WYG — Looking forward

Earlier trading updates (25 August and 24 November) had forewarned of a weak H1 trading period and we had revised estimates accordingly; a y-o-y improvement in International Development operating profit was not sufficient to offset a sharp reduction from Consultancy Services. This had some impact on cash flow, which is expected to partly flow back by year end. We made no material changes to estimates at this stage.

Development, creation and management of assets (ranging from infrastructure to property) in relatively advanced European economies and across public and private sector clients

WYG has successfully secured new framework agreements and orders over the last 12 months, although the rate at which they have translated into revenues has been somewhat frustrating. This occurred to some extent in H217 and a combination of effects led to a similar impact in H118. A slower build-up of workflow under framework agreements, some staff turnover in certain planning segments and a weak local Cumbrian planning market all contributed to constrain top-line progress in the UK. Although revenue was broadly in line with the previous two six-month periods, profit was sharply lower. Given a direct delivery service model, this probably reflects a combination of project phasing/profit recognition, an uneven revenue pattern and resourcing in advance of contracts that started later or ramped up more slowly. Despite this, management comments referenced a number of good segment positions and associated market opportunities (eg in defence, infrastructure and energy), so the tone was far from downbeat. Outside the UK, slimmed-down Polish office operations appear to have stabilised the local performance (although still delivering a small loss), while the Russian joint venture chipped in a modestly positive share of PAT (slightly below the H117 level). The divisional order book has risen well over the last year (ie from c £80m in September 2016 to c £86m at the end of FY17 and to c £96m in September 2017), so we can understand management’s frustration with recent revenue patterns. That said, it does suggest that there is scope for better financial performance over the remainder of this year and into the next.

Supporting long-term projects in less-developed countries/regions or fragile and conflict-affected states (FCAS) regarding complex governance, institutional and societal issues

Revenue, operating profit and margin all improved y-o-y. While sustaining the higher revenue levels seen in H217, the mix did not include some of the higher margin project work concluding in Turkey in that period. Activity remained good here – especially in water/waste water projects – and the mix/profit recognition may improve as the year progresses. Contracts in South Africa (in agriculture and water) are providing a firm business baseload in the region. The divisional order book at the end of September improved from the beginning of the year (ie +c £15m to c £74m) but was below the level reported a year earlier (ie c £83m).

Net debt stood at £10.1m at the end of September, an increase of £7.6m from the beginning of the financial year and operating cash outflow was the primary contributor to this outturn. (Allowing for seasonal trading patterns, the comparable net debt figure a year earlier was £4.9m.)

WYG typically sees a first-half operating cash outflow and H118 was consistent with this, being £5.7m overall in the period. A lower EBITDA outturn was one contributing factor; the £1.8m generated was partly absorbed by payments under legacy provisions (relating to vacant property leases and PII) the run-down of which has been seen in previous periods. There was also c £1m cash costs relating to the P&L separately disclosed items charge (including business reorganisation and refinancing) and other provision movements.

The H118 working capital outflow of £4.4m was in line with the prior year, albeit with a different composition. The primary feature in H118 was a £7m absorption into work in progress, which contrasted with the £6m debtor increase as the central item in H117. We believe that the difference reflects the slower start/stronger end to trading revenue this year, implicitly with more project completions slipping beyond the period end. (There was actually a debtor inflow in H118, which is consistent with a dip in activity levels during the period.)

There were no other major features further down the cash flow statement; net interest, tax and deferred consideration cash outflows were all very modest in H1, while capex of £1.2m was similar to the prior year. Otherwise, cash payment of the H117 dividend (at just over £0.4m) was the only other notable item.

Cash outlook: in line with previous years, management expects a H2 cash inflow and to end FY18 with £6-7m balance sheet net debt. There is obviously some way to go before we get to this point, but confidence in this scenario is supported by a significant build up in International Development debtors, especially in Turkey (partly arising in H2) expected to be substantially received before the end of calendar 2017. So, increased EBITDA and a working capital inflow are expected to be the main drivers towards management’s stated year-end net debt target. Beyond this, we currently only see a gradual further reduction by the end of FY20. Management has stated a target of returning to profitable growth backed by cash generation, so this will be a key metric to monitor going forwards. We note that WYG has elected to put in place revised banking arrangements, replacing a £25m facility with a larger £35m one and the term extended to September 2022 (previously 2019). In the near term, we take this as an indicator of a likely increase in bonded EU work (where advance payments require bank-backed security). In the medium and longer terms, it also provides headroom for potential acquisitions; we do not anticipate activity until management has demonstrated a period of more stable trading performance.

Earlier, we noted an improving order book position for both divisions. After a disappointing period of flow-through, translating orders to revenues and into profits is a key focus. In Consultancy Services, the c £36m orders scheduled for the current year is in line with the position a year earlier, so an expectation of a better H2 result should be well founded. The y-o-y increase in orders beyond FY18 (and £60m in total) suggests improving visibility of contracted work. In International Development, the order book portion for current year delivery is lower in value compared to a year earlier (ie £17m vs £25m, respectively) but is showing stability beyond this at just below £60m. With funding instrument awards (eg IPA II) now being made, further potential orders are possible.

We have not made any changes to our expected divisional contributions from our last published note. However, based on interim management guidance, we have now reduced tax rates (to zero in FY18, 10% FY19 and 12.5% in FY20) and, factoring in an increased number of shares in issue, this gives a c 17% EPS uplift this year followed by smaller increases in the following two.