Over the month I met with Peter Smith, the newly installed chief executive of Sureserve, which provides compliance services, such as boiler servicing and fire inspections on behalf of local authorities and registered social landlords. Sureserve is an attractive business because contracts are multi-year and revenues are reliable, as the services are non-discretionary and enforced by law. Last year Sureserve won a record 167 new contracts valued at £417m and the order book increased by 48% to £527m and with costs typically improving in the years after being mobilised, Sureserve looks set for a good few years of growth. While that alone was enough to pique my interest in the shares, there is another catalyst that could provide a significant re-rating - its Energy Services arm, which provides insulation services for local authorities and home owners as well as a business that installs smart meters. This side is growing like topsy driven by Government funding to improve the energy efficiency of public housing stock in order to hit net zero targets and pull hard-pressed families away from fuel poverty.
To “double turnover between FY’21-26”
Just to provide you with context over how Sureserve’s strong momentum has unfolded, back in August 2020 analysts were forecasting pretax profit of £10.4m in 2021 and eps of 5.2p but in the end, Sureserve posted £13.6m and 6.9p, respectively.
For the current year ending September 2022, Peel Hunt forecasts pretax profit of £16.6m and then £18.5m in ’23 for eps of 8.2p and 8.8p. If anything, Smith believes these too are conservative. His guidance is that group organic sales growth will continue running at c. 10% p.a. organically but more exciting, Smith says acquisitions will help double Sureserve’s turnover in five years (Sept ’21-’26) and increase group EBIT margins (currently 6.0%).
Firepower for more deals
Last December Sureserve acquired CorEnergy, an energy efficiency consultancy and project delivery firm, for £5.9m (6x EBIT) with specialisms in LED lighting / controls, solar PV, EV charging, battery storage and renewable heating solutions and Smith says more deals are likely. The group has net cash of £16.5m and access to a further £20m in bank funding (£15m RCF, £5m overdraft) and Smith says he would be disappointed if at least one more deal isn’t completed by this time next year.
History
Founded in 1988 and originally known as Lakehouse, the company endured the worst possible start to life as a listed company, following its introduction to the main market at 89p in March 2015. Little more than a month after maiden results showed pretax profit more than doubling to over £21m, it issued a massive profit warning, hammering the shares down to 35p and further warnings were issued followed by a succession of management changes.
Amidst the turbulence, Institutional investors then headhunted Bob Holt as the new CEO, a formidable entrepreneur, who had spectacularly built up social housing maintenance and repairs firm, Mears, from a tiny £10m market cap business to a £1bn giant, enriching his early backers with the shares soaring from around 11p when he joined in 1996 to over 270p when he sold out in 2012. Whilst at Mears, Holt had established a formidable record in building strong relationships (almost like a horse whisperer) with the leadership teams within the local authority and RSL sectors at a time when the then Blair Government had invested large sums into improving public housing stock through the Decent Homes Initiative. At Sureserve, he quickly set to work restructuring the business, cutting costs and selling two problematic divisions of construction and property maintenance to focus on the compliance and energy services operations. Once on an even keel, he handed the reins before stepping down to Peter Smith, a former executive at British Gas and CFO at MITIE, 60p, last November.
Two divisions
As currently constituted, Sureserve reports across two main divisions, which in the year to end September ’21 generated earnings before interest, tax and amortisation as follows:
• Compliance Services (£13.9m);
• Energy Services (£3.4m).
Compliance Services
The bedrock of Sureserve’s business is Compliance Services, which grew revenues 18% to £162m and operating profit 18% to £13.9m (80% total) last year.
Three quarters of divisional turnover is derived through the provision of domestic and commercial gas heating services, including annual services for boilers alongside related repair and maintenance works, with the majority of business on behalf of local councils and registered social landlords (RSL).
The other quarter is derived from the supply, installation and maintenance of fire safety and security systems including sprinkler systems, fire detection, alarms, retardants and checks on wiring; water and hygiene services, such as legionella control, water hygiene, microbiological sampling, water treatment, ductwork cleaning and grease extraction compliance; and lift installation and maintenance services.
Multi-year contracts
It’s a great business because the group typically receives a fixed fee for these works (c. 1/12th of annual fee recognised each month) on multi-year contracts, linked to inflation and 80% of divisional sales are recurring in nature. The real skill is scheduling its 2,500 strong workforce, 80% of which are front-line engineers, to manage the call-outs in the most efficient way possible in order to protect margins.
