To accept or not to accept was the dilemma facing Mouchel in March after it received competing bids from Interserve (at 135p) and Costain (151p). The board rejected both, saying the offers “significantly undervalued” the civil engineering consulting and services group. In hindsight, this was probably a mistake. Since then the stock has gone into free fall and trading conditions have deteriorated due to local authority spending cuts, which account for around two-thirds of revenues. However, I don’t think things can get much worse. And that creates an opening for patient investors prepared to back the management team.
According to the chief executive, Richard Cuthbert: “The fundamentals of our business and the medium to long-term opportunities remain strong. With banking facilities in place to 2014 and with our leading market positions in local government outsourcing, consulting, highways and water, we are well placed… to improve the quality and efficiency of public services.”
Admittedly, the order book was down slightly in July to £1.4bn from £1.5bn in May, albeit the pipeline was up at £2.2bn from £2.0bn. However, the firm is seeing an increase in bidding activity across its core markets. Net bank borrowings fell from £109m to £87m, with more cash to come from asset disposals and the collection of customer payments in the Middle East (most notably from Abu Dhabi and troubled Dubai property developer, Nakheel, which owes about £20m).
Mouchel (LSE: MCHL)
Looking ahead, the City expects turnover and adjusted earnings per share of £540m and 9.5p respectively for the year ending July. That puts the shares on a very cheap p/e ratio of 4.7. Add it all up and I rate the group on an eight times through-cycle EBITA multiple, which, adjusting for the debt and a £35m pension deficit, produces an intrinsic worth of about 80p a share.
Mouchel is not for the faint-hearted. It is unloved by investors and obliged to make a £30m loan repayment in May 2012, or face higher interest rates (it may be forced to issue warrants, which could be dilutive). All the same, its focus on the maintenance of existing infrastructure rather than new-build projects should serve it well. So too should cost pressures on local authorities, which should enhance the momentum behind outsourcing back-office functions to the private sector. Elsewhere, its operations within the water industry should also prove resilient, and profit margins ought to be helped by cutting overheads.
And don’t be surprised to see another offer being tabled – a takeover bid at over £1 a share is still likely. Preliminary results are due out on 27 October.
Rating: SPECULATIVE BUY at 45p (market cap £50m)
• Paul Hill owns shares in Mouchel