15 September 2017

Blog: Galliford Try - Hybrid Engine

by Scott Fulton | 15 September 2017

Galliford Try (GFRD, 1340p, £1.1bn)

Hybrid Engine

Peter Truscott and Graham Prothero (CEO and CFO respectively) presented the company’s recent final results and 2021 strategy to CAG’s sales force yesterday. A positive meeting focused on the basis for management’s longer term expectations within the three divisions. Overall, the relative strength of the 2016/17 figures has continued into the current year albeit that there remain issues to address, notably within construction. Anecdotally however, we believe that forecasts are likely to increase modestly across the timeframe. At present, the shares trade on a 21.0% discount to the current year sector average PER and a 47.0% yield premium.

Figure 1: House Builders Share Price Performances

Source: London Stock Exchange

The share sales by executives at Berkeley and Redrow, together with a more hawkish tone from the BoE, has dented sentiment towards house builders despite the generally positive news from the sector in recent weeks.

Persimmon* set the bar for house building results with its first half performance (22nd August). Operating margins rose by 380bps to 28.7%, net cash generation rose by over 5.0% and the company finished the half with over £1.0bn of net cash. Forecasts were upgraded and, initially, the share price strengthened.

Having enjoyed a relatively strong run in the last quarter, Galliford was not immune to the wider sector weakness. However, the response to the final results (13th September) was positive and the price has shown some resilience.

Galliford’s hybrid nature renders direct comparisons with “pure” house builders less relevant than with Kier and Countryside Properties, for example. In this regard, and despite the disappointment of the exceptional costs relating to construction contracts, Galliford has clearly outperformed its closest comparators.

Looking to forecasts, our take from the meeting was that Linden Homes is likely to see further margin growth in the short term as a function of higher margin land coming through. Partnership & Regeneration may be a beneficiary of further Government support for the affordable homes market, leading to an early achievement of the 8.0% to 10.0% EBIT margin on c. £500.0m of revenue.

Construction remains a risk to numbers given the discussions around “legacy” contracts but offers the potential of a return to c. 2.0% margins (on £1.5bn of revenue) within the medium term.

Galliford appears intent on a lower capital employed model (shorter Linden land bank, limited capital in partnership and no capital within construction) which should result in enhanced cash generation.

Figure 2: House Builders PERs (consensus, high & low)

Source: Bloomberg

The house builders’ recovery from post-Brexit lows has been compromised by generally wide ranges in forecasts for key valuation metrics. Analysts have tended to take either a positive view on growth (notably in margins and cash) or a negative view of UK house prices, demand and Government support.

Galliford’s guidance to the market and the detail of the 2021 strategy has resulted in a narrower range for EPS in the current year (see Figure 2 above) even before the detail of the final 2016/17 results was announced.

On consensus forecasts, the shares trade on a 21.0% discount to the sector average (unweighted) and a 23.0% discount based on the low end of the current forecast range.

Figure 3: Dividend Yield, Earnings Cover and Financial Position

Source: Bloomberg

Galliford’s recent dividend strategy was based on a lower than average dividend cover (1.8x to 1.6x) and it increased its total dividend for 2016/17 by 17.0%. This increase was towards the top end of recent dividend improvements within the sector.

The company has now stated that it intends to grow earnings cover to 2.0x “in the medium term” while maintaining a CAGR of 5.0% over the next five years.

*Capital Access Group acts for these companies