Tuesday 13 January 2015

Mitie (MTO) ... my Mitie concerns

Tuesday 13th January 2015

Since 2008, Mitie has:
  • Seemingly spent almost its entire haul from reported operating cash on acquisitions, tangible and intangible capex and other investing related cash requirements.
  • Seen net debt rise by £225.7 million, to £233.8 million as of H1 2015.
  • Paid dividends in the same period totalling £219.2 million. 
Since 2010, Mitie has:
  • Reported total restructuring and business exit costs of £197.1 million. 
  • Used acquisitions to seemingly contribute the bulk of revenue growth. 
  • Seen prepayments and accrued income rise significantly since 2007; even more noticeably since 2010.
  • Seen accruals and deferred income rise significantly since 2007; even more noticeably since 2010.
It would appear that an increasing amount of revenue has been booked but yet to be invoiced. This has coincided with a rise in invoices for services, which have yet to be delivered and thus one presumes cash outflows will be incurred upon delivery. These balances combined have risen by £318.1 million, or 426% since 2007.  

Since March 2014, Mitie has:
  • De-rated and underperformed the wider Support Services Index by c. 14%.
  • In H1 2015, Mitie reported negative free cash flow of £23.5 million; the first negative performance since at least 2008.
I am short Mitie. 

I received a call from the Varlet on Monday last, enquiring about Mitie (MTO LN), the facilities, property and energy services provider. Mitie is capitalised at close to £1 billion. Varlet quizzed me on whether I reckon it worthy of a short sale.

In our discussion we observed the fact that Mitie regularly competes against Serco (and for that matter GFS) on a number of contracts, typically in the judicial and healthcare outsourcing markets. That begged the question, that if Serco had seemingly been low balling at uneconomic levels on certain contracts, then how had Mitie competed against that to win a few itself? So I took a closer look at Mitie and trawled through its accounts ...

Underperformed and de-rated as compared to wider Support Services Index


The charts below suggest that something has happened to Mitie in recent months to turn off investors relative to its peers. Its shares have underperformed the wider FTSE 350 Support Services Index by c. 14% since March 2014. This has seemingly been partly driven by a de-rating on a forward earnings multiple as compared to its peers. 

Mitie's share price since 1998
Source: Bloomberg
Mitie's performance as compared to wider
FTSE 350 Support Services Index, since 2008
 Source: Bloomberg
Mitie's recent signs of de-rating on forward P/E basis
as compared to wider FTSE 350 Support Services Index
Source: Bloomberg
Is this recent under-performance warranted? I reckon so and here might be why ... 
   

Sources and uses of cash


During the period 2008 to H1 2015, on my estimates from its annual reports, Mitie has generated a cumulative £16.2 million in cash from its combined operating, investing and financing cash flows. Cumulative net financing cash flows are a negligible £3.7 million inflow, whilst cumulative operating cash inflows total £533.8 million and cumulative investing cash outflows total £521.3 million. Put another way, whatever it has hauled in over the last seven and a half years through operating cash, has gone out the door, largely by way of capex, acquisition spend and debt service.

Mitie's cumulative cash flows by use/source, 2008 to H1 2015, £m
Source: Mitie annual and half year reports
Mitie's cash flows by use/source, 2007 to H1 2015
Source: Mitie annual and half year reports
Despite generating a fairly minor cumulative net £16.2 million in cash during this period, its net debt level has risen from £8.1 million at 2007 year end (March year end), to £233.8 million at end of H1 2015 (September 2014), or by £225.7 million during this period. 

Mitie's cumulative net cash flows 2008 to H1 2015
as compared to net debt level 2008 and H1 2015, £m
Source: Mitie annual and half year reports
Incidentally, the group has returned a cumulative £219.2 million to shareholders during this same period by way of dividends. Put another way, one could conclude that debt has risen by £225.7 million and been almost exclusively utilised to pay equity holders their dividends. Of course there are other conclusions, which may also be drawn from these circumstances. 

