Stockwatch: A share for momentum traders

Is Morgan Sindall's momentum intact, such that upgrades and a further improvement in its rating are due? Despite fears, inflation and Brexit will crimp the UK economy, it's notable how this mid-cap construction and support services group is enjoying growth from its specialist areas.

At February's 2016 prelims, Morgan reported a 34% increase in earnings per share (EPS) and total dividend up 21%, with revenue up 7% and a 29% increase in the order book. Management also guided 2017 expectations slightly higher, and has done so again at the May AGM.

Stock chases upgrades in guidance

Over the three months to end-March the order book has risen 5% to £3.83 billion, the update boasting Fit Out (of offices) up 17% to a record £544 million.

Otherwise, latest figures are for the end-2016 order book which showed Construction/Infrastructure (e.g. expansion of Heathrow Airport, also work at the Sellafield nuclear fuel reprocessing plant) up 18% to £1.89 billion, Property Services (response maintenance services to social housing) up 90% to £687 million and Partnership Housing (with local authorities and housing associations) up 30% to £445 million.

Orders for Urban Regeneration had slipped 7% to £203 million despite a 42% revenue advance: this division tends to be lumpy, and despite a high level of construction activity a lower level of completions are expected in 2017 with a profits boost from 2018.

Morgan's accounting doesn't quantify what extent of work is linked to public versus private sector: support services groups for example have been pressured by some aspects of local/national government cuts, although the main political parties jockey ahead of the election to say how they plan to spend on housing and infrastructure.

Meanwhile, a buoyant fit-out market may reflect a "late-stage" business cycle: commercial offices represent 86% of this division's revenue, London being the largest geographic market at 65%; higher education 6%, retail banking 2% and government/local authority work making up the balance.

It would, therefore, seem Fit Out is potentially the most cyclical, albeit presently going great guns. The chief macro risk may be if Brexit undermines the UK economy to the extent of government reigning back spending, although the areas it is exposed to do look priority.

Management cites positive momentum continuing "with significant opportunities" in partnership housing, continued improvement in operational delivery in construction/infrastructure and the size/quality of order book on the fitting-out side.

Thus, the shares added 7% to 1,170p to buy, having started the year at about 750p.

Status change from cyclical to "defensive growth"

The five-year record shows the stock has bumped along sideways in a volatile band of roughly 550p to 850p, as investors tried to rationalise volatile profits and cash flows from a business where peak operating margin has as yet been only 1.4%.

But with 2017 expected to see record earnings and a sense that current momentum implies 2018 consensus figures may be cautious, the stock is rising in belief Morgan offers defensive growth.

On recent projections, the 12-month forward price/earnings (PE) ratio reduces to about 11.5 times, and the prospective yield is about 3.5% now that dividends are growing well since the three years for which the payout was cut to 27p per share. So the status change looks justified for the medium-term, with consensus figures likely due some upgrading.

The AGM update spoke also of margin growth in Fit Out and expected margin improvement in Construction & Infrastructure; as well it needs to. While company updates continue positively, margins may improve further, although when the cycle eventually turns down it's likely pressures will return.

Net cash offers development opportunities

The end-March figure shows £115 million of net cash, although the update cites average daily net cash for the first three months of the year at £154 million, higher than expected due to better working capital management. It offers opportunities for group development besides reducing the net interest charge for 2017 thus helping profits.

Management doesn't hint at acquisitions, but scope manifestly exists unless pricing at this stage in the business cycle is unattractive; or potentially the option for a special dividend payout. If the board persists to retain a high cash element, then it would indicate underlying caution despite their outward confidence; possibly lingering memories of 2013 to 2015 when challenging conditions impacted margins and profitability.

Similarly (as a result of acquiring), an eventual £39.4 million non-cash impairment charge to the 2015 accounts, relating to trade and other receivables on two old construction contracts, which were transferred as part of the design and project services division of Amec in 2007.

This explains the 2015 statutory pre-tax loss of £14.8 million (albeit which gave rise to a £4.8 million tax credit) and shows the dilemma with buying loss-makers. In 2007 it was billed as opening up significant growth opportunities in construction and regeneration. So, understandably the board may be picky about further deals.

Mind "accrued expenses" in the balance sheet

There's possibly another, less complimentary reason for high cash being retained. Within £277 million net assets at end-2016 (of which £217 million represented goodwill/intangibles, chiefly from past acquisitions), trade payables rose 10.9% to £748 million which is 2.25 times the amount for trade receivables and implies a cash cushion being prudently required to maintain this "deficit".

It also begs a question, are profits enhanced by costs sitting up on the balance sheet instead of promptly reflected in the income statement? The numbers within note 11 "trade payables" imply a 21.7% increase in accrued expenses to £482 million and a 45.2% hike in other payables to £36.3 million. Management doesn't clarify further but should, given this amount is material.

So this is a stock for momentum traders while UK public policy continues to boost Morgan's specialist areas, offering probably the best exposure. I balk, however, at the sense of a long-term investment, as eventually the cycle will bite. For traders who know what they're doing it's an intriguing long/short play.