The Guide to Investing in Stocks and Shares

Rok Group and Connaught Take a Hammering

Dan Tebbutt - A Shareworld Contributor

Published - 15th August 2010

Recently two building service firms have announced bad news and had their share prices hammered as a result.  Rok Group and Connaught are now both trading on a P/E ratio of less than 3.  But are they cheap? 

At a glance

2009 numbers	Connaught	Rok Group
Market cap	£22m (at 16.4p)	£30m (at 16.9p)
Revenue	£660m	£715m
Underlying profit after tax	£23m	£13m
Operating cash flow	£53m	£29m
P/E ratio	1.0	2.3
Debt	£145m	£52m
Net asset value	£168m	£106m
Tangible net asset value	-£47m	-£40m

Bad news

On 26th July Connaught identified an "urgent requirement for additional funds", and concluded that it will breach its banking covenants.

On 11th August Rok Group issued a trading update that reported "serious failings in the financial controls of the PHE [Plumbing, Heating & Electrical] business". 
As a result there would be a "material adverse impact on Group profit for the year".

The business

I don’t see anything fundamentally attractive in the sector that Rok Group and Connaught operate in.  The barriers to entry are low, and as a result they have little pricing power.  The effect on their margins is clear.  An anaemic economy and a budget-cutting government suggest that prospects for growth (or even maintaining existing revenue) are poor.

For a company in this sector to be attractive, it would need to either offer a high degree of safety (no chance of that in the case of these two), or be offered at a low price.

Connaught

It’s hard to see any way back from their present woes for Connaught.  If they cannot come to an agreement with their creditors then they face bankruptcy or at best a debt-for-equity swap that would effectively wipe out shareholders.  Even if they do struggle on, they are bound to face higher finance costs - and until they can reduce their mountain of debt they are never going to look like a solid prospect.

At best I think it would take Connaught 5 years to cut their debt to a manageable level.  And even then I don’t see them being worth a P/E ratio much better than 8 or so.  Discounting at 10% per year that would suggest a present value of about £100m, or about 75p per share.  I would only give that upside a 1 in 5 or so chance of happening - and almost all the alternatives would leave them worth nothing.

Given those odds, the present share price of 16.4p seems to be pitched about right.

Rok Group

For Rok Group I don't think the prospects are so poor.  This article on Rok Group suggests that they face about £10m of write-offs due to the PHE problems, but as they stated in their trading update this should still leave them with sufficient cash flow to reduce net debt and meet their banking covenants.  If Connaught do implode, then Rok Group could pick up some of their business, or at least be able to improve their margins in the face of declining competition.

On that basis I think Rok Group will probably survive, in which case they should be worth about £80m, or 45p per share.  That offers almost 200% of potential upside, although that still comes with plenty of risk attached.

I'm still pondering whether to pick up a few Rok Group shares.

UPDATE 8th November 2010: Rok Plc goes into administration, shares suspended at 18.5p