasing shareholder rewards.
Morrison underpins attractive earnings growth over the coming years, even after today's downgrades. Investec forecasts £34.7 million pre-tax profit in 2013, rising to £39.2 million in 2014 and £43.8 million in 2015. It sums up the situation well: 'Mears looks well positioned. Social Housing is set for a strong year. The Care business should be stable and we look for M&E to be resolved. Mears continues to offer double-digit EPS (earnings per share) growth, a rarity in this sector at present.'