Investors’ Chronicle: Speedy Hire, B&M, Pennon

BUY: Speedy Hire (SDY)

The tool, equipment and hire company looks well positioned for growth in spite of cost pressures, writes Jemma Slingo.

Shares in Speedy Hire have lost a third of their value over the past year. When you look at the group’s performance, however, this does not seem fully justified. While the equipment company had a difficult lockdown, revenue and profit before tax now exceed pre-pandemic levels, and demand for tools and building equipment shows no sign of waning.

Speedy Hire has invested around £70mn in its hire fleet over the past 12 months in order to meet increased demand and to mitigate the effect of increased supplier lead times. This has inevitably affected its financial position: net debt has doubled to £67.5mn since last year. Meanwhile, its operating cash flow has sunk by 60 per cent to £28.6mn and it has just £2mn of cash on its balance sheet.

Despite this, the group’s net debt-to-Ebitda ratio remains low at 0.9 times, and utilisation rates have increased to 57 per cent. The group has also managed to boost its gross profit margin from 55.6 per cent to 57.2 per cent, driven by a strong hire division.

There are obvious concerns. Inflationary pressures on salaries, utilities and fuel are expected to bite in 2023. Meanwhile, the group’s decision to end its apprenticeship scheme last summer won’t help with potential labour shortages, although it has set a target to have at least 5 per cent of its employees on some kind of “earn and learn” programme within five years.

So far, price increases have managed to offset the effects of cost inflation on both overheads and new equipment purchases. Many analysts also consider Speedy Hire’s end markets to be strong, despite concerns about the outlook for UK construction.

“We note that [the] government appears highly committed to its infrastructure programme and we are confident that housebuilders are likely to aim to grow volumes in 2023 even if house price inflation slows,” analysts at Liberum said.

This sentiment is echoed by Panmure Gordon, which believes the group is likely to see further upside from the government’s levelling up agenda.

BUY: B&M European Value Retail (BME)

The discount retailer expects profit margins to contract as customers rein in discretionary spending, writes Jemma Slingo.

After a stellar pandemic performance, growth at B&M European Value Retail has stalled and the discount retailer is facing an abundance of uncertainty.

Revenue and profit at B&M remain well above pre-Covid levels, but figures have plateaued year-on-year. This is largely due to the performance of B&M stores in the UK, which saw sales fall by 4.1 per cent to £3.9bn. In contrast, the group’s presence in France is growing fast.

Management expects adjusted earnings before interest, taxes, depreciation and amortisation (Ebitda) in 2023 to be between £550mn and £600mn. This estimate towers above pre-pandemic levels of £342mn, but is lower than profits achieved over the past two years.

Inflation makes firm predictions difficult, though. For B&M, product cost prices are likely to rise, while consumer spending is likely to be reined in. Inflationary pressures could also affect the type of products customers buy. General merchandise, for example — which has enjoyed consecutive years of very strong growth, and has good margins — could prove less popular than usual, as customers prioritise food and other essentials.

As such, B&M expects its adjusted Ebitda margin to fall by between 70 to 130 basis points, but to remain structurally higher than pre-pandemic levels.

The cost of living squeeze is not necessarily bad news for B&M. As the UK becomes more price-conscious, more shoppers may turn to discounters in search of bargains (according to internal price comparisons, a basket of food and fast moving consumer goods from B&M is about 15 per cent cheaper than one from its supermarket competitors.) Meanwhile, 93 per cent of all products sold at B&M are less than £20, making it less exposed to sharp reductions in spending on expensive items.

Historically, the firm has performed best when consumer confidence is weakening, such as in the first quarter of 2010, when austerity measures were introduced after the global financial crisis.

There is still a lot of change to deal with, not least at management level. Chief executive Simon Arora — who acquired the chain with his brothers in 2004, when it had only 21 stores — is retiring, and will be replaced by the group’s chief financial officer.

And B&M looks like it could fall further, particularly given warnings about a margin squeeze. Its shares have fallen 36 per cent since the start of the year to a 12-month low. In the longer term, however, the company looks poised to benefit from the rising cost of living. With a forward price-to-earnings ratio of just 10.1 — compared with a five-year average of 16.7 — it’s also cheaper than usual.

BUY: Pennon (PNN)

South West and Bristol Water owner outlined strong demand but also surging costs in its 2022 results, writes Alex Hamer.

Pennon has to face some choppy currents this year. It has forecast a hit of £8mn in added financing costs for each percentage point in inflation, meaning current trading conditions make for tough reading for the water utility’s accounting department. Power costs are also hitting operating margins, and the company said it expected wholesale electricity costs to rise 50-75 per cent this year.

While Pennon — alongside peers Severn Trent and United Utilities — is protected in the long term from inflationary pressures as these can be passed on to customers, it will still feel the impact in 2023.

But there are positives: the company noted a “substantial population increase in the south-west”, which will boost household demand; the vast majority of Pennon’s underlying cash profit comes from household water use. Non-household buyers account for a quarter of sales. The overall underlying cash profit was £384mn, a 15 per cent increase on the year before, although this figure fell when the contribution from new acquisition Bristol Water is stripped out.

The competition regulator signed off on the Bristol buyout in March. There should now be cost savings from the merger of £50mn out to 2025, Pennon said. The return on regulated equity, which is marked against a base set by Ofwat, was 9.2 per cent for South West Water and 6.3 per cent for Bristol Water — the former about par compared against peers elsewhere in the UK, while the latter showing room for improvement.

Consensus estimates compiled by FactSet see Pennon (now in its first full year post-Viridor sale) losing some cash profit margin this year, but this was already outpacing its pre-Covid-19 level (48 per cent in 2022 compared with 37 per cent in 2019). This looks like solid enough progress to us to move it to a buy.