RTC Group plc2018-06-16T12:18:31+00:00

RTC Group plc – Published 10/04/18

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Company Overview:

RTC Group plc.

Company Description.

“RTC Group Plc is listed on the Alternative Investment Market of the London Stock Exchange. It is focused on white and blue collar recruitment providing temporary, permanent and contingent staff to a broad range of industries and clients in both domestic and international markets. It has three principal trading subsidiaries engaged in the recruitment of human capital resources and the provision of managed services.”

“ATA is one of the UK’s leading engineering and technical recruitment consultancies. Supplying white and blue collar engineering and technical staff to a broad range of SME clients and vertical markets. Ganymede is focussed on the supply and operation of blue collar contingent labour into safety critical markets. Global Staffing Solutions predominantly provides managed service solutions for international clients.”

“Whilst non-core, the Derby Conference Centre, houses Group headquarters and generates additional revenue from letting spare capacity to external businesses in the form of office incubation and conferencing space hire.”

29, March 2018.

Index

FTSE AIM

Ticker

RTCR.L

Latest Close

52.3

52 Week High

79.5

52 Week Low

48.2

P/E (F)

6.8

Dividend Yield %

6.6%

Dividend Cover

2.1

Rating

Hold

CEO:

Andy Pendlebury

CFO:

Sarah Dye

Price Target

60.5

  • Scope for revenues to beat estimates in 2018 but gross margin will be key to the bottom line. A repeat of the 2016 or 2017 gross margin performance will likely see earnings per share fall to 5.8 pence, whereas a stable margin could mean EPS rises to 11.5 pence in 2018.

  • Smart Metering contract win is a material development for Ganymede but Network Rail headwinds are around the corner and may become pressing in the years ahead. Further contract wins or acquisitions are key to offsetting this pressure.

  • Recent earnings growth driven entirely by movements in the administrative cost base, which have been necessary to offset mounting revenue and margin headwinds. We assume a stable administrative cost base in 2018.

  • Margin pressures may well intensify in light of a tight labour market, winding down of Network Rail Control Period Five and looming bid process for Control Period Six.

  • Network Rail headwinds may explain increased emphasis on acquisitions. Acquisition strategy may be welcome in light of uncertain outlook although shareholders should expect to be called upon.

  • Share price rated at lower end of sector range. Earnings growth or a rerating are key to change here. A rerating seems unlikely but earnings growth would drive share price appreciation if the company gets its gross margin into line. A fair value for the shares is probably close to 60.5 pence at the present time.

Revenue trends and outlook

RTC revenue growth has remained solid in a challenging environment although selling costs have continued to rise faster than turnover, leading to a persistent deterioration in gross margin for the group between 2015 and the end of 2017. At the divisional level, this appears to have been driven by revenue pressures in Ganymede and margin pressure in ATA. Divisional margin pressures may well be the result of a tightening labour market or competitive pressures that are largely beyond the board’s control.

Source: 2017 Annual Results.

The deterioration has so-far been neutralised by reductions to the cost base below the line, enabling RTC to grow earnings notably over the period despite the advent of noncash charges like those relating to the past acquisition of RIG Energy. Indeed, substantially all of the earnings growth generated by the company between 2015 and the end of 2017 appears to have been the result of cost base measures rather than business growth.


Looking ahead, revenue pressures in Ganymede appear set to subside in the short term given the win of a smart metering contract with SSE Plc, which is to deliver £28 million to the top line between November 2017 and December 31, 2020. The contract win delivers meaningful revenue for the division and group as a whole. It also leaves consensus for a 1.8% fall in the top line to £70.4 million during the December 2018 year looking overly pessimistic.

However, there is more to the story. The 2017 year coincided with a marked increase in Network Rail demand for temporary and permanent staff in infrastructure projects and came ahead of planned reductions in headcount that take effect in the current 2018/19 year and persist out until 2024.

The client, which accounted for more than £20 million of Ganymede’s revenue in 2017, is set to reduce spending on agency staff by £19 million in the current year. Further, Network Rail’s strategic plans for Safety, Technical and Engineering work also envisage an annual 3% reduction in headcount in the remainder of Control Period 5 and throughout Control Period Six.

Both the permanent and agency staffing requirements of Network Rail throughout the looming Control Period Six, which runs between 2019 and 2024, is budgeted to be lower than it was during the current Control Period Five. Agency staff spending of £141 million is budgeted to be some 30% lower than the £198 million provided for Control Period Five.

Source: Network Rail, Infrastructure Projects Strategic Plan, page 51.

RTC discloses in its annual filing that one client in Ganymede was responsible for annual revenues of £15.5 million, £21.2 million and £20.4 million respectively in the 2015-2018 years. We assume this client is Network Rail.

On this basis, and taken together with budget data from the latest Network Rail strategic plan, Ganymede appears to have captured between 30% and 50% of Network Rail Infrastructure spend on agency staffing in the 2015-2018 period. It took 33% of the actual spend in 2016, down from 50% in 2015, and 37% of the budgeted spend for 2017.

Our best guess is that a proportional part of the £19 million reduction in agency spend pencilled in for the current 2018-19 year will also fall at the feet of Ganymede. This could result in a divisional revenue hit ranging between -£4.5 million and -£7.1 million. Put differently, RTC could capture between £10.1 million and £18 million of the budgeted spend for 2018.

This could mean Network Rail now poses a material revenue headwind. That said, the smart metering contract with SSE Plc may more than offset the impact of diminishing revenue from Network Rail in the current year. The company has given no guidance on the pace at which it expects to earn the contract fee although assuming a smooth and even run rate, the smart metering contract may add as much as £8 million to the top line in 2018.

