Utilitywise — Update 28 October 2016

The results were broadly in line with the guidance given by UTW in the trading statement issued at the beginning of August (revenue of “at least” £82m, EBITDA “greater than” £18m, net debt £0.2m). However, the revenue and EBITDA results were lower than we had originally forecast for FY16, in large part due to the shortfall in expected consultant headcount growth in the Enterprise Division, which we discuss below. The cash flow performance was better than originally forecast and we also discuss this in more detail.

The Enterprise Division remains the most important contributor to UTW’s profitability, accounting for over 90% of group EBITDA. Despite the shortfall in consultant headcount, the Enterprise business managed to increase its profitability in FY16 thanks to improved productivity, with EBITDA rising from £14.3m to £17.1m, although gross margins were affected by staff attrition and the growth of the lower-margin international business. Encouragingly, however, the proportion of renewals and extension business fell below 30% of the total business in FY16, contributing to the improved cash flow performance. By contrast, the smaller corporate business suffered a 65.4% decline in EBITDA to £1.2m, despite a 6.9% increase in revenue. A change in business mix depressed the margin and investment in product development, particularly in relation to the energy services offering, added to the cost base, reducing profitability in FY16 but offering the prospect of enhanced sales opportunities in FY17 and beyond, as evidence by the recent signing of a contract with Asda.

We have updated our forecasts for FY17 following the publication of the FY16 results and introduced new forecasts for FY18. We assume an increase in consultant headcount to 700 in FY17 and to 800 in FY18. The forecasts for consultant headcount growth are lower than previously assumed and are the principal reason for the reduction in the FY17 forecast. We assume that extension business as a proportion of new business remains below 30% and that UTW begins to reap some revenue benefit from the investment in the Corporate business. It should be noted that the forecasts were not changed following the trading statement, leading to larger adjustments now.

Over the last 18 months UTW has striven to reduce the proportion of extension business that it writes and to improve contractual terms with its key suppliers with a view to reducing the rate of growth in accruals and improving cash flow. To this end, UTW negotiated three separate changes to payment terms with existing suppliers during the course of FY16. Although the payment terms vary between suppliers, in general the revisions will allow UTW to receive cash on the same terms for an extension contract as for a new customer, ie 75-80% of the expected revenue on the signing of the extension, with the remaining 20% subject to reconciliation at the end of the process. In addition, two of the contract renegotiations provided for UTW to receive payments of £3.6m and £2.25m in FY16 as a result of applying the changes in terms to historic accrued revenue balances. During the course of FY16 UTW also reduced the proportion of contract extension business to below 30%.

UTW’s targeting an improvement in cash flow appears to be bearing fruit, with a year-end net debt position of £0.2m compared to a net debt position of £6.7m at FY15 and an Edison pre-trading statement forecast of net debt of £3.8m. We assume that UTW is successful in maintaining extension business at current levels and continues to achieve some further improvement in supplier terms. We see UTW moving into a comfortable net cash position in FY17, although we expect net debt at H1 and a stronger H2, and a further strengthening of its position in FY18.

In FY16 UTW targeted an ambitious increase in consultant headcount of 150-200. However, despite the recruitment of c 500 new consultants during the 12-month period, as a result of exceptionally high levels of staff attrition the recruitment did not result in a significant uplift in consultant numbers. Year-end FY16 numbers show consultant headcount of 625 (FY15: 610), significantly below our original, pre-trading statement estimates of 740. This shortfall in headcount against forecast accounts for the bulk of the undershoot in revenue and profitability versus our original forecasts for FY16. Ensuring retention of existing and newly recruited consultants will be a key challenge for management in FY17 and beyond. UTW has created a “People Operations Function” and is pushing through improvements to its recruitment, induction and training programmes as well as addressing issues such as flexible working, which should result in a lower level of attrition during the current year, but the market will lack visibility on this key metric in the short term. We have based our forecasts on the assumption that UTW is successful in increasing consultant headcount to 700 by the end of FY17, which marks an increase of 75 on FY16 numbers and 63 versus the end of September figure. This assumption represents a key variable in our forecasts. Based on our forecast revenue of c £95k per consultant/pa, a shortfall of 10 consultants would reduce revenue by £0.95m versus our forecast and, assuming a margin of c 25% (similar to that achieved by the Enterprise Division in FY16), reduce EBITDA by £0.24m.

UTW announced that CFO Jon Kempster is to leave the company but will remain in place in the short term in order to ensure a smooth transition to the incoming CFO, Richard Laker, who will join form Augean. Richard Laker will form part of the new management structure along with Geoff Thompson as Chairman and Brendan Flattery as CEO. Mr Flattery intends to implement a strategic “refresh” of the business, which should be completed by Q117.

Based on our revised forecasts (at a price of 169p/share), UTW stands on a prospective P/E of 8.6x, an EV/EBITDA of 7.0x and a yield of 4.1% for calendar year 2016. This compares to a market (FTSE All-Share) P/E for FY16 of 16.6x, EV/EBITDA multiple of 9.3x and yield of 3.8%. This rating appears conservative for a company that, despite the slower growth posted in FY16, continues to demonstrate an ability to increase revenue and profits. Our EPS forecasts for FY17 and FY18 imply CAGR for calendar 2015-17 of 7%, (FTSE All-Share 11% over the same period). UTW can also point to an improving cash-generation profile (Cash EPS/EPS for the period 2012-15 = 50% compared to 2016-18e c 70%) and a well-covered (3.0x FY16) and growing dividend.

For UTW to trade on a market multiple, we calculate that FY17 EPS would have to fall to c 10p. This scenario appears remote, and even in the event that UTW failed to add to consultant headcount in the current year, we estimate that its EPS would be broadly static. Conversely, a 25% discount to the FTSE All-Share P/E multiple for FY16 to reflect the uncertainty surrounding consultant recruitment (reducing the multiple to 12.5x) would imply a share price for UTW of 245p. At a price of 200p, UTW would trade on a P/E of 10.2x, still a 39% discount to the market.