Hargreaves Services has underappreciated hidden assets: cash from the sale of its coal assets and the use of its land bank for residential use
I have often been surprised how slow the market is sometimes in recognising when a business transforms itself, especially in the small cap space. I believe my holding in UK listed small cap Hargreaves Services represents a deep value “Rembrandts in the Attic” play, a growing business backed by both attractive land assets and cash.
This article is for illustrative purposes and is not intended as investment advice.
Hargreaves Services, used to be a coal miner and is now a diversified industrial services group and a brownfield land developer. Its strategic transformation has continued steadily over the past four years, moving away from UK coal mining and into environmental services and repurposing its land bank into residential homes. Importantly for the rating and the attraction of the shares to a wider ESG focused investor audience, Hargreaves has now over the past few weeks exited all material coal related business activities ahead of schedule. In my opinion the shares tick all the valuation boxes, and enjoy catalysts to material valuation uplift thanks to its cash and attractive land bank assets. As this transformation becomes fully understood by investors, the shares offer stunning upside potential.
Investment Case: Transformational change in a business with sizeable hidden assets
Sale of coal inventory – bank debt eliminated
The transformation of the business away from coal continued much faster than anticipated. In December, Hargreaves sold all of its speciality coal to its German Joint Venture, Hargreaves Raw Material Services GmbH (“HRMS”), for a cash consideration of c.£24m. This was not only an important strategic step, it moves the Group into a net cash position (ex. Leases) and transforms the balance sheet. Analysts had expected Hargreaves to sell down its remaining coal inventories over the two-year forecast period and this transaction accelerates the process. This faster than expected exit from coal related activities releases the capital tied up in the coal business. The impact on PBT is neutral but the balance sheet benefit is immediate, eliminating net bank debt by the May year end (a £15m reduction compared to previous forecasts). The Group’s remaining coal stocks (i.e. non-speciality coal for heavy industrial uses) are expected to be sold to third parties over the remainder of the current financial year, which will leave Hargreaves with no material direct revenue streams relating to coal production or trading.
New Core Business Environmental Services Winning Contracts
The pivot toward becoming an environmental services provider means Hargreaves has better growth prospects given the higher growth and longer term contract nature of the sector. Hargreaves has already been winning several new contracts in its industrial services division globally over the past year. In the UK, it has been appointed by Severn Trent Water to a three-year Mechanical Services framework contract for the provision of maintenance, repair, removal and installation of both clean and wastewater assets. There is an extension option for five more years. In Hong Kong, the business has been appointed by CLP Power to two key contracts (three-years duration with extension options for two more years) at Castle Peak and Black Point power stations. The work here encompasses the maintenance, repair and refurbishment of boilers, condensers and critical components.
The Land Bank is Attractive to Residential Developers
Hargreaves had already conditionally sold 14 acres of land for £10m to housebuilders Cruden Homes and Bellway pending infrastructure works. Post period end, Hargreaves Land completed its first sale at Blindwells (to Bellway), an important milestone. Good progress is also reported at the Unity JV at Hatfield with the exchange of conditional contracts with Harron Homes for 200 homes on a 23 acre section of the site (completion 2023). Prospects for further land deals there and at the former Hatfield Colliery site near Doncaster look bright, too.
More recently, they announced a further sale of land at Blindwells, its major 1,600 unit residential development site near Edinburgh. Following the completion of the first sale of land at Blindwells to Bellway in January, Hargreaves Land has now exchanged a conditional sale contract with Persimmon for a further 12.9 acre parcel. Completion is conditional on receipt of detailed planning permission and the completion of infrastructure works to service the site. The Persimmon phase has a capacity for 192 homes including 30 designated as affordable. The minimum sale value of this phase is £9.3m, with one third payable on completion and two further equal instalments to be paid 12 months and 24 months later as infrastructure serving the plots is constructed. Completion is expected in the second half of the financial year ending 31 May 2022.
Recent Trading Update: Resilient H1& Positive developments post period end
In their recent trading update in December, Hargreaves has reiterated their full year profit expectations and confirmed that the Covid-19 pandemic has had a limited impact on business activities. The group trades on just FY22 P/E 9.5x, with a dividend yield of 8.2% so is attractive to both growth and income investors.
As expected, revenue and underlying PBT both declined during H1, primarily due to the phasing of works on HS2 within Specialist Earthworks. Group revenue was £92.0m (H1’20: £124.7m), resulting in underlying PBT of £1.1m (H1’20: £2.4m). An interim dividend of 2.7p was declared and the statement reiterated the Board’s intention to pay a 12p additional dividend alongside this year’s final.
Cash generation was a highlight of the period, with net bank debt reducing by 69% to £8.0m,
compared with £25.4m in November 2019 and £13.5m in May 2020. The position has been
strengthened further post year-end by the sale of Hargreaves’ remaining speciality coal business. This is expected to result in a year end net cash position (before leasing debt).
Impact on forecasts
The cessation of coal trading reduces revenue forecasts by £25m and £30m in the years ending 31st May 2021 and 2022 respectively and by £20m in FY23. However, the impact on underlying PBT is forecast to be neutral as a lower interest charge and an increase in Hargreaves’ share of profits from the HRMS JV offset the lost contribution from direct coal trading (c.£1m in FY’21).
- Hargreaves is a small cap business
- Land values may be impacted by a weak UK economy
- Contract wins are uncertain
- Environmental business services focus is new
I believe Hargreaves represents a low-risk investment given its extremely low valuation, its land asset backing and its cash rich balance sheet. There is every prospect that the shares will be materially re-rated as the markets come to recognise the transformation the group has undergone. Its environmental services business focus undoubtedly has better and greener growth prospects relative to coal mining. To aid its growth, the company has managed to unlock capital from coal activities to reinvest into this new core business. The group trades on just FY22 P/E 11x, with a dividend yield 7.2% so is attractive to both growth and income investors. As the group’s transformation becomes fully understood by investors, the shares offer stunning upside potential.
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