Investors’ Chronicle: Hill & Smith, IWG, Glencore

BUY: Hill & Smith (HILS)

Record numbers for Hill & Smith at the half-year mark were reflected in a buoyant share price performance on results day, writes Mark Robinson.

Once the divestment of erstwhile subsidiary, France Galva, is taken into consideration, revenue for the group, which manufactures and supplies products for the construction and infrastructure industries, increased by 19 per cent at constant currencies, while operating profit at £62.5mn was 38 per cent to the good on the same basis. The underlying margin rose by 240 basis points to 14.9 per cent. So management now believes that full-year profits will be “modestly ahead of current market consensus”.

The positive outcomes point to the overall resilience of the domestic UK market, aided by leading market positions in several niche areas in the infrastructure sector, although the outlier was in the UK galvanizing services segment where profits were constrained by reduced volumes and higher energy costs.

But it was the engineered solutions division that gathered the plaudits. It contributes around 43 per cent of group revenue, derived from a diverse range of industries including those engaged in energy generation, marine, rail, and construction. It also provides one of the main conduits into lucrative US markets. Operating profits at the division more than doubled to £30.9mn on the back of “strong volume growth in [the group’s] higher-margin US composite and structural steel electricity substation businesses” as Washington pumped further capital into upgrading the country’s ageing electric grid. Indeed, the divisional performance highlights how Hill & Smith’s heavier weighting towards US end-markets is having a positive impact on profitability.

It’s an inherently capital-intensive business, but the solid financial performance has been predicated on prudential capital management. The working capital outflow in the period was £7.2mn, against £41.5mn last time around, representing a relatively modest 17.5 per cent of annualised sales. Debtor days were in line with expectations at 55 days, although they have reduced appreciably due to the offloading of France Galva. Capital expenditure at £12.7mn was down by a quarter on the first half of 2022 despite new investments in US composites and galvanising. Finally, the group generated £38.7mn of free cash against an outflow in the equivalent period last year, providing further scope for capital returns and acquisitions.

The shares change hands at 16 times Peel Hunt’s earnings per share forecast of 103.7p, which is just shy of the five-year average. But, given that several new infrastructure bills have already been signed into law under the Biden administration, we can expect those revenue channels will continue to provide enhanced regional opportunities.

SELL: IWG (IWG)

The flexible workspace operator remains a lossmaking company dragged down by debt, writes Mitchell Labiak.

IWG posted another year of record revenue, but this growth continues to come at too great a cost for us to be anything but bearish. Its pre-tax loss remained the same, and its loss per share increased. In other words, even as revenue climbs, increased costs mean the company is still far from profitmaking.

IWG pinned a lot of these increased costs on a shift in the way it does its accounting, with its results for the same period last year restated. But the picture is bleak regardless of how IWG accounts for it. Shareholders have not received a dividend payment since 2019, and the company did not indicate when they will next do so.

The problem is an inherently flawed business model. Unlike flexible office landlords such as Workspace, IWG does not own its buildings. Rather, it leases offices from landlords and then sublets them. And it hasn’t posted a pre-tax profit since the pandemic hit because the cost of running the business and paying its leases continues to be more than the revenue it brings in from those wanting IWG’s flexible office service. 

This model also means its debt — the bulk of which is leases — is eye-wateringly high. And although the debt pile has decreased since last year, this was accompanied by a drop in the value of its assets, making its net debt mountain 34 times larger than its shareholder equity.

Consensus forecasts from FactSet predict pre-tax profit by the end of this year, but we are sceptical. Even in good times, the margin for IWG’s model is wafer-thin. A business built on subletting remains unconvincing to us.

HOLD: Glencore (GLEN)

The mining and trading giant will still pay out another $2.2bn in “top-up” shareholder returns, writes Alex Hamer.

Glencore’s future as a coal mining giant is up in the air thanks to its efforts to buy out Canadian miner Teck Resources and then split up the combined entities’ mines. 

In the meantime it remains a globally significant producer of the power plant and steel mill feedstock, and the first half’s profits reflected the decline in prices so far this year. The easing of the energy rush seen a year ago has led to thermal coal and metallurgical coal prices to cool off by between a third and half compared to 2022. The calmer market also knocked trading earnings. 

The company reported adjusted Ebitda for the half of $9.4bn (£7.4bn), down 50 per cent from the record hit a year ago. The trading and mining divisions both fell by 50 per cent, in adjusted Ebit terms for the former and adjusted Ebitda terms for the latter.

Higher costs also made Glencore’s mines less profitable, with the copper and zinc units hit particularly hard by lower prices and higher costs. A weaker cobalt price also hurt copper earnings, with the formerly hot battery metal now in oversupply. 

On a longer-term outlook, the trading division should still be ahead of recent years (excluding 2022’s war-driven profits), with adjusted Ebit of $3.5bn-$4bn for the full year.

For shareholders, the weaker performance will not damp returns. Glencore will pay a $1bn special dividend early next year, and announced a new $1.2bn buyback programme that will run over the coming six months. A further $2bn has been put aside to cover the potential Teck merger, which management said would be paid to shareholders if no deal is agreed. 

Chief executive Gary Nagle also said the company would not spin off its coal assets if a merger does not happen.

The outlook for earnings depends on metals prices — the copper division, for example, would see Ebitda of $5bn for the full year at the current spot price, down from $5.7bn in 2022. At spot, coal would tumble to $6.8bn from $18.6bn last year, although this would still be ahead of 2021. Analysts see overall company cash profits at $19.7bn, 43 per cent down on last year. 

Last year was potentially the perfect environment for Glencore — highly volatile with desperate buying going on due to energy security concerns. There is of course potential for this to happen again, but for now it looks like a return to thinking about managing costs and setting up the portfolio for the next squeeze.