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Should I pile into Interserve plc, up 20% today?

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The share price of support services and construction company Interserve (LSE: IRV) is up 20% this morning as I write.

When shares break out upwards after a period of consolidation, the movement is often driven by an improvement in the underlying fundamentals of a business. In many cases, an initial lurch up can be followed by a further drift higher as the company’s outlook continues to improve and as the market digests better prospects for the firm.

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Ahead of expectations

The catalyst for Interserve’s move today is the release of an update on trading at the end of 2017 and the firm’s expectations for 2018. The outcome for 2017 turned out just as the directors thought it would when they updated the market in October. Back then they said that second half operating profit would be down to around 50% of the level achieved in 2016 and the company was on course to breach its banking covenants – ouch!

A string of operational problems and poor trading caused the share price to slide and today’s 120p or so is around 85% lower than the highs achieved during 2014. Anyone caught holding on through that move is looking at an investing disaster requiring an upward reversal of around 550% just to break even. It wouldn’t be surprising to find many investors cautious about the stock, but elements of today’s news are encouraging.

The firm reckons 2018 operating profit will be ahead of market expectations and its restructuring programme called ‘Fit for Growth’ will deliver benefits of £40m to £50m by 2020. However, there’s still the thorny issue of out-of-control borrowings and at the end of 2017, net debt stood around £513m. The covenant-can has already been kicked down the road a little with lenders agreeing to defer covenant testing until 31 March 2018, instead of at the end of the year, and the directors say constructive discussions with lenders over longer-term funding are progressing.”

An uncomfortable ‘hold’

Even now the firm expects debt to go higher and to peak in the first half of 2018 because of ongoing “significant” cash outflows from Energy from Waste operations, a normalisation of trading terms with the firm’s supply chain and exceptional costs. Looking ahead, the directors think future cash flows from the energy from waste business will be “broadly neutral,” but in the meantime, exceptional costs relating to restructuring actions and the current refinancing activity are piling up. The company plans to make a further announcement regarding its longer-term funding arrangements in due course, after discussions with lenders are complete.

So despite the turnaround potential, I reckon Interserve remains an uncomfortable place to be for shareholders. When I last wrote about the firm back in October, I said: “Interserve has proved the weaknesses of its business model. Multi-discipline contracting and outsourcing is a tough way to earn a living.” One look at the longer-term share price chart reveals how vulnerable the firm is to the ups and downs of economic cycles.  The extra operational problems layered on top of the cyclicality in the business make the shares doubly unappealing, so I will not be rushing to buy any of the firm’s shares.

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Kevin Godbold has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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