What's driving the Travis Perkins recovery?

Despite near-term uncertainty, there's an air of optimism at Travis Perkins after years in the doldrums.

Unloved for so long due to Brexit headwinds and a depressed DIY market, Travis Perkins (LSE:TPK) showed investors today that there may be reasons for optimism amidst the gloom.

The stock was swept more than 11% higher as well-received annual results showed a better-than-expected end to 2018, as well as progress on plans to sell its plumbing and heating arm.

While these are still early days in the recovery, the shares are now up by more than 40% since October's low of 970p marked the culmination of a four-year descent for the stock.

Sentiment has picked up since the company unveiled its December strategy update, which was built around the plumbing and heating sale and on improving the profitability of the Wickes division ahead of a medium-term review of options for the consumer business.

Management also wants to streamline the general merchanting arm over the next 18 months in order to save up to £30 million a year, whilst continuing to support its successful Toolstation business on the back of a period of "exceptional growth".

Analysts at Liberum are upbeat about the strategy, even though they admit they previously have been in the minority as one of only three buyers of the stock.

They said today: "There are grounds for optimism. There is hope of upside from the disposal of plumbing and heating, and possibly Wickes, as well as cost savings.

"The market backdrop is dull, but more stable than widely feared, and we find a 9% free cash flow yield compelling for a market leader poised to exploit its scale more effectively."

With shares trading at a projected 2019 price/earnings multiple of 11.5x, Liberum said the valuation looked to be interesting "given portfolio rationalisation and scope for improving market trends post Brexit."

They have a target price of 1,450p, which would take shares back to a level last seen in January and June of last year.

Today's results included a 2% rise in the total dividend to 47p a share, which management said reflected confidence in future cash generation as well as the group's prospects.

In a note published earlier this month, analysts at RBC Capital Markets highlighted the potential for significant returns of cash to shareholders should the plumbing and heating unit be sold later this year and followed by Wickes in 2020.

They said:

"If we look out five years, then we see the current level of dividend as sustainable, even with dilution on disposals, and we see the potential for cash returns of about £1.35 billion."

Much will depend on the return to more normal trading conditions, with Travis again reporting that the UK DIY market had been "particularly challenging". While the Wickes performance improved in the second half, like-for-like revenues in this business still declined 4.4%.

This was offset by more resilient trading in general merchanting, with same-store sales up 1.4%. Toolstation in the UK surged by 11.4%, helped by the addition of 4,000 new products, the roll-out of IT systems and the opening of a third distribution centre.

Overall, adjusted earnings per share rose 3.7% to 114.5p. However, restructuring costs and a non-cash impairment of £246 million against the goodwill in Wickes resulted in a bottom-line loss of £49 million.

Chief executive John Carter said: "Whilst we remain positive about the long-term outlook for our end markets, we are planning for uncertain market conditions to continue in the near term.

"The group remains focused on self-help actions to underpin performance in the near term, whilst continuing to invest for the future."