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Sparking up an investment in electrical contractor T.Clarke (CTO)

Important: What follows is not a recommendation to buy or sell T.Clarke. I’m a private investor, storing and sharing notes. Read my disclaimer.

Name:      T.Clarke
Ticker:    CTO
Listed:    London (FTSE Small Cap)
Business:  Construction and materials
More info: Digital Look / Google Finance
Company:   T.Clarke website

Key numbers for T. Clarke (10/02/09)

(From Digital Look)

Share price:        125p
Market cap:         £50 million
Debt:               None (Net cash £26 million)
Range (year):       106.25p / 190p
P/E(08/09/10):      12.1 / 6.0 / 8.5
PEG (Latest/Fcast): 0.1 / n/a
Year end:           31st December
Yield:              9.6%/11.3%
Div cover:          1.2 / 1.6

T.Clarke: An interesting income story

Who would buy a construction company in the teeth of a recession? Only an idiot, surely? Only… your humble writer.

Before you click away to read the latest dire economic update on Robert Peston’s BBC blog, let me explain my thinking.

T.Clarke isn’t any old construction company. It’s a premier electrical contractor that can trace its roots back over 100 years.

From the official T.Clarke website (which features an exemplary investor’s section):

In a history that spans three centuries, starting with the electrification of Royal Palaces, Country Houses and State Buildings, T.Clarke have been selected to work on many of the country’s great landmark construction projects.

In that time, the company’s ethos and principles have remained constant. Today, just as in 1889 when Tommy Clarke won his first contract.

T.Clarke has as far as I can tell a solid, cautious management, and has been winning a string of prestigious contracts in recent times. Most importantly, its balance sheet is very strong.

How strong? Well, it was holding £26 million net cash as of its November 2008 interim statement, after paying its October dividend.

The market cap is currently £50million, so this is a company priced at only twice what it currently keeps in pound notes under its mattress.

Then again, the company needs to generate a lot of cash, given the large dividend it’s paying out.

Can T.Clarke keep paying its dividend?

The analysts’ consensus has T.Clarke’s dividend per share increasing to 13.31p for the year ending December 2009.

According to Digital Look there are 39.5million shares in issue. I therefore make its total annual dividend commitment a shade over £5.25 million per year.

Last year’s annual profits were £12.72 million, which would more than twice cover the dividend.

In normal times, you’d snap up shares on a forward yield of c.11.3%, which is an awfully large income stream compared to risk-free cash saving rates of around 3%, and around twice the dividend yield of the FTSE 100.

But these aren’t normal times. Yesterday, UK Government minister Ed Balls said the UK faces its worst recession for 100 years!

That abnormally high-yield is telling us that the market believes the dividend will likely be cut. Digital Look’s figures above show the P/E rising for the year ending December 2009, which is due to analysts expecting a fall in profits of c. 30%.

The question is whether the market is right, or over-fearful.

The threat to T.Clarke’s profits

There is every reason to be scared about T.Clarke’s revenues dwindling, for sure. The UK is in the grip of a severe commercial property slowdown, and partway through what could be a long and deep recession.

To pick just one of endless gloomy construction reports:

The construction industry is facing its sharpest decline for nearly 30 years and with little or no prospect of any turnaround in the short term, employment levels across the industry are expected to fall sharply throughout 2009.

However not all construction projects – and not all construction companies – are the same.

In my view, much of the contraction will (and has) hit residential housing, where it’s likely to be small independent contractors who suffer worst.

T.Clarke, and its network of local subsidiaries, frequently tackles more complicated construction projects, such as schools, hospitals and shopping facilities like the new Westfield Centre in West London.

You’d pre-order a bag of magic beans before you banked on more shopping centres materialising in the next few years, but other infrastructure projects could prove fertile for T.Clarke.

The UK Government is bringing forward £3 billion of capital spending in the next two years, more than a third of which will go on schools and other higher education projects. (Source: Investor’s Chronicle January print edition).

Then there’s the work on the Olympic facilities in East London, which might actually prove the first Olympics to earn its keep by helping to tide over construction companies who win a place at the table.

With its long track record of winning roles in major projects, T.Clarke could conceivably thrive as it provides bolt-on professionalism and cost-control to these sorts of projects.

On the other hand, plenty of the UK government’s public spending firepower has already been spent over the past decade, so don’t expect a President Obama-style infrastructure spending bonanza from Gordon Brown and co.

And it goes without saying that the consumer slowdown could spread from housing and shopping into the wider economy, regardless of near-zero interest rates. Just ask the Japanese.

Positive comments from T.Clarke’s chairman

The last two Interim Statements from T.Clarke do provide some reassurance.

On November 19 2008, the company said it had a fairly resilient order book, though it was cautious on 2009:

Overall, the Group is in good health and the business remains resilient. We have good visibility, albeit at lower levels than at the same time last year, and the order book for 2009 going forward stands at £180m. The Group has a strong balance sheet and we are dedicated to returning value to our shareholders.

