WYG — Embracing change

A pre-close statement reduced company guidance and reported FY17 PBT came in slightly below our reset expectations, and EPS slightly higher due to a tax credit. Nevertheless, double-digit revenue growth, EBIT margin improvement and a good H2 working capital performance were all highlights of a decent year overall. UK project delays signalled in Q4 are now substantially on stream and significant new business has been won here and overseas since the year end.

UK: Divisional revenue rose by almost 12% in the year, though reported profitability declined by broadly the same percentage. (We estimate that c £5m of the revenue uplift and c £1m of EBIT arose from the full year effects of FY16 acquisitions, mainly benefiting H1 year-on-year comparisons.) After a relatively slow start UK revenues grew strongly in H1 as seen in Exhibit 1. Against this and expected momentum into H2, WYG added technical staff, which held back margins and profitability in H1. Project deferral and delays in Q4 (as pointed out in the March update) meant that this cost was also carried in H2 with restricted opportunity to generate additional revenue and margin. We note that the higher H1 activity level was sustained in H2 such that revenue and EBIT were almost identical (where a stronger Q4 would normally drive a second half bias). Sector highlights in the year included transport project frameworks, new residential schemes and higher education facilities. By implication, workflow from some government departments (eg the MoD, Ministry of Justice) was relatively subdued. FY17 ended with an order book of c £82m, slightly up year-on-year with c £48m scheduled for delivery in FY18. On 2 June, a potential £40m+ of new UK government work (including the MoD) was announced with c £15m of this firm for delivery in FY18.

Europe, Africa and Asia: In aggregate, EAA experienced a c 15% revenue reduction but saw a good year-on-year EBIT uplift in FY17. Behind these numbers, there was a two tier underlying performance with difficult trading conditions in public sector work in Poland but much stronger donor-funded programme activity in the Balkan states. The commercial environment in certain workflows in Poland has deteriorated in recent years and WYG has decided to focus on fewer strategic sectors going forward. Additionally, its nuclear newbuild project team has been scaled down and a charge taken against work undertaken to date. In contrast, project work in the western Balkans and a number of African countries has grown significantly – to £46m – and the prospects for further wins are understood to be very good. Follow-on work under the CRIDF climate resilience programme across Southern Africa has further boosted the order book.

Middle East and North Africa (including Turkey): MENA made an unprecedented contribution in FY17, one we had not foreseen, even at the interim stage. There was a higher volume of work certainly, including incidence of completions on higher margin engineering projects, which saw a significant profit drop through. The year-end order booked dipped as a consequence but indications from a number of funding agencies (EU, EBRD) remain favourable; the margin outlook is also better than we had expected though is unlikely to match the exceptional level attained in FY17.

From a modest net cash position 12 months earlier, WYG ended FY17 in a £2.5m net debt position. This was lower than our expected £5.8m; the better year end outturn was due to a number of line items, mainly better trading cash performance as well as lower outflows on capex, acquisitions and dividends. Reported free cash flow was effectively neutral for the year and, hence, the headline movement was attributable to acquisition consideration and cash dividend payments.

Looking at the detail, in operational terms a good EBITDA increase and much more modest underlying working capital outflow drove a healthy core cash performance. Relatively lower UK activity at the year end, as noted in the end FY17 update, manifested itself through a wip reduction and significant increase in debtors, which was substantially offset by increased payables leaving the modest working capital outflow overall. Against this, a similar level of legacy cash payments (relating to property and PII provisions) plus outflows relating to exceptional items resulted in an overall trading cash inflow of £3.4m, an improvement from a £1m outflow in FY16.

Interest and tax payments were in line with the prior year though capex saw a temporary step down and spend on tangibles/intangibles was effectively in line with depreciation/amortisation in the year. WYG is not a fixed capital intensive business but we had anticipated higher spend consistent with business growth aspirations. The combination of a slower than expected end to FY17 in the UK together with organisational change probably led to a pause in spend during H2 as these factors and any knock-on effects on office infrastructure in the UK and overseas were digested.

Deferred cash consideration and related payments on prior year acquisitions (ie North Associates and Signet) totalled £2.3m. The respective split between these two companies was not disclosed with the results but should be visible when the annual report is published in July. During FY17, only the FY16 final dividend cash payment was made, while the FY17 interim was paid out after the year end (and we had expected both). We understand that the declared interim and final dividends in any one year will be paid out in cash in the following financial year going forward.

Cash outlook: We expect good increases in EBITDA – partly offset by some working capital absorption – to result in a rising operating cash flow profile over our estimate horizon. With reducing legacy cash outflows and our expectation of limited other exceptional payments, this translates to a positive group free cash flow position, building faster than underlying EBITDA. Overall, we expect WYG to be modestly geared by the end of FY18, moving into a net cash position thereafter.