Mitie's increase in net debt from 2007 year end
as compared to cumulative dividends paid since 2007 year end, £m
Source: Mitie annual and half year reports

Free cash flow


Mitie's free cash flow (FCF) performance during the period H1 2008 to H1 2014 was good and broadly consistent.   
  • FCF has invariably been weaker in the first half and stronger in the second half of the year.
  • FCF has become generally weaker still in the first half of each consecutive year and consistently strengthened in the second half of each consecutive year. 
  • FCF seemingly peaked in H2 2013, with second half FCF totalling £86.7 million (on my estimates), and full year 2013 FCF of £87.7 million. However, this looks to have been somewhat bolstered by a sale and leaseback of some if its commercial van fleet, which was sold at a fair market value of £17.8 million. 
  • Nonetheless, FCF weakened in 2014, to £72 million, and was negative for the first time in H1 2015 at (£23.5 million). Of course the group may highlight that this was principally due to losses and closure costs on business(es) which were exited over recent years. But even so ...
Mitie's free cash flow performance on half year basis
and Bloomberg consensus implied expectation for H2 2015 (March year end), £m
Source: Mitie annual and half year reports, Bloomberg 

Restructuring and business exit costs


Restructuring and business exit costs have totalled £197.1 million during the period 2010 to H1 2015. Further, they have risen rapidly in the latter part of this period. 

The bulk of this is £71.1 million, which is reported to relate to exceptional charges in relation to design and build contracts in Mitie's Energy Solutions business. Amortisation of acquisition related intangibles is also relatively high at a cumulative £44.1 million during this period. 

Mitie's restructuring, acquisition related, and exit costs
or "other items" on half year basis, £m
Source: Mitie annual and half year reports

Acquisitions


Mitie has reported a cumulative cash outflow of £348.6 million on the purchase of subsidiary undertakings, net of cash acquired during the period 2008 to 2014. 

From year end 2007, Mitie's revenue increased from £1,228.8 million, to £2,142.6 million, or by £913.8 million. Its organic revenue growth is reported to have averaged 5.3% during this period (according to statements contained in its annual reports). Mitie currently trades at 0.55x EV to current year sales. Since 2008, this multiple has been as low as 0.35x and as high as 0.71x. It has averaged 0.51x. Assuming Mitie would have paid broadly the same multiple for acquired sales as that which it trades on itself, then that would suggest that Mitie should have received at least £684 million (£348.6 million cash spent / average of 0.51x EV/sales) in sales from its acquisitions since 2008.

Mitie EV to sales multiple since 2008
Source: Bloomberg
Acquisitions were relatively small in 2008 and 2009. The group reported a cash outflow of £26.9 million and £2.2 million in each year respectively, related to the purchase of subsidiary undertakings, net of cash acquired. 

The big acquisitions were in 2010 and 2013. 

In the 2010 financial year, the group bought 100% of Dalkia Energy and Technical Services Ltd and Parkersell Ltd, together Dalkia Technical Facilities Management (Dalkia FM), for a total consideration of up to £130 million on 12 August 2009. 

It also purchased 100% of Environmental Property Services Ltd (EPS Ltd) for a maximum consideration of £40.9 million, on 20 November 2009 with an initial consideration of £36.8 million.

Combined consideration on Dalkia FM and EPS Ltd was £170.9 million. The reported cash outflow in the year associated with purchase of subsidiary undertakings, net of cash acquired, was £157.9 million. 

Dalkia FM was reported to have contributed £160 million to revenue and £6.6 million to the group's operating profit before other items in 2010. EPS Ltd was reported to have contributed £30.1 million to revenue and £1.6 million to the group's operating profit before other items in 2010. Combined this was a contribution to revenue of £190.1 million and £8.2 million to operating profit.   

Headline revenue before other items (of which other items contributed nothing to total revenue in 2010 and 2009) was reported to be £1,720.1 million in 2010. This was £198.2 million higher than 2009 revenue of £1,521.9 million. Hence, organic growth was 0.5% YOY in 2010 and acquisitions contributed 12.5% to 2010 revenue. 

The group indicated in its 2010 annual report (note 29. Page 88) that had its 2010 financial year acquisitions taken place at the start of the year, then the group's revenue and operating profit before other items would have been approximately £1,870 million and £100 million respectively. Hence, this suggests that both Dalkia FM and EPS Ltd combined, would have reported c. £340 million in revenue during 2010 (£1,870 million less £1,720.1 million plus £190.1 million). Similarly, they would have reported c. £15.2 million in operating profit. This suggests that on the basis of combined consideration paid for both businesses of £170.9 million, that they were indeed purchased for c. 0.46x sales, i.e. broadly in line with Mitie's own multiple at that time. 

