Interactive Investor

Stockwatch: A steady turnaround backed by 6% yield

13th October 2017 09:07

Edmond Jackson from interactive investor


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Is this AIM-listed asset/energy support services group Lakehouse a genuinely evolving turnaround, or does a 6% prospective yield imply the market has justifiable doubts?

I initially drew attention as a potential recovery play in January 2016 after Lakehouse had plunged below 40p from a 90p flotation price in March 2015, its property-related sub-contractor services hit by a diktat to landlords to reduce rents by 1% annually for the next four years.

Energy services were also running into landlord constraints, hence lower margins for insulation contracts and delays installing smart meters. Investors dumped stock in a sense they had been misled by an early January 2016 update that things were in line.

The drop below 40p implied a price/earnings (PE) of 4 based on revised forecasts by Peel Hunt, Lakehouse's broker, and a prospective yield of 7.5%, yet the table shows how the year to end-September 2016 actually resulted in big losses.

That August, with the stock down to 26p after a third profit warning - an old adage suggests is the trigger to "buy" - I was encouraged how Bob Holt, the founder of Mears Group, a successful support services group, had decided to become executive chairman. I thought the stock "still speculative but favouring upside" amid a challenge to reduce £30.6 million net debt.

Those results seemed a classic clear-out and, although profit/earnings have been downgraded by 18% for the latest financial year, and by 12% in respect of 2018, it appears to mainly reflect a disposal.

The proceeds mean expectations for the dividend remain at 2p and 2.5p per share, hence a 6% yield with the stock currently at 40.5p. Its fall from 52p mid-year suggests the market perceives risks given Lakehouse's orientation towards local authorities and housing associations; both of which face spending constraints, also Labour party rhetoric tending against private sub-contractors.

Disposal, debt reduction and cash flow should support dividends

Interims to end-March 2017 showed net debt of £24.7 million, having blipped up and down e.g. with deferred consideration payments for acquisitions, a legacy of rapid expansion.

Holt asserted last June that, after a strategic review, the group's core businesses of compliance, energy services and construction were performing well, although property services had declined from 37% to 20% of group revenue, like-for-like, hence interim group revenue was 11% lower at £149.8 million, despite the three other divisions advancing 14% overall.

The market had been concerned about operational cash flow conversion but this had mitigated to a 12% outflow versus 170% in first-half 2016 year.

Since an April 2017 dividend payment the board has opted to defer an interim payout, but "we maintain our policy of paying a progressive dividend, so the subject will continue to be reviewed during the second half."

This is crucial because dividends are the prime support until earnings recovery is established, also considering £64.3 million goodwill/intangibles within £47.9 million net assets. The end-March 2017 balance sheet had only £0.3 million cash versus the cash flow statement, showing £4.6 million paid as dividends during the 2016 financial year, also £4 million proceeds from bank borrowings during first-half 2017.

The current sale of Orchard, a consultancy business helping companies with energy procurement and usage, for £12.4 million with an estimated £5 million gain on book value is said to help reduce debt, but also looks welcome to secure payouts.

Medium-term sale of property services also?

Strategically, the sale of Orchard is said to enable focus "on the group's operative-focused activities within its compliance and energy services divisions", which sounds a bit odd not to mention property services.

You quite wonder if the board is open to offers for the property services side; cited as "a significant operational turnaround, given the challenges in roofing in 2016", currently stabilised albeit with some risk of further write-downs until legacy contracts are closed out in the current second half.

My reading is that management will continue to pursue a turnaround, but if property services lag other divisions to dirty results reporting then a sale looks possible.

Given net debt of £24.7 million at end-March, further debt reduction and cash-resource to develop the better-performing activities also make returns to shareholders, might improve the stock's rating. The group does have a £35 million bank facility so there is no near-term pressure to cut debt.

Income statement is no great shakes

Looking back at June's interims to end-March 2017, cost of sales marginally increased like-for-like from 8.79% to 8.96% of revenue, and "other operating expenses" from 7.47% to 8.38% of gross profit; which to an extent may reflect operational gearing with the fall in turnover, i.e. some costs being difficult to cut proportionally.

Yet like-for-like interim operating profit slumped 49.1% versus turnover down 10.7% to £149.8 million, so cost control should be a priority. A bit further down the statement, exceptional costs jumped from £0.6 million to £1.1 million, not massive in context but higher even so. Amortisation of intangibles edged down 5.4%, albeit a substantial £5.3 million in context, hence a £2.8 million operating loss on an IFRS3 basis then £0.8 million net finance costs extended the pre-tax loss to £3.6 million versus £1.8 million like-for-like.

So, even setting aside the discrepancy between statutory and normalised profits, the income statement conveys there is "plenty yet to do", part-explaining why the stock has been a roller-coaster back to its level a year ago. As proclaimed in the interim results highlights, cash flow has at least levelled from a £10.6 million outflow on operations.

Lakehouse - financial summary           Broker forecasts
year ended 30 Sep 2012 2013 2014 2015 2016 2017 2018
Turnover (£ million) 152 192 302 340 334    
IFRS3 pre-tax profit (£m) 3.9 4.1 0.1 3.2 -33.3    
Normalised pre-tax profit (£m) 4.2 4.6 4.4 11.8 -9.9 5.5 8.6
Operating margin (%) 2.9 2.5 1.8 3.9 -2.8    
IFRS3 earnings/share (p) 1.8 1.9 -0.2 1.7 -18.6    
Normalised earnings/share (p) 2.0 2.2 2.5 8.2 -4.0 2.7 4.3
Earnings per share growth (%)   10.2 15.2 228     56.4
Price/earnings multiple (x)         -10.2 14.9 9.5
Cash flow/share (p) 2.1 2.3 3.7 13.1 -2.6    
Capex/share (p)       1.0 0.6    
Dividend per share (p)         2.9 2.0 2.5
Yield (%)         7.2 4.9 6.2
Covered by earnings (x)           1.4 1.7
Net tangible assets per share (p)       1.3 -11.6    
Source: Company REFS              

Funds raise exposure

Between March and July this year, announcements show funds such as Oryx International Growth, North Atlantic Smaller Companies Investment Trust and Harwood Capital - all operated by Christopher Mills, a US/UK smaller companies specialist - increasing exposure through 10% to 15.24% as of last July; which is encouraging because these funds are effectively locked in - selling would drive the price down against their interests - thus demonstrating conviction.

So, although Lakehouse appears unloved by the market and its updates convey a sense of "plenty remains to be done", the long-term case looks intact and a 6% prospective yield fair compensation for the holding risks.

Fears of a Conservative party leadership contest and a Labour government before 2022 appear overdone. Thus, Lakehouse merits accumulating by patient investors: a chance to lock in attractive yield with capital upside as progress with the turnaround reduces risk.

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