Sureserve attends to these jobs via a network of local offices operated by three subsidiaries, Aaron Services (East, Midlands), K&T (London, South East) and Sure Maintenance (UK wide). These businesses are all 30 years old and over the years have developed in-house propriety scheduling software to ensure best utilisation of call-out staff. There is an element of seasonality to the business with the better weather in the summer prompting fewer call-outs and cold winters generating more. However, proof that the new management has the mettle for the challenge is shown by EBIT margins lifting from 5.2% in FY’18 to 8.6% in ’21.
As I mentioned, Sureserve picked up £417m of new business last year but Smith still believes there is plenty of runway left and interestingly it only holds a 9% share of the £1.17 billion UK gas services market. Smith aims to grow partly through incremental gains from existing clients such as a boiler needing to be replaced or an RSL needing to upgrade a plant room (which houses the lift mechanism and fire electrical systems) in a block of flats. But the real gravy is in tendering for new contracts. Traditionally these lasted 3-5 years but since the Pandemic they’ve increased in length and last year’s wins included a huge £140m 10 year contract with the Guinness Partnership and a £36m 8-year contract from PA Housing, both long-standing customers.
Tendering weighted to quality
I had assumed that new business is mostly won on price but not so, says Smith. In fact, 60-70% of the weighting ascribed to contracts out for tender is based on a quality metric and only 30-40% is weighted to cost. That’s largely because local authorities and RSLs must comply with strict laws, such as the 1974 Health & Safety Act, Control of Substances Hazardous to Health (2002), Water Supply Regulations (1999) and Lifting Operations and Lifting Equipment Regulations. On top of that social housing tenants have rights under law to expect minimum standards of heating. As Smith says, clients want to know Sureserve has the capacity and skills to fulfil its responsibilities and currently it wins around 2 out of every 3 contracts it pitches for. Contract renewals are running at an impressive 80%.
Energy Services (20% profit)
While the Compliance business already provides an attractive backdrop for the shares, there are further grounds for optimism based on the stellar progress of Energy Services, which increased operating profit 325% to £3.4m last year on a 40% jump in sales. This side is focused on regeneration of housing, again funded by central and local Government, in order to improve fuel poverty through installing (and maintaining) better insulation such as loft, cavity and internal wall and other renewable energy capabilities such as heat pumps and solar PV and associated battery storage.
Three quarters of revenues come from Everwarm, a Scotland-based subsidiary whose customers include Aberdeenshire, Renfrewshire and Ealing Borough councils. It has a 16% share of the £147m Scottish insulation market but is much smaller outside Scotland. Unlike in compliance, there’s no guarantee of revenues as such but momentum is driven by the urgency of Government to achieve net zero by 2050 and fuel poverty targets.
The remaining quarter of energy services comprises a business (Providor) that installs smart meters on behalf of three large utilities, Scottish Power, EDF and Octopus Energy. Revenues are based on the level of installation activity alongside recurring asset management fees, although Providor does not currently own the meters.
Acquisitions likely
Sureserve is a highly cash generative business and has swung from net debt of £11.4m at FY’18 to net cash of £16.5m at ’21 and Smith is determined to put this cash, alongside that debt facility, to good use through further acquisitions.
Within Compliance this will be in the form of in-fill gas service businesses to improve its geographic coverage and utilise their staff, vehicle fleet and contracts. Smith says he knows them all pretty well – rivals include British Gas-owned PH Jones, T Brown (South East based), Liberty Gas (North West), BSW and Swayle - and would expect to pay c. 4-5x EBIT. Within renewables he is aiming to buy in expertise in the areas of solar, lighting, battery technologies and heat pumps with the target ideally making revenues of £5m-£15m and EBIT margin of 10-15%. Such a deal would likely cost 6-8x EBIT, he says.
Slater increases stake
One final point in its favour is that Sureserve’s contracts provide a block of strong earnings visibility and its order book already covers 73% FY’22 revenue, 46% FY’23 and 33% of FY’24. Anyone buying the shares is in good company; Slater Investments, the investment vehicle run by Mark Slater, recently increased his holding to 15.16%. Trading on a PE of 10.4 falling to just 9.7, the shares are cheap. I am a buyer.
