Shares in Britain’s largest environmental support-services firm have fallen 25% since March due to jitters about the October Spending Review. However, this reaction looks harsh.
Last week the secretary of state for energy and climate change, Chris Huhne, reaffirmed the government’s commitment to alleviating fuel poverty via its new flagship Green Deal. This is good news for Eaga because the scheme ensures that everyone cuts down on carbon emissions and energy costs by insulating their homes and using new boilers and so-called smart meters. These are services that Eaga is currently delivering “excellently”, according to the National Audit Office, under the existing Warm Front initiative (49% of sales). So the business is well-placed to pick up contracts when the Green Deal is implemented.
Furthermore, by installing modern heating systems and insulation for local councils, Eaga is able to benefit from any work carried out, while its expertise also helps utilities reach their own obligations under the country’s Carbon Emissions Reduction Target scheme (28% of sales).
Yet energy efficiency and carbon reduction are only part of the story. The firm is also involved in business process outsourcing and delivering a £500m contract for the BBC to help switch over from analogue to digital broadcasting technology. Eaga is also trying to tap into the solar market by installing panels on social housing estates in return for government tariffs. The landlord gets to reduce its carbon emissions, the tenants pay lower bills, and Eaga receives a steady income from the tariffs.
Gamble of the week: Eaga plc (LSE: EAGA)
For the year ending May 2010, Eaga advised 218,000 properties on energy efficiency, installed 37,200 new boilers, conducted 393,000 maintenance check-ups for landlords, and decreased the nation’s carbon footprint by 11.9 million tons. Of the group’s turnover, 82% is derived from either public or regulated industries. This offers solid earnings visibility and Eaga has already hit around 78% of this year’s top-line target. The City forecasts 2010/2011 sales and underlying EPS of £834m and 15p respectively. That puts the shares on a lowly p/e of 7.7, despite having a cast-iron balance sheet (net cash of £37.9m) and offering a 3.3% dividend yield.
Granted, green developments are susceptible to possible policy changes. Yet, after Huhne’s reassuring statements last week in Parliament, a U-turn looks unlikely, even given forthcoming public-sector cuts. So I would value the group on an eight-times EBITA multiple. After adjusting for the cash pile, that gives a fair value of 180p per share.
Recommendation: BUY at 115p
• Paul Hill also writes a weekly share-tipping newsletter, Precision Guided Investments