Sureserve Group 2020 outlook Well positioned for clean growth strategy Industrial support services 29 January 2020 In our last note, we commented that Sureserve was in the ‘show me’ stage and we expected it would gain traction with investors once it had delivered Price 50.5p full-year results. The stock has risen from 30p at the time we made the Market cap £80m comment to 50.5p as of yesterday’s close. FY19 results beat our expectations across the board (revenues, EBITA, EPS, net debt and Net debt (£m) at 30 September 2019 7.4 divisional performance), affirming Sureserve’s transition to a service- Shares in issue 158.9m based business underpinned by regulatory requirements. Over the next decade we see increased opportunity as the UK policy on energy Free float 95% efficiency gets more attention. We have increased our FY20e EPS forecast Code SUR from 4.4p to 5.1p and introduce our 2021 forecast. Our fair value estimate Primary exchange AIM increases from 45p to 65p. Secondary exchange N/A Revenue PBT* EPS* DPS P/E Yield Share price performance Year end (£m) (£m) (p) (p) (x) (%) 09/18 190.8 6.6 3.4 0.25 15.0 0.5 09/19 212.1 8.3 4.5 0.50 11.2 1.0 09/20e 230.2 10.0 5.1 0.50 9.8 1.0 09/21e 241.9 11.2 5.7 0.75 8.9 1.5 Note: *PBT and EPS are normalised, excluding intangible amortisation, exceptional items and share-based payments. Well positioned for the UK’s push on clean growth There is increasing pressure on the UK government to follow a clean growth strategy, first outlined in legislation in 2017. Further development has been distracted by the politics of the last two years, but the UK government now has % 1m 3m 12m clean growth firmly on its agenda. Sureserve is well placed to enable the energy Abs 48.5 87.0 98.0 savings and efficiency measures to be implemented as part of the strategy. An Rel (local) 51.9 81.7 77.3 order book of £333m means that c 72% of FY20 revenues are already committed. 52-week high/low 51.5p 26.0p FY19 results very encouraging Business description FY19 results showed an improving performance in both the Compliance and Sureserve Group is engaged in the provision of Compliance and Energy Services through two Energy Services divisions and came in ahead of our expectations. Cash generation divisions, focused on customers in the outsourced was strong, with net debt falling from £11.3m in FY18 to £7.4m FY19. The increase public and regulated services sectors in the UK. It in dividend from 0.25p to 0.5p signals management’s confidence in the progress is the market leader in social housing gas made. We have upgraded our FY20 estimates, with revenues up from £215m to compliance. £230m and PBT up from £8.6m to £10.0m. Management commented that it is comfortable given the strong start to FY20 with the c 10% consensus earnings Next events growth expectation and would anticipate that the group will make progress to pay AGM March 2020 down its debt by the FY20 year end. Interim results June 2020 Valuation: Fair value estimate of 65p Analysts Neil Shah +44 (0)20 3077 5715 Our updated sum of the parts valuation suggests an EV of £111m versus the Stephen Rawlinson +44 (0)20 3077 5700 current EV of £88m and implies a share price of 65p. The increase in our earnings [email protected] estimates for both divisions, the expansion in peer group multiples we have seen since the UK election results and the lower net debt all contribute to the increase in Edison profile page valuation. The growth in central costs from our FY19 estimate of £2.7m to our FY20 Sureserve Group is a research estimate of £3.6m offsets some of this increase. client of Edison Investment Research Limited. Investment thesis: Carbon neutral creates opportunity There is a secular growth trend toward improving energy efficiency. On 29 June 2019 the UK government signed legislation that committed it to a legally binding target of net zero carbon emissions by 2050. The Business, Energy and Industrial Strategy Select Committee report of 12 June 2019 set out 25 recommendations for the government to meet the legally binding climate change obligations, highlighting that buildings contribute to 19% of the UK’s carbon emissions, of which 77% comes from homes. It also highlighted that the Clean Growth Strategy set a target to upgrade as many houses to the Energy Performance Certificate (EPC) Band C by 2035, and for all fuel poor households and as many rented homes as possible to achieve EPC Band C by 2030. At the time the paper was published only 30% of the UK’s houses met the EPC Band C rating. The government’s response on 30 October 2019 disagreed on some of the findings, but agreed that a significant increase in deployment rates would be required to deliver the transition to net zero. The 2019 Conservative Party election manifesto