A similar exercise suggests that since and including 2010, that the group has on average paid 0.63x sales for acquired businesses (these are my estimates). Further, that these combined businesses would have contributed at least £509 million to revenue since 2010. 

So if since 2009, headline revenue had risen from £1,521.9 million in 2009 to £2,142.6 million in 2014, or by £620.7 million, and acquired businesses had been achieving a combined c. £509 million in revenue in each respective year they were bought since 2010, then I reckon this would imply that revenue growth from Mitie's existing operations has been pretty paltry.  

Mitie acquisitions and contribution to revenue
Source: Bloomberg

Prepayments and accrued income


Prepayments and accrued income have risen sharply over recent years, both in nominal terms and as a percentage of sales. For example, in 2007, prepayments and accrued income were reported as £23.3 million or 1.9% of sales. By 2014, this had risen by £146.8 million, to £170.1 million or 7.9% of sales. 
Mitie's prepayments and accrued income & as a percentage of sales, £m & %
Source: Mitie annual reports
I would reckon very little of this significant increase in nominal terms and as a percentage of sales has any bearing to prepayments and is altogether linked to revenue that may have been booked and yet to be invoiced.


Accruals and deferred income


Accruals and deferred income have also risen sharply over recent years, again both in nominal terms and as a percentage of sales. For example, in 2007 accruals and deferred income were reported as £51.3 million or 4.2% of sales. By 2014, this had risen by £171.3 million, to £222.6 million or 10.4% of sales. 
Mitie's accruals and deferred income & as a percentage of sales, £m & %
Source: Mitie annual reports
I would reckon very little of this significant increase in nominal terms and as a percentage of sales has any bearing to accruals and is altogether linked to cash costs associated with service to be delivered. 

Hence, it would appear that an increasing amount of revenue has been booked but yet to be invoiced. This has coincided with a rise in invoicing for services, which have yet to be delivered and thus one presumes cash outflows will be incurred upon delivery. These balances combined have risen by £318.1 million, or 426% since 2007. 

The combined increase in prepayments and accrued income and accruals and deferred income since 2007 is £318.1 million, and both now represent 18.3% of sales as compared to 6.1% in 2007. The fact that trade receivables as a percentage of sales have been relatively stable since 2007 - and in fact shown a slight reduction since 2011 - suggests that payment terms by customers have been largely unchanged during this period. 
Mitie's trade receivables and as a percentage of sales, £m & %
Source: Mitie annual reports

And so ...


I take the view that these factors above are likely to remain a concern for some time going forward and view the risks as being towards further matters of interest emerging. Further, on any occasion I sense I may have misjudged things, I will reflect upon the charts below ...

Mitie's net asset value per share (NAV)
as compared to NAV ex-goodwill & other intangibles per share, p
Source: Mitie annual reports
Mitie (MTO LN) share price as compared to Serco (SRP LN)
Source: Bloomberg
As experience with Serco has shown, when concerns become warranted, situations have a habit of unravelling quickly.

I'm short Mitie at 270p/shr.

See prior Serco views here:
Serco ... high fives and low 300s
Serco ... at it again?
Serco ... not much PECS appeal    

Disclaimer: The information, discussions or topics referred to on this blog should in no way be considered “advice” to buy or sell anything. The information which may be referred to is freely available in the public domain and where required the source of information is referenced to for verification. While every effort has been made to ensure the veracity of any information contained within this blog, the author accepts no responsibility for the accuracy of any information contained within this blog or for the sources of information which may be referred to. Readers are responsible for their own actions and interpretation of the information contained within this blog. 

4 comments:

  1. Hey Matt, I'm an equity analyst working at a value oriented fund. Your analysis on MITIE raises some very interesting points, it'd be great to have a chat... whats the best way to contact you?

    ReplyDelete
    Replies
    1. Good afternoon MB2Z,
      Feel free to email me your details at matthew.p.earl@hotmail.co.uk.
      Best
      Matt

      Delete
  2. Any further developments on this story? Stock is getting to enticing short levels?

    ReplyDelete
    Replies
    1. Hi David,
      I would say that anywhere around these levels is a gift.
      Best
      Matt

      Delete