British outsourcer Mitie is so certain management and shareholders’ interests should be aligned that it named itself after the slogan, ‘Management Incentive Through Investment Equity’. And it’s a philosophy that seems to work for Mitie: in the past five years, turnover and profits have doubled. Judging by solid first-half results, that trend is set to continue.
Mitie makes money from unglamorous yet essential services such as cleaning floors, guarding buildings, disposing of confidential waste and repairing boilers. Clients range from London’s Royal Free Hospital and Banco Santander, to Channel 4 and Land Securities. Given that private and public-sector clients (comprising 60% and 40% of sales respectively) are busy saving costs by outsourcing non-core services, its prospects look attractive. Mitie has a hefty £5.6bn order book, equivalent to three times revenues.
Sadly, investors aren’t interested. The stock has underperformed the FTSE by 40% since September due to concerns about future government spending cuts. But although some belt-tightening is inevitable, front-line and non-discretionary services under long-term deals are unlikely to be cancelled en masse. And even when Whitehall mandarins chop budgets left, right and centre after the general election, Mitie’s position as a linchpin in the flagship Building Schools programme is unlikely to be affected. Sure, there will be project delays and margin pressure, but Mitie should be able to cope – especially as it has a good track record when it comes to protecting its 5.3% profit (earnings before interest, tax and amortisation, Ebita) margins. Wage inflation is likely to stay muted for the time being, with extra outsourcing volumes feeding through into bigger economies of scale.
Mitie (LSE: MTO), rated a BUY by Nomura
What’s more, Mitie doesn’t have to win new clients to expand because it is successfully cross-selling bundled services into its existing customer base. Indeed, these multi-activity agreements generate strong barriers to entry (retention rates are over 90%) and now represent a third of group turnover, up from 10% a decade ago. The long-term target is 50%. Furthermore, the introduction of tighter environmental legislation, along with electricity feed-in tariffs, is likely to increase demand for its carbon emission operations. Laws to fine companies that employ illegal immigrants will come into force shortly, so there should be an acceleration in the shift towards larger suppliers with more transparent corporate governance procedures.
The City is forecasting turnover and underlying earnings per share of £1.7bn and 18.4p respectively for the year ending March 2010, rising to £2.0bn and 20.7p over the next 12 months. That puts the shares on low price/earnings (p/e) ratios of 12.4 and 11 – a 40% discount to rivals Serco and Capita. It also pays a decent 3.3% dividend yield. Despite spending more than £155m on acquisitions in 2009, Mitie’s net debt of £100m is still just one times earnings before interest, tax, depreciation and amortisation.
With only around 5% of the business exposed to cyclical areas, such as shop and office refitting work and plastering for new-build residential properties, Mitie looks well placed. It will benefit as more organisations are forced to outsource non-core activities to reduce overheads. Nomura has a 300p price target. Full-year results are due out on 17 May.
Recommendation: BUY at 228p
• Paul Hill also writes a weekly share-tipping newsletter, Precision Guided Investments