Wednesday, October 10, 2012

May Gurney (MAYG) - 138p

May Gurney (MAYG) is a support services company, which provides essential maintenance services to the public sector (60%) and regulated (e.g. utilities) sector (40%).

I have bought some shares in it at 138p, and explain why I think it looks good value below.

The mkt cap is £97m at 138p/share (with 70.2m shares in issue).

Click here for full list of MAYG RNS announcements
Click here for MAYG Annual Report

(as always, this is not a recommendation or advice, but is simply my opinion on a share that interests me. Always DYOR (do your own research) and take professional advice, etc).

As you can see from the chart below, MAYG shares plummeted by half on 6 Sept 2012 when they issued a rather alarming-sounding profits warning.

Chart Showing Financial Data

However, the latest trading update, on 9 Oct 2012 seems to show that the shares halving in price was a big over-reaction, and they have risen nicely on this update. I feel the valuation is now looking very attractive, and believe that these shares look significantly undervalued, hence why I have bought some at 138p.

The latest trading update indicated that H1 trading (6m to 30 Sept 2012) is in line with expectations. Full year broker consensus for EPS this year is 24.6p, so that values the company on a bargain PER of just 5.6. That seems far too low to me, and I suspect the share price should be on a PER of 10-12, so that would suggest a target of 246-295p a share, or 78-114% upside from the current price, not bad if I'm right!

The dividend yield is also very attractive at 8.4p forecast divis for this year, yielding a stonking 6.1%. The dividend does not seem to be under any threat either.

So one might expect that the company is up to its neck in debt? Actually no, it's almost free of conventional debt, with the latest trading statement indicating net debt of just £3m at 30 Sept 2012.

There are also finance leases totalling £74m, but I have looked into this, and these pertain to vehicles & plant bought by them to service client contracts (e.g. refuse collection vehicles, etc). MAYG state that, "the obligation to repay the capital and interest related to this asset financing is contained within the contracts where the assets are utilised". Hence one can safely disregard this debt for the purposes of valuing the company, as it is effectively risk-free, and supported by the corresponding asset value.

MAYG's contracts are long-term, and not susceptible to Govt spending cuts, since they focus on repairs-based contracts, and essential services, hence will always be required regardless of the macro picture. They do a variety of public sector projects, here are a few examples;

  • Bristol City - Waste collection, street cleansing, winter maintenance
  • Cheshire West & Chester - Waste & recycling
  • East Sussex - Highways maintenance
  • Richmond upon Thames - Street lighting
  • Network Rail - BCDP, property & maintenance
  • Fulcrum - Gas connections & pipe laying
  • Welsh Water - civil engineering

So obviously bad debts are not something that MAYG has to worry about, which further de-risks it.

Their order book stands at a very impressive £1.5bn, with potential contract extensions of £1.1bn, plus a bidding pipeline of a staggering £4bn! So the growth is set to continue, and their turnover already reached £695m for y/e 31 Mar 2012. Obviously it's low margin work, and they achieved a margin of about 4.3% last year, delivering £30m operating profit. Not bad for a £97m mkt cap company. Margins tend to build throughout the life of contracts, so high recent growth could mean margins have scope to rise.

The contracts which went wrong and caused the mkt cap to drop by about £90m in Sept 2012 seem to be ring-fenced, and have required a £10m one-off provision - hardly the end of the world. Their CEO walked the plank at the time, and they now have an interim CEO who seems to be stabilising things, and indeed delivering good new contract wins. I also like the fact that MAYG expense the considerable costs of bidding for contracts as they go along, which is a conservative accounting treatment.

So to summarise, I see this as an opportunity to hopefully grab a bargain at 138p/share, the main points being;

  • Very low PER of 5.6 times brokers consensus for this year seems unduly harsh.
  • Dividend yield of over 6% whilst we wait for a re-rating.
  • Strong contract wins ongoing.
  • Problem contracts are relatively small, and liabilities ring-fenced.
  • Sound balance sheet with little to no structural debt.
  • Public sector & utility company clients, so little to no bad debt risk.
  • Impressive long-term order book.
  • In-line H1 Trading Statement 9 Oct 2012.
  • Activities are essential public services, so not susceptible to Govt spending cuts.
  • Director salaries are reasonable.

I have initiated a discussion of May Gurney here on Motley Fool. Please feel free  to add your thoughts to the discussion.

I suppose the main downside risk is that there could be more bad news to come from the problem contracts, or new problem contracts might emerge. However, given that the CEO walked the plank last month, I would have expected them to have kitchen-sinked any further problems by now. So hopefully that could be the last of the problems, and in any case once problems are ring-fenced investors tend to move on & look instead to the future.

There is no financing risk, i.e. onerous bank borrowings, which sunk companies like Jarvis or Rok. So I see this as much lower risk situation, with great upside based on such a low rating.

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