BUY: Hill & Smith (HILS)
Operating margins are on the rise at the supplier of products for the construction and infrastructure industries, writes Mark Robinson.
Hill & Smith has lauded the performance of its US businesses, describing a “standout performance in composites and electrical utility”. The stateside segment contributed 76 per cent of underlying operating profit in 2023, which rose by 26 per cent to £123mn. This was on the back of a 150 basis point hike in the operating margin to 14.8 per cent.
Exposure to the US market could well increase as the provider of sustainable infrastructure products also announced that it had acquired FM Stainless, located in Ellijay, Georgia, a manufacturer of stainless-steel pipe supports. Among other benefits, the £6.6mn deal should generate “material cross-selling opportunities in an attractive growth market”, according to group chair Alan Giddins.
The tilt for FM Stainless follows £48mn that was invested in “growth and margin accretive acquisitions” last year, all of which are trading in line or ahead of expectations. With a promising M&A pipeline in prospect, and a lowly covenant leverage of 0.4 times Ebitda, we should expect further deals over the medium term.
Hill & Smith is making progress towards achieving its medium-term financial framework with annual performance targets, as set out in March 2023. Management maintains that improved capital allocation is demonstrated by the 280-basis point increase in the group’s return on invested capital to 22 per cent. It also helps that cash generation remains strong, with a conversion rate of 115 per cent in 2023.
The forward rating of 17 times FactSet consensus earnings is slightly up on the long-term average, so we might normally call time on our “buy” investment case set out in July 2021. Yet the structural drivers linked to US infrastructure remain in place and the group has a pleasing tendency to outstrip earnings projections.
HOLD: Synthomer (SYNT)
There are some green shoots starting to emerge, but recovery is an uphill struggle, writes Jennifer Johnson.
Polymer specialist Synthomer has spent the past couple of years battling against both macroeconomic and sector-specific headwinds. Destocking in base chemical markets impacted the group, as did a post-pandemic slowdown in demand for nitrile latex (used to make medical gloves).
Management has taken steps to try to limit damage to the business, although falling revenue and profit numbers don’t suggest that these have been a success. However, other metrics indicate that a bounceback could be under way. Net debt was reduced across the last financial year from over £1bn to roughly £500mn, with performance aided by strong cash generation in the fourth quarter.
Free cash flow was up to £85.7mn (from £69.2mn in 2022) thanks to cost reductions, lower inventories and lower raw material prices. The balance sheet was also propped up by a £276mn rights issue in October. According to management, trading since the start of the year has been encouraging, “though evidence of a broad-based demand recovery remains limited”.
Reducing leverage to around 1-2 times net debt to Ebitda is a key priority in the medium term. Given that it was 4.2 times at December 31, there remains significant work to do. Peel Hunt analysts suggest the group could make disposals from its £565mn of non-core revenue. “If these do not become a reality, Synthomer can trade within its covenants, but the debt would weigh heavily on the investment proposition,” they added.
The company is targeting up to £40mn in additional annualised cost reductions this year — evidence that it remains committed to its self-help programme. But with few catalysts in the foreseeable future, we’ll stick with a hold rating for now.
SELL: Persimmon (PSN)
The housebuilder delivered a bad set of results and expectations of the future look bleak too, writes Mitchell Labiak.
It’s not just about the numbers. Investors like to hear a bullish story from companies, too. That might explain why Persimmon’s share price sank 4 per cent in early trading on Tuesday despite its weak performance being in line with analyst expectations.
As analyst Aynsley Lammin from Investec put it, although the results contained no surprises, “the tone on recent trading and the outlook seems a bit more cautious than what peers have recently reported”. In other words, it’s not what Persimmon said, but how it said it.
The housebuilder warned that “the near-term outlook remains uncertain” and that “market conditions are expected to remain subdued throughout 2024”. Its forward sales figures are increasing, albeit modestly, with high interest rates continuing to make buyers wary. The net private sales rate rose to 0.59 for the first 10 weeks of 2024 from 0.54 in 2023.
Consensus forecasts are for earnings per share to return to growth this year, hitting 84.3p and growing to 106p by 2025, and covering dividend payments of 61.6p per share this year and 67.2p next year.
We are less confident because growth looks costly. Persimmon anticipates switching from a net cash position to a net debt position as it invests in building again. Completions nosedived to 9,922 in 2023 from 14,868 in 2022, highlighting the levels it will need to return to.
Lammin said he did not expect the financing costs from debt to hit profit forecasts materially. Even so, we are bearish on this stock. If Persimmon’s balance sheet predictions prove correct, it would be one of the only FTSE 350 housebuilders not sitting on a cash pile. Its rivals could easily outmanoeuvre it in the market recovery with their relatively healthier coffers.
