Spotless Outlook Sparkles

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-Undemanding valuation
-Leading position in Oz/NZ
-Diversified customer base
 

By Eva Brocklehurst

Spotless Group ((SPO)), which provides facilities maintenance, has bettered prospectus and broker forecasts in FY15. Earnings were strong across most sectors with new contracts and acquisitions in the mix.

The company continues to benefit from the growth in aged care as well as a strong government maintenance sector. Resources remains the most subdued area in which the company operates, with base & township revenue below several broker forecasts. The commercial & leisure segment also slowed as a result of a deliberate move away from single service cleaning contracts.

Valuation is undemanding, in Macquarie's opinion, as the stock is trading at a 25% discount to global peers. When assessing the stock the broker takes into account the company's smaller size, Australasian concentration and short life as a recently re-listed company. This is countered by strong earnings margins and positive growth outlook, as well as a leading position in Australasian facilities management.

Macquarie forecasts 8.4% earnings growth in FY16, supported by acquisitions. This accelerates to 12.0% in FY17 as acquisition margins improve. The company has ample capacity for acquisitions and believes there is 1-2% further margin available over time. Spotless is currently bidding on an enlarged contract with Rio Tinto ((RIO)) and an outcome is expected by December.

There were some negatives in the report, with a delay in the NZ government laundry contract resulting in a 4.0% revenue shortfall in that area. Higher depreciation expense is expected in FY16, reflecting a full year of defence contract mobilisation. Still, the base business should benefit in FY16 from a full year of NSW and Queensland defence contracts, Macquarie maintains.

UBS assumes 6.2% profit growth in FY16 with incremental contributions from acquisitions and new contracts. The broker remains more cautious about margins, despite the success to date in expanding these. UBS forecasts an earnings margin of 10.8% in FY16. The broker remains attracted to the growth potential, strong industry position and the diversified, high-quality customer base.

Deutsche Bank also favours a more cautious margin outlook, lowering estimates to allow for the inclusion of lower-margin AE Smith installation revenue. The broker also assumes lower net working capital requirements. All up, the impact on FY16 means forecasts for 10% profit growth, with a robust 5.0% dividend yield.

Outside the resources sector, the environment is favourable, Citi observes. Earnings are stable and the competitive intensity favours this company as a scale player with back office synergies and a strong operating track record.

Furthermore, a dividend can be funded at an assumed long-run 75% pay-out and still provide head room for acquisitions without affecting covenants. The broker highlights the potential for net debt to grow by $600m in FY16 before debt covenants are threatened.

FNArena's database shows four Buy ratings. The consensus target is $2.28, suggesting 22.1% upside to the last share price. Targets range from $2.17 to $2.45. The dividend yield is 5.8% and 6.4% on FY16 and FY17 forecasts respectively.
 

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