included the following pledges: Investing £6.3bn to improve the energy efficiency of 2.2m disadvantaged homes, reducing their energy bills by as much as £750 a year. This will be achieved through: – £3.8bn social housing decarbonisation scheme. This scheme will focus on improving the insulation provided in two million social homes, reducing energy bills by an average of £160 a year. – £2.5bn home upgrade grants. The programme will replace boilers, provide insulation and in some cases replace energy systems wholesale. A total of 200,000 homes will be upgraded, providing an average annual saving of £750 a year. It will cover costs of up to £12,000 and apply to fuel poor households, both private and social, with poor energy efficiency. The legislation on many aspects of Sureserve’s work in compliance, heating and insulation is gaining political priority and getting tighter, leading to increased demand and revenue opportunities. The key investment attraction of Sureserve is that it is in a position to capitalise on these policy initiatives: Scale: the suppliers of services in the areas in which Sureserve operates, especially in the Compliance division, are mainly small and locally based. That provides scope for taking advantage of scale economies, procurement efficiency and opportunities, when the balance sheet permits, to acquire and consolidate in the industry. Relationships create a barrier to entry: the company has strong client relationships built over many years, within the local authorities, the registered providers of housing, central government and organisations such as the Energy Saving Trust. This provides Sureserve with a unique ability to access contracts and major projects such as Arbed and Energy Company Obligation 3 (ECO3). Brand and reputation a further barrier to entry: the business has well established brands in its markets, which it retains and invests in. These brands provide recognition and confidence to clients and customers. Scope for new opportunities: The company has invested in developing management and skills to grow the business, particularly in apprenticeships and in new growth areas, such as smart meters. That creates efficiency and opportunities for growth. Roll-out of government initiatives a key sensitivity How the drive to improve energy efficiency is carried out is a key issue in the short term. Both the ECO 3 and smart meter roll-out have had issues (see page 9). While the long-term direction is for growth in both areas, successful implementation of policies may lead to near-term bumps in the road. Sureserve Group | 29 January 2020 2 Company description: Energy efficiency and services Sureserve operates through two divisions: Compliance and Energy Services. For the first time the group provided a more detailed revenue breakdown of these two divisions in the 2019 segmental reporting note (see Exhibits 1 and 2). Exhibit 1: Compliance division breakdown (62% of Exhibit 2: Energy Services division breakdown (38% of FY19 group revenues) group FY19 revenues) Water and Lift services hygiene 9% Smart services metering 5% 24% Fire and electrical services 11% Energy Gas services services 75% 76% Source: Sureserve Source: Sureserve In Compliance the workload is in planned and responsive maintenance along with installation and repair services, in the areas of gas, fire and electrical, water and air hygiene and lifts. The company supplies these services mainly in social housing markets and on public building assets, as well as on some industrial and commercial properties. The principal subsidiaries and brands in this division are as follows: Gas compliance has three branded businesses: K&T (focused on South England), Aaron (Midlands and East England) and Sure (North England). Total revenues in gas compliance for 2019 were £100m, with each of the branded businesses delivering revenues in excess of £30m suggesting a relatively even mix, albeit K&T is slightly larger than Aaron and Sure. Fire and electrical services are through Allied Protection, which services and maintains fire alarms, emergency lighting, portable fire extinguishers, smoke vents and access control systems in the South East and East Anglia. Post Grenfell, there will be much more testing, in our view. Water and hygiene services are delivered through H2O Nationwide, which has 350 clients including hospitals, local authorities and hotels, providing services such as microbiological sampling, legionella control and water treatment on a national basis. The water operations are extending their markets from social housing and making inroads into industrial and commercial markets. Lift services are through Precision Lifts, which installs and maintains lifts for local authorities and social housing associations.