Here’s a horrifying fact. Over the past ten years, UK government debt – excluding bank bail-outs and unfunded pension promises – has trebled to a whopping £900bn. Public services, at 48% of GDP in 2009/10, cost far too much for the country’s over-stretched private sector to support. The good news is that there’s plenty of scope to lift productivity and cut waste. This is where the outsourcers step in. Estimates suggest that £100bn worth of public services could be contracted out, compared with just £15bn currently. In particular, plump justice, health, education and local council areas make ripe pickings for operators such as Mitie.
The firm makes money from unglamorous yet essential services such as cleaning floors (eg, at the Tower of London), guarding buildings, disposing of confidential waste and repairing boilers for everyone from London’s Royal Free Hospital and Santander, to Channel 4 and Land Securities. Better still, the group is winning lots of new business, and recently bagged three significant client wins. These were: a £110m, ten-year social-housing deal with Orbit Group; a 16-month, £34m agreement for the development of a data centre for a bank; and £25m of work with the UK Border Agency to manage the Campsfield immigration centre.
CEO Ruby McGregor-Smith said in January that “government opportunities (45% of sales) are expected to rise over the next 12 months”. And she added that the group is on track to hit expectations for the year ending March 2011. The City is penciling in turnover and underlying earnings per share (EPS) of £1.9bn and 20.5p respectively, rising to £2.0bn and 22.0p in 2011/12. The stock trades on mean p/e ratios of 9.8 and 9.2 – a wide discount to rivals Serco and Capita. It also offers an attractive 4.3% yield.
Mitie (LSE: MTO), rated a BUY by Seymour Pearce
Net debt at £110.6m is well within banking facilities of £230m, and represents a comfortable one times earnings before interest, tax, depreciation and amortisation (EBITDA). On this basis, I would rate Mitie on a ten times EBITA multiple. After adjusting for the gearing, that generates an intrinsic worth of about 260p per share.
As for risks, profit margins are likely to come under pressure. However, the board has an enviable track record at keeping a lid on wages. There could be project delays too, although front-line and non-discretionary services under long-term deals are unlikely to be impacted too much. Better still, Mitie doesn’t even have to win many new clients in order to expand – it is already cross-selling bundled services into its existing customer base. These multi-activity agreements generate strong barriers to entry and represent a third of group turnover, up from 10% a decade ago. The long-term target is 50%.
With only around 5% of the business exposed to cyclical areas, such as the refitting of shops/offices and social housing, Mitie looks well placed to take advantage of tougher times ahead. Seymour Pierce has a 300p share price target. A pre-close trading update is expected around 31 March.
Recommendation: BUY at 200p
• Paul Hill also writes a weekly share-tipping newsletter, Precision Guided Investments