I’m so concerned about the risks facing investors in Mitie (LSE: MTO) that if I owned the stock, I’d sell it today.
Imploding balance sheet
Ruby McGregor-Smith became Mitie’s CEO at the end of March 2007 and formed a formidable executive partnership with finance director Suzanne Baxter.
The table below shows some features of the balance sheet at the time Ms McGregor-Smith inherited it and at the last two reporting dates.
| 31 Mar 2007 | 31 Mar 2016 | 30 Sep 2016 | |
| Net assets (£m) | 204 | 415 | 225 |
| Intangible assets [of which goodwill] (£m) | 158 [148] | 532 [465] | 421 [359] |
| Goodwill as % of net assets | 73% | 112% | 160% |
| Net asset value (NAV) per share | 65p | 115p | 63p |
| Net cash/(debt) (£m) | 6 | (178) | (232) |
| Gearing | 0% | 43% | 103% |
As you can see, net assets grew impressively from £204m to £415m between March 2007 and March 2016. However, this was driven by a large increase in intangible assets — mainly goodwill from Mitie’s multiple acquisitions.
At 31 March 2016, the group’s healthcare division accounted for £107m of the total goodwill of £465m. Just six months later — in Ms McGregor-Smith’s last results before stepping down — the healthcare division goodwill was entirely written-off. Her successor, Phil Bentley, sold the business for £2.
The write-off and an increase in borrowings were largely responsible for net assets plunging between March and September 2016. In fact, NAV per share of 63p was lower when Ms McGregor-Smith departed than when she arrived (65p). And the balance sheet was considerably weaker: goodwill represented 160% of net assets compared with 73% in 2007, while net debt had ballooned to £232m (103% gearing) from net cash 10 years ago.
I suspect there’ll be further goodwill writedowns when Mitie releases its annual results later this month, with new boss Mr Bentley likely to do some serious ‘kitchen-sinking’. And I wouldn’t be surprised if there’s a discounted fundraising at some point — well below the current share price of 211p — to shore up the balance sheet.
It gets worse
Mitie (and its peers) have often been accused of opaque and possibly aggressive accounting, with much justification, in my opinion. There are a number of things in Mitie’s accounts that concern me, including the level of accrued income. This is revenue that has been recognised but not billed.
The table below shows accrued income as a percentage of revenue for Mitie and its peers.
| 2013 | 2014 | 2015 | 2016 | H1 2017 | |
| Capita | 8.1 | 9.3 | 9.4 | 8.6 | — |
| Interserve | 4.7 | 4.9 | 4.6 | 5.0 | — |
| Mitie | — | 8.3 | 8.5 | 10.6 | 12.8 |
| Serco | 8.0 | 6.0 | 7.1 | 7.6 | — |
Mitie’s accrued income as a percentage of its revenue has been increasing every year and, worryingly, is dramatically higher than its peers. Another disconcerting aspect to this is that at various points in time the four companies switched from reporting ‘prepayments and accrued income’ in one line to reporting them in separate lines.
Capita, Serco and Interserve did this in 2010, 2014 and 2015, respectively. Their prior year comparative numbers are consistent with those in their previous annual reports. However, in Mitie’s case (2015) the numbers don’t tally. There’s a £42.2m discrepancy. The company gives no explanation for it. It takes a nerdish comparison and reworking of receivables in the two annual reports to figure out that in 2015 Mitie retrospectively reclassified at least £13.3m and probably £42.2m as accrued income in 2014.
I’m expecting a writedown of accrued income in the upcoming results. And other nasties. Finance director Ms Baxter has followed Ms McGregor-Smith out of the door and new boss Mr Bentley has brought in KPMG to lead an independent review of the accounts.
These are just some of the reasons why I rate the shares a sell.