As mentioned earlier, WYG announced significant new business wins in June. Coupled with better momentum from existing UK programmes, these factors justify to some extent the decision to sustain the pre-emptive increase in UK technical staff in FY17. We have effectively assumed that the June contract wins were incorporated into previous management guidance. On the previous divisional presentation basis we have followed through a lower rate of UK profitability for now and a higher contribution from MENA (though with a more conservative margin versus the actual FY17 outturn). The net result is slightly lower group profit estimates as shown in Exhibit 2. Under the new organisational structure, roughly 70% of EBIT (before central costs) comes from Consultancy Services in our model.

Having flagged a new strategic growth plan back in December, external detail has been slow to emerge no doubt due to a slower Q4 than previously anticipated. Nevertheless, the company has been working on the delivery platform for a growth phase and a number of organisational changes as part of this are now becoming apparent. We expect previously identified sector strengths in infrastructure, energy, mass migration, water management, climate adaption and UK housing to remain core and the changes are designed to ensure that the company can respond rapidly and allocate resource to the most attractive opportunities. We expect a more comprehensive exposition of group strategy to come from management in the next six months, but we now provide an overview and our interpretation based on those features that are currently visible.

WYG has moved to functional or service-oriented divisional reporting compared to its regional structure previously. Crudely, this entails the provision of:

We expect that this will facilitate improved co-ordination – and more obvious linkages and support – between common service types wherever they are required. The UK is also seen as a base from which to grow with multi-national clients worldwide. More centralised group services will also allow some reduction in regional hub overhead outside the UK and overseas offices should be more clearly aligned with new business development and execution. As far as we are aware, non-UK activities will continue to be run on a core capability/delivery network basis (compared to UK services, which have always been substantially delivered directly by WYG employees). Of the £4m exceptional charge taken in FY17, £3m related to overseas activities.

Exhibit 3 shows a bridge from previous to new divisional reporting for FY17 results, which provided a more detailed split of financial performance from what was previously known as Europe, Africa & Asia. Southern (ie Balkan states) and non-European activities accounted for 60% of EAA revenue and were the primary profit contributor in the year, generating a 13.7% EBIT margin (before central costs). These operations are now part of the International Development division, which also includes MENA. Meanwhile, Central & Eastern Europe (including Poland) and a small specialist Russian JV are now part of Consultancy Services alongside the UK operations. The JV made a small profit contribution but CEE recorded a significant loss; we understand that intensified competition in certain market segments in Poland contributed to this and to the decision to refocus and scale down this regional office.

Some £3m of the £4m FY17 exceptionals concerned the restructuring of the Polish hub and included a full write down on wip carried on a significant nuclear project led by Amec Foster Wheeler (announced in July 2014). The remaining £1m charge related to the net cost of a strategic review, other organisational change and pension scheme matters.

Senior management has also undergone significant change over the last 12 months, starting with the appointment of Iain Clarkson as CFO in June 2016. FY17 results were accompanied by the news that CEO Paul Hamer is moving on to the same role at privately owned Sir Robert McAlpine. Successor Douglas McCormick assumed the CEO role on 12 June and he brings experience from large infrastructure consulting, project management and contracting (Atkins Rail) and at plc board level (Sweet Group, a multi-discipline building and infrastructure service provider from March 2015 until its acquisition by Currie & Brown in August 2016). The change of CEO was not anticipated by the market but the swift baton change heads off any uncertainty that could have arisen with a staggered handover. The well-flagged retirement of Chairman Mike Tighe at the forthcoming AGM will see Jeremy Beeton step up from senior independent director to non-executive chairman, at which point the group board will be comprised of two executives and three NEDs.

These board changes underscore the view that the business turnaround phase is now complete and the early stages of the return to growth coincide with strategy renewal and new stewardship of the business. Below the main board, the two new divisions have externally appointed MDs:

Their tenure indicates that the new strategy – which was first flagged in December 2016 – has, in practice, been progressively implemented for almost six months now. We understand that the divisional FD roles have been taken up by the former head of MENA (International Development) and former UK FD (Consultancy Services). Additionally, Consultancy Services is now split into three primary business areas, which are all being headed by internal group appointments, as follows:

The former Major Projects team has expanded to form a new Strategic Advisory Practice. Headed by Clive Anderson (WYG since 2000) this multi-disciplinary approach brings WYG network capability together to create integrated client solutions across both of the new divisions. We believe that the latest announcements complete the formal organisational changes within WYG. Over time, the redefined structure will generate new divisional track records in revenue, margin and order book development that we will appraise as they become apparent. Clearly, the UK will remain the dominant contributor to Consultancy Services and the MENA region for International Development for the foreseeable future.

Looking at the picture as a whole, we consider it unusual to see this level of senior personnel and strategy change simultaneously. It is however a logical transition when we consider that the senior team responsible for the delivery of the new strategy – with the exception of the new CEO – have been within WYG for a reasonable amount of time now and, in reality, have been forming the new strategy during this time. We would expect more detail regarding the financial implications and scale of aspiration of the new management team to become apparent during the next six months.