SIF Folio: Morgan Sindall promises H2 recovery

We’re now approaching the end of the half-year results season. In the past, I’ve not covered results from companies in my rules-based SIF portfolio. In keeping with my hands-off approach, I’ve usually avoided any review of a stock’s performance until the end of its nine-month holding period.

However, I’m considering providing additional coverage of the performance of shares while they are still in the portfolio. There are a couple of reasons for this. 

The first is that many companies have faced unprecedented challenges and headwinds this year. There’s a real sense of uncertainty about how many businesses are performing, something that’s not always true. 

The second reason is that my approach is becoming somewhat more active than in the past. For example, I’ve recently introduced a stop-loss rule and also have a policy of selling after a profit warning. 

I know that many of you follow company news quite closely, so I’d be interested to hear your views on this - should I provide more consistent coverage of news from stocks in SIF?

This week I’m going to trial this new format by taking a look at last week’s half-year results from construction group Morgan Sindall. This FTSE 250 stock fell by more than 50% in February and March, as investors feared the worst. Four months later, most parts of the business are back in operation. I think it’s a good time to take a fresh look. 

Morgan Sindall (LON:MGNS): still a sector winner?

(Original buy report: 03/03/2020)

I’ve been following this construction and regeneration group since I held the shares in SIF in 2017, when it delivered a total return of 59% in nine months. I don’t expect a repeat performance this time round - Morgan Sindall’s share price has fallen by nearly 30% since I bought the shares for the portfolio in early March. 

However, I remain of the view that this firm is one of the best operators in this sector. I’m in no doubt that one reason for this is the presence of owner-management -- founder John Morgan remains in the hot seat and controls 9% of the stock.

Last week’s half-year results received a warm reception, lifting the stock 17.5% in one day and boosting the firm’s StockRank to 94:

Half-year review

As expected, revenue and profits for the period fell sharply due to the impact of lockdown and supply chain challenges on construction sites:

Reassuringly, we’re told that revenue rose by 17% during the first quarter before falling 23% in Q2. So trading was strong before lockdown.

Another positive was that period end net cash rose to a healthy £146m during the period. Of course, many firms massage their cash flow to deliver strong period end figures. But I think the quality of Morgan Sindall’s cash position can be gauged by comparing it to average daily net cash of £153m - almost identical.

The company admits that this figure was increased by £22m as a result of various tax and related deferrals during the first half. These will all have to be paid, so perhaps we should say that average daily net cash was £131m. That compares to a figure of £123m for the same period last year. Not a bad result.

Outlook: Many companies are still using the pandemic as an excuse to withhold guidance for the year. Increasingly, I’m not sure this is justified. Fortunately Morgan Sindall’s management do have a clear view on the likely outturn for the current year.

Revised guidance is for pre-tax profit of £50m-£60m this year. Taking the midpoint, this implies an H2 pre-tax profit of £39m. The comparable figures for 2019 were £90m (FY) and £54m (H2). If the firm can hit this guidance, then I think that will be a solid result in the circumstances given ongoing disruption and cost inflation.

Taking a slightly longer view, one of my main concerns earlier this year was that Morgan Sindall’s order book might start to deteriorate. Although it’s too soon to be sure, there’s no sign of this happening so far. The company says that its secured workload actually rose by 5% to £7,962m during the first half.

As you can see, the new work came from two divisions, Construction & Infrastructure and Partnership Housing. I’d expect these sectors to be relatively resilient in a recession, given the government’s commitment to invest in infrastructure and the need to support affordable rental housing.

There’s no dividend as yet, but I suspect that if this guidance is delivered, the board will declare a reduced final dividend for 2020. Analysts have pencilled in a payout of 25.4p for this year, giving a forecast yield of 2%.

My view: Morgan Sindall has always had a good track record of cash generation and a relatively strong balance sheet. But I don’t think the company has any special advantage in terms of profitability. The group’s operating margin has averaged 1.8% since 2014, according to Stocko stats. 

Instead, I think the firm’s performance is the result of very good management - tight control of working capital, well-structured contracts and good operational execution. These support a respectable level of returns on capital employed.

My guess this performance stems at least partly from the company’s founder-led culture. This suggests that when John Morgan does eventually retire (he’s 64), shareholders could face an element of key-person risk. Fortunately, there’s no sign of this happening just yet. 

My view of this business remains very positive. This is supported by the latest broker forecasts, which suggest a solid recovery in earnings next year:

I’m interested to note that the stock also qualifies for Richard Beddard’s Nifty Thrifty Screen, which has returned 116% since its inception at the start of 2012. 

Stockopedia’s algorithms continue to rate Morgan Sindall highly, with a StockRank of 94 and a Super Stock style. My SIF screen also likes this stock, which is currently one of just five shares qualifying for the screen.

These algorithmic results match my own subjective view on this stock, so I remain very happy to continue holding.

Disclosure: Roland owns shares of Morgan Sindall.