Questor share tip: Mears still a long term buy

Mears
493p-8
Questor says BUY

SOCIAL housing and care provider Mears may operate in a not very glamorous sector but it offers steady dividend growth and returns for the patient investor. The results announced yesterday were fairly unflattering, causing shares to slide nearly 2pc , but dig a little deeper and there are plenty of signs this could be a buying opportunity.

Mears maintains social housing for local authorities and registered social landlords. The company has a fleet of vans and workmen who fit kitchens,

fix boilers and generally keep council housing serviceable. It also provides personal care in homes on behalf of local authorities. Social housing generates 83pc of group revenue and care services represent the balance.

Social housing maintenance has been a very tough market for the past five years. During the Blair years the “Decent Homes” initiative made it a lucrative business, but that finished in 2012, and when funding dried up from 2008 onwards cash got very tight, as shown by the collapses of competitors Rok and Connaught.

Mears did not escape and the shares suffered as investors feared for the sector, but the company weathered the storm and increased the dividend every year. It has now emerged with less competition, more business, and a better outlook. In fact, as competitors struggle, Mears has gone on the offensive, buying loss-making Morrison for £24m in 2012.

Some analysts questioned the wisdom of buying a competitor on its knees, why not just wait and pick up the contracts? But the purchase removed the bidding risk and David Miles, chief executive, said Morrison was now fully integrated and the recovery in trading was ahead of plan.

Mears isn’t even perturbed by the risk of a change of government and cuts to the social housing budget. Mr Miles said that 90pc of the group’s social housing revenue is paid out of each council’s housing revenue account, which has been ring-fenced from cuts. Local authority revenue accounts in London have actually increased by between 20pc and 30pc during the past three years because of rapidly rising rents, and this provides a bigger pool of money to spend on maintenance through Mears.

The care business has not delivered the rapid growth that was expected but the fundamentals remain of an ageing population who prefer to stay in their homes. The care business delivers a higher profit margin than the property maintenance unit, reporting revenue up 9pc to £123m and operating profit up marginally to £9.6m.

Mr Miles believes Mears is now well-placed. The order book was flat at £2.8bn but that provides certainty for 92pc of group revenue in the year ahead and 70pc next year.

Mears’ full-year results were uninspiring at the reported level, with statutory pre-tax profits edging up to £21.7m from £19.9m in the year before. However, the company went through a costly restructuring last year. Underlying pre-tax profits increased by 26pc to £36.6m, once costs of about £6m associated with sorting out troubled Morrison contracts and an £18.8m charge for selling a loss-making electrical and engineering maintenance business are removed.

The company has emerged more focused and is still highly cash generative. Mears generated free cash flow of £23m in 2013, and that covers the £7m paid in dividends almost three times. The group had net debt of just £500,000 at the year end, down from £12.4m a year earlier, and is expected to have net cash of some £11.6m by the end of 2014, according to Investec estimates.

The shares have had a strong run, more than doubling during the past two years and are now just off record highs. Mears shares trade on a forecast price-earnings ratio of 15.5 times,

falling to 14 times next year. With steady work flow and the possibility of more acquisitions this year, Mears looks like it could have a bit further to run yet. Buy.