Further contract wins could deliver material growth but failure to deliver here over the current year could stoke concerns about the revenue outlook beyond the current year.

Writing on the wall leads to increased emphasis on acquisitions

We suspect the notable and increased emphasis placed on acquisitions as part of the company’s future growth strategy, in the 2017 results presentation, was an acknowledgement by management of the headwinds that are around the corner. They see the writing on the wall.

After all, stalling revenue and a bottom line under pressure would deal a fatal blow to the board’s “turnaround” and growth narrative. With Network Rail clearly set to become a lesser contributor to revenue at RTC in current and subsequent years, the pressure is on for management to secure new work (or acquisitions) to preserve and grow the top line.

“The Board now believes the time is right for RTC to pursue a transformational acquisition plan…We believe we have a proven senior executive team to attract both the debt finance and new capital support that our ambition plans will necessitate. We see consolidation as a key industry imperative over the next 5 years,” – 2017 results.

The company has been succesful with acquisitions in the past and could be again although there are risks around target selection and integration, as with all acquisitions. Shareholders may well be called upon to fund this pursuit.

Balance Sheet

RTC has no term debt on its balance sheet and the company’s only liabilities are those relating to an an invoice discounting facility of £9 million and a bank overdraft of £50,000. The invoice discounting facility was drawn by around £4.7 million at year end, giving RTC net debt of 2.7 times Ebitda.

Given the nature of the facility, it is unclear how prospective creditors would view it should the company seek out debt finance to support an acquisition. If potential lenders were to view it as anything more than a liability in the strictest legal sense of the term then RTC may have trouble securing funding at viable rates. This would mean an equity raise becomes necessary.

Dividend

Interim and final dividends taken together amount to a payout of 3.5 pence for 2017, which equates to a yield of more than 6% that is covered a healthy 2.1 times over. The board has committed to a progressive dividend policy also. However, the outlook for the dividend will be determined entirely by events at the bottom line.

If our “blue sky” scenario materialises then there would be scope for continued growth of a meaningful dividend. In the event our “black sky” scenario materialises the level of dividend cover will fall below 2 times and doubts could grow over the company’s ability to sustain it.

Valuation

Consensus is for earnings per share of 7.7 pence in 2018, which leaves RTC trading at 6.8x forward earnings. Equally, the company is trading around 7x its 2017 diluted EPS of 7.54 pence. This is toward the lower end of the 6x – 17x range of multiples for comparable peers.

Shares have derated since early 2016 and are yet to be inspired by promises of higher revenue from the move into smart metering. This is the result of a deterioration in sentiment toward the UK economy and, likely, scepticism about the company’s ability to preserve or grow its bottom line.

We think a rerating is a long way off given the cloudy outlook for the company and pessimism toward the economy but, if RTC does deliver, then earnings growth can drive share price appreciation later this year although the prospect of further Network Rail headwinds in 2019 may crimp enthusiasm for the shares to some extent.

Model

We modelled two scenarios. In both the company suffers a -£4.5 million hit to Network Rail revenue in Ganymede that is offset by an estimated £8 million increase from smart metering in 2018.

The company refrains from further cost efficiency measures, non-cash charges recur at close to 2016 levels and the company sees interest expense return to £100,000. It pays a corporation tax rate of 19.25% and the share count remains steady. The only variable between the two scenarios is a change in RTC’s gross margin during the 2018 year, which has a material impact on gross profit that transfers down to the bottom line.

Under our “blue sky” scenario RTC earns a gross margin of 16.7%, which is unchanged from that seen in 2017. This could happen if RTC swaps existing Ganymede revenue, which came with a margin of 15.7% in 2017, for a larger amount of smart metering income with a superior margin of 20%. In this scenario RTC generates earnings per share of 11.5 pence, which would be an increase of 52% from 2017.

Under our alternative “black sky” scenario the 2015-2018 margin trend continues. A gross margin of 15.65% represents what would be if exactly the same rate of deterioration of a little over 1% seen in 2017 were to recur again in 2018. Under this scenario RTC generates earnings per share of 5.8 pence, which would be a 22% decline from 2017.

Summary

The interim update due in August will provide a steer on which of our blue and black sky scenarios is more likely to materialise in 2018. For now, we assume a blended average of the two scenarios is most likely, which would yield earnings per share of 8.65 pence for the full year. At a constant forward multiple of 7 times this implies fair value for the shares is probably close to 60.5 pence at the present time.

Should our blue sky scenario crystalise over the coming months then it would be likely to generate improved sentiment toward the company and lead to a wave of upgrades to estimates for the top and bottom line in 2019.

In the absence of further contract wins, or acquisitions, we think such upgrades would be foolish as Network Rail headwinds will mount further once into the New Year, which would create scope for much of the 2018 progress to be unwound.

As a result, and as things stand at the moment, we are tempted to view a year-end or New Year rise in the share price as providing an opportunity to crystalise profits although this could change. We will reassess this in August.

Should our black sky scenario develop, or were it to prove that we have underestimated the challenges posed by a lower Network Rail staffing requirement, then it would likely be very bearish for the forward outlook.

Baring in mind that this company can fare very poorly in an economic downturn and, given the late stage of the current economic cycle, it would be difficult to envisage a scenario where management are able to right the ship and repair investor confidence before things change. There may well be another two-to-three years left to go in the current upturn but this company is not one to have around the chest when the cycle turns.