In light of the uncertainty in the financial markets, the Board is taking a more cautious view with regard to expectations for 2009. We are of the opinion that although markets are challenging, they are likely to stabilise during late 2009 with the Group seeing an upturn in market conditions in 2010.

On the 13th January 2009 it confirmed it had won an Olympics contract, plus two other high profile gigs:

Following the announcement in November that the Company was preferred bidder on the London Olympic Stadium, T. Clarke’s London team has commenced work with Team Stadium on construction, completion of which is due in early 2011. The 80,000 seat stadium will form the centrepiece of the 2012 Summer Olympics.

Also, following the successful completion of the Westfield Shopping Centre at White City, London, T.Clarke is now the preferred bidder for the new Westfield Shopping Centre at Stratford, London, E15. This major retail development is located on the edge of the Olympic development site. When completed it will form part of the 13.5 m sq. ft Stratford City development.

The Company can also confirm that contracts have been exchanged with Brookfield in relation to the ‘Pinnacle Tower’ in Bishopsgate, London, EC2. The Pinnacle is a 65 floor, 1.5 m sq. ft commercial office tower development in the heart of the City of London. It is likely to be the City’s largest single commercial office building when it is completed.

As written above, I’d not put much store by a new shopping centre with unemployment approach two million souls – except that this is part of the Olympic redevelopment in Stratford, so very likely to be completed.

Best of all was the trading statement of 29th January 2009:

T. Clarke performed well during the year and, following a post year end contract review, is pleased to report that underlying operating profit for the year is expected to be significantly higher than current market expectations. While the Board expects to make certain provisions in 2008 for impairment of goodwill, reported profit before taxation for 2008 is also expected to be materially above current market expectations.

The Board remains confident in the resilience of the business going forward, despite these challenging times.

Electrical storms ahead?

Don’t take complete confidence from these statements, however. Electricals are one of the last elements that go into a construction project, which in my view means electrical contractors are lagging victims of a slowdown.

And that forward order book of £180 million as of November 2008 doesn’t even add up to a full year of revenue, which is expected to exceed £210 million for the year ending 31st December 2008.

Even landmark projects in London are getting mothballed, so big projects are definitely going to be harder to come by in 2009 and 2010.

Still, the company knows that better than you or me. And what we’ve seemingly got is a cautious management with a history of delivering what it says it will deliver.

If you look back to annual reports issued during the slowdown in 2003, Chairman Russell Race was not afraid to warn of problems ahead, and of falling profits. I’m taking a lot of comfort from the fact he seems broadly optimistic for now, against a very tough background.

Finally, when profits fell during that slowdown, T.Clarke continued with a progressive dividend policy.

You can’t buck maths – if revenues and hence profits are massively impacted by the deepening recession, the dividend will be toast – but that cash pile provides a fair amount of comfort.

In my view, T.Clarke’s dividend should get through 1-2 year slowdown intact. And with interest rates at 1% and the government spending tomorrow’s money today with abandon, that’s my expectation.

Economic Armageddon and you can kiss your dividend and any capital invested goodbye, however.

Director buying

The Chairman isn’t the only upbeat member of the management team. Other directors are positive enough to put money into T.Clarke. Three bought in January 2009:

Director             Price paid     Amount invested
Beverley Stewart     115.00p        £17,250.00
Victoria French      114.00p        £5,700.00
Bob Campbell         112.40p        £11,240.00

John Lee bought CTO in October 2008

I’m far from the only private investor who rates John Lee, the long-standing Financial Times columnist who invests in small caps.

Lee bought T.Clarke in October last year at 130p, saying in December:

“I am optimistic that T Clarke [and Vitec] will at least maintain their dividends – both are yielding around double figures.”

Conclusion: I bought CTO at 113p

If you were hoping for a killer statement where I revealed that T.Clarke was guaranteed to prove a good investment over the next couple of years, I’m afraid I can’t supply it.

All I can suggest you do is read up the annual reports and trading statements, and make you own mind up. (Note when you do so how plain the annual reports are. No glossy photos, no fancy covers – all pointers in T.Clarke’s favour, in my curmudgeonly view!)

There’s no rush to buy small caps at the moment, that’s certain.

Even if the market does start to recover in 2009 (and I’m less pessimistic about the economy than many), large caps are very likely to outperform small caps, so arguably new money should be going into beaten down blue chips, not risky £50 million construction companies.

For me though, a prospective yield of more than 11% makes T.Clarke a gamble worth taking.

I’ve only made a small investment, equivalent to just less than 1% of my total portfolio, and I’ve tucked it into an ISA so I can enjoy that 11% tax-free for as long as it lasts.

I made my investment on January 6th 2009, and paid 113p.

I’m currently showing a modest profit, but I have no great hope for the share price advancing during this year. Survival until 2010 and beyond with the dividend intact will certainly meet my expectations.

Note: Monevator takes no responsibility for the accuracy of this post. I may buy or sell at any time. Read my disclaimer.

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