This is a detail look into Interserve segment analysis of their divisions. I did a piece on the fundamental of the overall business HERE.
To analysis their segment results, you need to use the following ratios:
-Return on segment assets;
-Capex to depreciation;
-Capex to sales;
-EBITDA less capex; and
-EBITDA less capex as % of EBIT.
Let’s get started.
Overview of Interserve’s divisions
First, we start with the EBIT MARGINS.
Looking at the different divisions, the equipment services stood out with EBIT Margins growing to 20% from 10% in six years. Meanwhile, the worse division is their UK construction because, despite rising sales and division manages to make fewer profits, while being burdened with too much liabilities. Their international support services fell from grace as margins fall from 14.4% to 3.06%, but their international construction division is recovering from a three-year hiatus.
Before we declare that equipment services, let’s look at their return on segment assets.
The equipment services saw improving returns that increased to 17%, but lacks behind UK Support Service and International Construction, both reporting 21.7% and 26.6% respectively.
Biggest Divisional Contribution
Which division(s) contribute more in profits than the rest?
There are two divisions, one is the UK support services division and the other is their equipment services division.
Starting with UK support services division, which is their biggest division, it makes up close to 47% of total group sales. Full-year profits have fallen by £11m from last year to £80.8m but it accounts for 70% of group operating profits.
Next, we got the biggest EBIT margin earner, the equipment services. Despite having sales of £224.1m it manages to earn £48.6m or 35% of group profits. That is impressive and would fetch a lot of money if Interserve decides to sell their best division.
Adding both the divisions’ profits together, let’s compare it to the company’s normalised operating profits.
You see both these divisions make up the majority of profits, despite accounting for 55% of group sales!
What value would Interserve get for disposing of their divisions, separately? (Sums of its parts)
This is the juicy section where I reveal how much each division would (hypothetically) fetch in the market.
P.S. The value, multiples and write-downs given are based on the sector averages, with the added risk to political risks along with Brexit uncertainties.
You may have your own multiples that would be higher or lower than my estimates!
This is Interserve high-value asset, but how much will it fetch in the market?
First, the average operating profits growth comes to 24%, but last year growth slowed to 9.2%.
Second, it has net assets of £226m, comprising of £290.8m in assets and £64.4m in liabilities. So, we can assume the company holds little debt apart from payables, some provisions and pension deficits.
Third, it has a high EBIT margin of 21% and makes 16% return on assets. With £48m in operating profits, deduct 20% for taxes which leaves it with £38.4m after-tax profits.
Based on the above assessment, I would attach a 13-times multiple on after-tax profits giving it a £500m valuation. That valuation is higher than their current valuation and is more than twice the value of their net assets.
The reasoning behind this is because of the high EBIT margins (20%+) rather than the group average of 2%-3%. Add the above average return on assets.
The downside is we don’t know how much operating leases that equipment services are responsible for!
UK Support Services
Their most profitable division and biggest division.
First, the average profits growth is 23.2%, but last year it saw a decline of 12.36% meaning either things have got worse or this was a blip. I suspect the former!
Second, it has NEGATIVE net assets of £11.1m, comprising of £372.4m in assets and £383.5m in liabilities. So, you can bet it has a lot of obligations attached.
Third, the EBIT margin saw a gradual improvement to 4.5% and it makes a decent return on segment assets of above 20%.
Fourth, after-tax profits would come to £64m.
Given that it is responsible for a lot more liabilities and requires increasing capital to grow profits, but produces lower EBIT margin, then it is wise to attach a lower multiple.
So, I would give it a 4 to 7-time after-tax profits valuing it between £256m and £448m.
International Support Services
A former shining star.
First, this division average 18% profits growth, Today, it is producing zero profit growth.
Second, it has net assets of £55.2m, comprising of £128.6m in assets and £73.4m in liabilities.
Third, this division was Interserve best division with EBIT margins of 15% but has fallen from grace. Now, it earns a measly 3%, along with negative returns. With £8.2m in operating profits and deducting 20% tax gives it £6.8m in after-tax profits.
At best, potential bidders would pay no more, then the division’s net assets of £55.2m. The reasoning is lower EBIT margin.
UK Construction Services
First, it has average 33% negative profits growth, which saw their operating profits fell from £24.5m to an operating loss of £3.1m, despite increasing revenues.
Second, it has net liabilities of £179.2m, comprising of £255.4m in assets and £434.6m in liabilities. My suspicion would be that this division carries the bulk of the company’s liabilities.
Third, this division has the lowest EBIT margins, which is negative.
If Interserve sells this division, it would be a “write-off” division meaning a provisional impairment. Therefore, expect a writedown of £200m-£300m. Sometimes, these writedowns are not free of charge because the company wants to pay off some debt, therefore they would raise equity or do a Rights Issue.
Note: All this could come in disguise.
A turnaround division.
First, despite negative average profits growth of -2.8%, their latest profits growth is around 30%!
Second, it has net assets of £63.6m, comprising of £63.6m in assets and £0m in liabilities.
Third, EBIT margins have recovered to 5.69%. With £16.9m in operating profits and deducting 20% tax gives it £13.6m in after-tax profits.
This is an improving and recovering division with zero liabilities attached. Also, it has a decent EBIT growth and improving returns on segment assets. I would give it a multiple of 11 times after-tax profits valuing it at £149.6m.
Adding it altogether
Adding all the sums of its parts gives Interserve a valuation of £806.8m.
However, the group has net debt of £274.4m and pension deficits of £52.4m. After these deductions, Interserve has a valuation of £480m. Current market value has tumbled to under £300m.
But, the above information is based on last year.
Have the 2017’s interim results change Interserve’s valuations?
Starting with their UK Support Services, H1’s 2017 operating profit has fallen to £29m from £43.2m. I estimate the full-year number to come in at £55m, down from £80.8m last year. So, it leaves after-tax profits of £45m.
Also, I will lower the multiple ranges from 3.5 to 6.5 times, valuing it between £157.5m and £292.5m.
Their International Support Services saw operating profit (almost) wiped out as it comes in at £0.9m down from £6.5m, though it was an improvement from a loss of £0.3m in H2 16. Management is optimistic due to increased workload, but for prudence, I will knock £5m and value this division at £50m.
Their International Construction saw profits increased to £8.3m from £6m, a 38% increase. This will add more value to the business. However, there is growing political risks as operations are in the Middle-East, so I will leave valuation unchanged at £149.6m. Otherwise, it would increase to £200m!
Meanwhile, the company’s UK Construction saw an operating loss of £2m from a £4.5m profit. With the waste business disposed of, I suspect net liabilities to fall, but I don’t have confirmation of this. But, I will it the benefit of the doubt and improve write-down provisions from £200m-£300m to £140m-£240m.
This division performance remains relatively unchanged, but operating margin has fallen slightly. Valuation unchanged at £500m.
Here is the table showing sums of its parts on my forecast 2017:
Putting it together, Interserve’s sums of its parts is down to £734.5m. But, with net debt rising to £500m and estimated pension deficit of £75m, the market equity comes to £159.6m from £480m!
Higher debt levels have taken a lot of value in Interserve business making it expensive.
Thanks for reading and if you want to know about the overall fundamental of Interserve, click here for further analysis.
And, please subscribe and share this post.