Earnings growth undervalued

FY18 results were in line with our estimates with good organic growth rates generally – particularly in Electrical Services and Fire Solutions – and this was supplemented by acquisition contributions in those two divisions. An improving debtor collection profile was the other notable feature of 2018 results and year-end net debt stood at £14.3m (or c £22m pro forma including Trinity).

Maintenance, inspection and testing of working safely at height solutions and design, installation and testing of permanent façade access and fall arrest equipment.

The divisional performance presented in Exhibit 1 above is all organic. A reduction in commercial installation work was evident in H1 and this continued in H2, with management attributing this to fewer cradle installation jobs. These are larger, lumpier projects and total installation revenues – versus an abnormally high FY17 - declined 31% y-o-y to more normal levels. More positively, higher margin maintenance and testing income grew by 13%. This suggests that the division continues to experience good client renewal rates and is also securing healthy new business levels in this area. As a consequence, the overall split between installation and compliance/testing workflows was broadly even for FY18 as a whole and contributed to the beneficial margin impact at divisional level, though absolute profitability was slightly lower. Looking ahead, management expects a similar level of cradle installation work in FY19 – though enquiry levels are building – and, with growth in maintenance and testing, other things being equal, this mix effect would point to some divisional margin progression in FY19. Investment in staff suggests that further organic growth is likely.

High-level building services including surveys, installation, maintenance, remedial works & cleaning

As in Access & Safety, the reported FY18 divisional financial performance was all organic. The year was characterised by reduced exposure to commoditised lower margin work and greater focus on the specialist steeplejack and rope access service. Although we cannot quantify each of these effects, the net result was low single-digit divisional revenue growth in the year, a modest increase in staff levels but good year-end momentum. The successful new contract win activity flagged at the interim stage – and in part due to referrals from elsewhere in the group – converted to a c 18% y-o-y revenue pick-up in the second half (although the absolute numbers concerned are small context of the group). This also followed through into profitability, with improved gross margins feeding into 200bp EBIT progress to an above group average 24.5% for the year.

Portable appliance and fixed wire testing and design, installation and testing of complete building lightning and surge protection systems.

This division was the group’s largest revenue and operating profit generator in FY18, growing both metrics by c 50% in absolute terms in the year. We estimate that organic progress was c 17% for revenue and c 12% for EBIT with the remainder coming from the annualised and in-year effects of three acquisitions1. Following a 78% y-o-y increase in revenues, we believe that secondary testing/ inspection activities represented c 60% of the divisional total while primary installation project revenues also rose strongly (+27%). The relative importance was not split out, but acquisitions contributed to this growth in both categories as did organic new business wins and, in the case of secondary revenue streams, high contract renewal rates on a rising contract base. The acquisitions themselves are now said to be fully integrated and trading ahead of pre-PTSG levels and this is clearly the case with the operating profit margin at Guardian, in excess of 30%, in its maiden 10-week contribution. On an annualised basis, this business represents around one quarter of revenues of the enlarged Electrical Services division and management sees a clear opportunity to add scale to it by incorporating repair and maintenance services to its core testing and compliance offering. This is supported by noting that the average number of divisional staff broadly doubled in FY18 (versus revenues up 53%); this indicates to us that the acquired businesses had lower average revenue per head. An aspiration to bring together PTSG’s Clarity scheduling platform with Guardian’s Traq-It customer interface system over time offers the prospect of improving engineer utilisation and more efficient commercial management, in this and other divisions in due course.

Design, installation, testing, replacement, maintenance and certification of fire protection and suppression systems (including dry risers, sprinklers, alarms, emergency lighting & extinguishers).

