Spie : Pressure on margins is set to gradually decrease

Publication date 28/03/2018 18:07 - Writing date 28/03/2018 17:50 - Equity data - Recommendation: Buy - Target: € 26.70 - Equity analyst: Christophe Chaput - [email protected] - +33 (0)4 72 68 27 03 - ESG analyst: XXX - Corporate Governance: Opportunity (2) - / - / - H1 trading update 27 April 2018 - - - - Although the increase in 2017 leverage was stronger than initially anticipated due to acquisitions and restructuring efforts, Spie is still a sound credit in our view, given its business exposure to the maintenance of existing facilities (around 70% of sales) and solid FCF generation. Strong FCF generation coupled with a return to organic growth and a pick-up in the group's 2018 margins (although limited to 10bp this year) should pave the way for a gradual improvement in leverage after a 3.5x peak at the end of 2017, despite dividend payouts and continued bolt-on acquisitions. - The 2.5x level remains realistic but is unlikely to be reached by the end of 2018 (rather in 2019 or 2020). We have not identified any outperformance drivers for the 2024 bonds on a standalone basis, given Spie's weak position with regards to its current ratings and a possible new bond issuance. - That said, the scenario of an acquisition of Spie by Engie is credible and, if it were to materialise, would lead to a substantial spread tightening. - We are maintaining our Buy recommendation to remain exposed to this possibility. - >Support factors - - Strong player in the European multi-technical services market (no.°3 behind Engie and Vinci) with a strong presence in Western Europe (38% of pro-forma sales generated in France, 32% in Germany & Central Europe and 22% in North-Western Europe) and a broad business portfolio (mechanical and electrical services, facility management, ICT services).- Solid FCF generation (€ 214m in 2017) driven by a low capital-intensive business model (€ 36m capex, i.e. 0.6% of sales) and structurally negative working capital (representing 1e26 days of sales).- Adequate liquidity with no major debt maturities before 2023. The pro-forma liquidity position at the end of 2017 (after bank refinancing) is € 1.21bn, of which € 608m in cash and € 600m undrawn revolver maturing in 2023. This is largely sufficient to cover the € 340m of other debts and seasonal cash flow.- Potential for improvement at SAG in margins (€ 15m remain to be unlocked) and working capital (-20 days of sales vs. -27 days for the rest of the group).Points to watch - - Decline in 2017 margins (EBITA margin of 6.3% in 2017 vs. 6.6% pro forma for SAG in 2016) given pressure in the UK (competition and sluggish demand), in oil & gas (weak demand) and in France's services sector (competition). A pick-up in margins is likely to begin in 2018, helped by a return to organic growth and restructuring/integration efforts.- Low positioning of Spie's Ba3/BB ratings in their category, especially following an increase in leverage from 2.8x at the end of 2016 (pro forma for SAG) to 3.5x at the end of 2017.- Dividends (€ 77m in 2016) and bolt-on acquisitions (11 deals in 2017 for incremental sales of € 321m), which were covered by FCF.- No financial covenants in the bond documentation.- High pension liabilities (€ 694m liabilities at the end of 2017).