Infrastructure provider Nexus Infrastructure (LON:NEXS) today put out a profit warning in a trading update as it revealed that ongoing issues in its Tamdown department would ‘materially’ affect profit this year. The share price fall was in the region of 30% in early trade:
There are several interesting aspects to this. Firstly, Van Elle Holdings gave out a profit warning last week, and can be considered at least broadly similar and yet its share price gained. Like that warning, Nexus also gave information of a very promising order book but this seems to have been given short shrift by the markets. Looking at current prices, Van Elle seems to have gone from strength to strength and is up 35% from the warning.
Another point is that Nexus carries a Stockopedia rating of 98, which goes to show that no company is safe. Only Plus500 (99) and Royal Mail (98) have been at higher or equal rating when a profit warning has hit. Both these companies share prices are well under the price at warning as well.
The current warning from Nexus comes almost exactly a year since the last one, which also knocked the share price in the region of 25%. In these type of industries, profit warnings seem to be almost built into operations, with the same factors coming up time and time again such as contract delays, difficulties in fulfilment. This is a double-edged sword for investors, on one hand these type of companies tend to never be amazingly successful as margins are hemmed in to an extent. On the other hand, relative to earnings they are some of the cheapest investments on the market and many have solid balance sheets and pay a good dividend yield.
The warning seems to take the ‘good news, bad news’ type. First the good:
For the six months ended 31 March 2019, Nexus expects to have achieved Group revenue of £71.0m (H1 2018: £62.9m), an increase of 12.9%. The Group order book at 31 March 2019 was £311m, up 32% year on year, with growth across Tamdown, TriConnex and eSmart Networks. The Group cash position increased to £17.8m at 31 March 2018 from £14.8m in the corresponding period last year.
The order book is much larger than revenue, so expect that these services are big projects that take a long time to complete.
Then onto the bad:
Tamdown revenue was up 6.1% year on year. However, the Tamdown business has seen delays and changes to customer build programmes, affecting resource planning, increasing mobilisation costs and so impacting efficiency. Also, customer pricing pressure and higher than expected cost inflation have resulted in increased pressure on revenues and margins. Management anticipate that these current trading conditions, which are being caused in part by the uncertain political backdrop, will continue in H2. In H1 gross margins were c.13% and management expect margins to remain around this level for the remainder of the year, materially reducing profit for the full year. Despite the difficult market backdrop, Tamdown continues to win work from its extensive housebuilding client base, with an order book of £145m (2018: £118m) up 22.5% year on year.
Gross margins are higher than operating margins. In the last year these two figures were 16.6% and 7.8% approximately, so it follows that a material hit to profit might be around 20-30%.
Nexus appears to be yet another business which has been dressed up for IPO and then something goes wrong after. It listed in July 2017 and its figures painted a good picture of growth: from 2013-2016 it’s operating profit grew from £3.61m to £10.4m and margins from 4.4% to 7.6% as well as a high cash conversion rate. On almost all metrics these seem to have gone backwards, albeit the fall was not as pronounced before today.
Last years profit warning surrounded one of its three reporting segments, TriConnex, but the warning about Tamdown is far more relevant. From the accounts we can see as such:
Tamdown makes up the bulk of operating profits, so the warning and loss of margins here will have way more effect. The decrease in gross margin shows some decline to the past year. Year on year, revenues are only 6.1% up and with a harder H2 predicted it may be the case that revenues end up flat or worse for the whole year. By looking at the comparatives for 2017 the trend seems flat.
The good news is that TriConnex is growing after its problems from last year, although the 30% comes from a lower base. Looking at the figures the gross margin of c.31% also shows a decline, down from 32.4% in 2018 and 33.7% in 2017. Perhaps this comes as no real surprise as contractors such as Nexus will be squeezed, and competition is rife.
The better news is that the company is in decent shape financially. There is a modest borrowing of £4.4m which is outweighed by a large cash position, which has been more or less maintained. Aside from 2017, the business is capex light and spends very little in this area, nor capitalises many costs. On the flipside, asset backing is also quite thing. There are £3.7m of land and buildings but the greatest asset on the balance sheet is trade receivables, which is income booked but not as yet paid.
The capex light position and the cash balance should give extra security to the dividend. Dividend payments totalled £2.439m in the past year representing approximately half of the net free cash flows. Whilst net free cash flows seem to be threatened with the profit warning, the company has a progressive dividend policy and can afford to maintain the dividend if it believes that things will recover.
As always the consideration must be whether the factors given are temporal or more fundamental. Increased customer pressure and cost inflation seem to be here to stay, as well as delays relating to political uncertainty. Whilst management do believe that the current conditions will continue into H2, there is a good case to think that these conditions will continue for much longer than that and lower margins will have to be accepted. Therefore an increased order book will not deliver commensurate increases in profit.
To be fair to the Stockopedia rankings, the company has earned it so far. The profits are real, it is no capex heavy, and it is also has a good cash position. Other things look good: management look competent, have good interest in the shares and are not overpaid. Despite the profit warning there is no reason why there should not be a dividend of some sort. The bigger question is to whether it can recover and get back on track. I do think it can, but the trouble is with these companies is that another warning may come in.
As with many companies in this sphere this seems a binary bet on the state of construction. If it does recover, there will be a good upside to the price, if it does not there will be a stagnation and price might fall even further. In my own view I do think in part the high rank here has led this to being over-priced a little for what it is, and around the current price is fair until prospects improve. 3/5.