Yesterday morning Arcadis reported 2Q13 results which came in below our and consensus expectations as profitability was adversely impacted by Continental Europe, (temporarily) higher costs in North America and ongoing pressure in Water. Management guides for FY13 Profit growth of 0-5% y/y while pre-result we were at +10% and consensus even at +14%. Also Operating Cash Flow surprised negatively blamed on items which should reverse during the second half of the year.
Change in forecasts:
Taking into account the pressure on margins, which we believe should recover from 3Q13 onwards; we trim our adj. Eps forecast for FY13 by 7% and for FY14 by 3%. We expect 0% growth in Net income from operations in Q3 and 1% in Q4. This compares to 8% over 1Q13 and 2% over 2Q13. Our FY13 Adj. Eps forecast now stands at € 1.47 and for FY14 at € 1.73. Our FY14 forecasts conservatively take into account a 4Q14 Operational EBITA margin of 9.0% for Continental Europe vs. >10% targeted by management.
End markets improving:
Arcadis’ backlog continues to develop well and is up 5% versus the end of the year. A positive surprise was the 7% improvement in the Continental Europe backlog vs. year end 2012 and the confirmation that Continental net organic revenues growth is bottoming-out (-4% in 2Q13 vs. -10% in 1Q13).
Especially the Buildings segment is performing well with net organic revenues growth at 9% in the quarter, supported by Emerging Countries. We expect this trend to continue, supported by € 70m 1H13 synergy wins by ECH and L&S on top of € 70m over FY12. Also Environment did particularly well with net organic revenues growth of 9% in the quarter (partly compensation from weak 1Q13). This is especially important as Environment has higher margins and represents almost 30% of Group net revenues. We disagree with the fact that Brazil social unrest could be a risk for Arcadis and we rather see it as a medium term opportunity as the Brazilian government should be enticed to pamper its citizens by investing in social infrastructure.
Over the coming 2/3 months there are no visible triggers on the horizon, while likely the 3Q13 results (end October)will show the first signs of “real” margin recovery combined with ongoing organic net revenues growth. Arcadis will update the market on its tri-annual Strategic Review (2014-16) in February 2014. We see room for further acquisitions which in the past have been a trigger for the shares. Also the sale of the energy assets (€ 20m BV) could be a positive as these activities are non-core and would free-up cash.
On our revised forecasts, and post yesterday’s share price correction, Arcadis is now trading on an adjusted P/E 2014 of 11.3x, an EV/EBITDA of 6.8x and a FCFE-Yield of 9.8%. With almost 20% upside to our TP of € 23 we lift our rating to Accumulate (from Hold).