This developing division delivered very high growth rates from both ongoing and two acquired operations (one in 2017 annualised and one part-year contribution in 20182). It has historically had the highest proportion of installation revenues reflecting the mix of the dry riser businesses brought into the group in 2016 and this was extended with the acquisition of M&P to over 80% of the divisional total in 2018. We would normally expect this to result in a lower than average blended gross margin, but demand for fire-related testing and compliance services has been high and an implicitly slimmer operating cost structure in the year together allowed the division to generate an above-average EBIT margin of 23.2%. Strategically, M&P improved the division’s geographic coverage and the post year-end acquisition of Trinity Fire and Security Systems is a genuinely transformational deal. First, it adds capability in electrical and electronic systems (eg alarms, lighting) to the existing mechanical portfolio (ie dry risers, sprinklers, extinguishers) which brings the opportunity to be an integrated solution provider in this area in respect of new business (both installation and secondary) and across the expanded existing client base. Secondly, c 60% of Trinity’s revenues are generated from test/inspection which moves this revenue stream to almost half of the enlarged division with total annualised revenues of c £55m. In context, Trinity adds c 330 staff – around half of which are field engineers – to the FY18 divisional average of 65. PTSG’s challenge is to raise engineer utilisation, integrate the field service offer and do so with an efficient operating structure to raise Trinity’s acquired EBIT margin of c 5% towards the divisional average over time. In the near term, Trinity will be margin dilutive but this starting point, the step up in scale and the potential to cross-sell service lines all represent significant opportunities to drive divisional profitability forward.

End FY18 net debt was £14.3m, £5.3m lower than at the start of the year. The major elements of this reduction were underlying positive free cash flow of just over £11m, total M&A-related outflows of c £22m and just over £20m of new equity proceeds. Rising cash dividend payments and year-end leases also featured.

EBITDA (including asset disposal profits) rose by £4.8m to £17.1m driven primarily by the Electrical Services and Fire Solutions divisional performances. As well as acquisition effects, there was clearly organic growth in the year although the associated working capital was less than seen in previous years (ie a £3.7m net outflow versus £7.9m in FY17). As we commented on initiation, debtors/receivables is the key line item here and several favourable effects are apparent. First, there was an absolute reduction in the level of accrued income relating to installation/project work, in part due to lower new cradle work but also to collection days outstanding (moving from 38 to 30 in FY18). Second, while trade receivables rose by c £5m y-o-y after a strong Q4 trading period the increase was partly mitigated by lower collection days (from 93 to 86). So, a combination of business mix, acknowledged faster payment from certain customer types and generally better commercial management by PTSG have all contributed to this outturn. Elsewhere in free cash flow generation, we note that net interest and tax payments were in line with their P&L equivalents and obviously higher y-o-y, while net capex was negligible with capex matched by asset disposal proceeds. Looking at M&A spending, the c £22m noted above comprised initial cash consideration of c £12m (the largest element being Guardian) and payments for fees/integration activities and deferred consideration, which are not reported as one line but which we have aggregated here.

Cash flow outlook: On a pro forma basis – including the £10.8m Trinity acquisition (£7.7m net of cash) in January – PTSG starts FY19 with c £22m net debt. Absent any new acquisitions but allowing for a c £1.7m loan note repayment, we expect PTSG to end the new trading year with net debt of c £18.8m, or 0.8x EBITDA. We would suggest that there is still room for improvement in trade debtor collection and days sales outstanding will continue to be a closely monitored metric.

Management expects 2019 organic and acquisitive progress to result in further substantial earnings growth and stated that the new financial year had started well. For the record, we expect announced acquisitions (M&P, Guardian and Trinity) to contribute around three quarters of our FY19e EBIT uplift acknowledging that some of this will be organic for those businesses under PTSG’s stewardship (ie against pre-ownership profitability) and the impact at PBT level will be lower after taking interest adjustments into account.

In minor estimate revisions, we have not assumed a bounce back in cradle installation revenues in Access & Safety, but this is offset by better run rates of profitability in Electrical Services, against our earlier expectations. Otherwise, new FY21 forecasts extend our projected growth profile and contribute to a three-year EPS CAGR of 11.7%. Dividend growth is currently anticipated to be broadly half of this level (at 5.3%), with earnings cover above 7x. Although not currently factored into our estimates, we consider that further group acquisition activity is likely; in the absence of this, PTSG could clearly declare a faster rate of dividend growth than we currently expect.