Very few companies will benefit from soaring energy prices. Sureserve (SUR) looks better placed than most, however. The Aim-traded group has reinvented itself in recent years, shifting from construction and property maintenance into heating and energy, with a focus on social housing. As fuel poverty spreads this winter, the contractor’s services – which include installing insulation, smart meters, heat pumps and solar panels – are likely to be in high demand.
Sureserve had a difficult start to public life. After listing in 2015 under the name of Lakehouse, it spread itself too thin, struggled to digest an acquisition spree and failed to shrug off underperforming legacy contracts. Profit warnings followed and, in 2018, it was forced to offload its construction and property business. The group collapsed into administration the following year, owing creditors more than £27mn.
Lakehouse’s compliance and energy arm was the only division left standing and, from the wreckage, Sureserve emerged.
The group has learnt from past mistakes. It is now tightly focused on keeping buildings warm, and is selling off old businesses that “do not naturally fit with [its] longer-term ambition”, including two subsidiaries that test lifts and fire and electrical equipment.
It’s niche work, but management estimates that providing heating support for social housing is a £2bn market. Sureserve has a 9 per cent share already and aims to double sales and “significantly improve net margins” within the next five years. A new management team was appointed in 2021 to achieve this.
Two-thirds of Sureserve’s revenue comes from its ‘compliance’ division, which installs, maintains and repairs heating systems for local authorities and housing associations. While not particularly glamorous, the business generates steady recurring revenues, and social landlords are grappling with a growing number of mandatory service requirements.
More interesting is Sureserve’s energy arm, which deals in insulation, smart meters, electric vehicle charging points, heat pumps and other types of renewable technology. While operating margins are tighter here, it is still early days and the growth opportunities are obvious – if depressing.
In February, the group noted that “the political significance of fuel poverty remains high, with a government requirement to continue tackling this key social issue alongside a phased reduction in fossil fuel reliant systems”. Since then, the energy crisis has dramatically worsened, and low-income families face a frightening winter ahead. Client demand, therefore, should be high.
Analysts at Shore Capital expect energy services to grow faster than bread-and-butter compliance. However, they also flag several cross-selling opportunities among Sureserve’s major housing associations and local authority clients.
It’s not just about organic growth, though. Sureserve is an asset-light business with a solid cash position (if you strip away annual lease liabilities of around £11.5mn) and looks poised for a buying spree. Last December, the group acquired CorEnergy – a company that specialises in low-carbon technologies – to help drive its new strategy, and further purchases are planned. While these will partly be fuelled by the sale of the group’s lift and fire safety businesses, dividends have also been suspended to free up cash.
Investors might not be thrilled by this last point, but Sureserve’s strategy is bearing fruit. Operating profit has grown steadily since 2018, and customer relationships are deepening. In the six months to 31 March, the group’s order book jumped by 50 per cent year on year to £512mn. Some 96 per cent of 2022’s expected revenue is covered by the order book, which provides good visibility for the months ahead. Meanwhile, the average value for Sureserve’s long-term maintenance contracts is also growing, from £2.4mn in 2019 to £5.5mn today.
This is all well and good, but it is important to check that Sureserve is not being over-optimistic in its assumptions. In ourrecent cover feature (Spotting the Warning Signs, IC, 5 August 2022), we noted how revenue recognition can pose a problem for investors in construction and support services companies, if managers make overly bullish assumptions about a project’s future profitability before receiving any cash.
The way Sureserve recognises its revenue depends on the service it is providing. While gas services tend to be recognised on an ‘over time’ basis, for example, smart metering revenue is recognised at the point when control is transferred.
This seems to be a sensible approach. A common sign that something might be amiss is the appearance of large amounts of accrued income – or estimated expected revenue – on a balance sheet. However, Sureserve’s accrued income has remained stable at between £17.5mn and £18mn since 2019. Meanwhile, cash flow has generally been good, and the group reported a closing cash balance of £11.8mn (excluding leases) on 31 March 2022.
Changes to working capital have impacted the amount of cash generated from Sureserve’s operations over the past 18 months, which is worth keeping an eye on. However, the amount of trade receivables written off by the group is very low: in 2021, trade receivables overdue by more than 30 days accounted for just 3 per cent of the total sum.
“Operating in the environment that we do – and given who our customers are in terms of local authorities and social housing associations – once you send an invoice and you submit all the paperwork with the invoice, you do get paid,” chief financial officer Sameet Vohra told investors in May. “The history of bad debt in this organisation is incredibly low.”
The main threat to Sureserve is rising costs. In the first half of 2021, the group’s operating margin edged up to 3.7 per cent, from 3.5 per cent a year earlier. However, it remains extremely slim and chief executive Peter Smith warned that “there will be some pressure on margins in the second half”.
Labour costs are the real killer. Sureserve employs over 2,300 people and wages jumped by 22 per cent in 2021, compared with a 14 per cent rise in headcount. However, the group said that turnover remains “very, very low” at around 5 per cent.
There are other encouraging signs. Management said margins tend to be lower in the first half of the financial year because there are more reactive repairs and callouts in the winter. The fact Sureserve managed to grow margins – even if only slightly – during this period is therefore reassuring. Meanwhile, all company contracts have inflationary clauses built in, meaning costs can be offset by annual price rises. Management says that Sureserve’s long-standing relationships with local authorities and suppliers make these conversations easier.
Ultimately, costs will always be a worry for a company with skinny margins. However, that looks more than adequately compensated for given Sureserve’s defensive market position in a sector experiencing high demand. Neither should prospective investors overlook its status among other small companies: Sureserve was one of just four businesses across the FTSE Small and Aim All-Share indices which this week met all the criteria of our High Quality Small Cap screen, which ranks stocks against a variety of factors including value, return on equity, and historic and projected growth in earnings and operating margins.
London’s junior market has been having a rough time of late, down 28 per cent year on year. However, as energy prices pile on the pressure, Sureserve looks set to buck the trend.
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