A story of continued growth
UTW’s business grew again in H117 and the company recently set out plans to extend its growth profile to 2021. In the short term, changes to business practice and accounting treatment have led to a significant increase in our projected FY17 net debt figure, although our EBITDA projections for FY17 are little changed. Recent share price falls, resulting from the announced changes, have left UTW trading at a significant discount to market multiples and offering a significant yield (above 5%) for CY17 despite a dividend that is well covered by both EPS and (from FY18) FCF.
H117 results: Gain and pain
UTW’s H117 results were characterised by continuing growth in a number of key metrics but also a significant exceptional charge, changes to the business modus operandi and accounting treatments.
Underlying growth
Prior to exceptional items, UTW reported 11% growth in revenue, flat EBITDA but a 4% rise in profit before tax and a 5% increase in the DPS. The key figures shown in Exhibit 2 are prior to exceptional items, share-based payments and intangible amortisation. At the EBITDA level, a £1.4m increase from the Enterprise Division was offset by £1.4m decline at the Corporate business. We examine the divisional split in more detail later in this report.
Beyond the figures highlighted, UTW also achieved a 14% increase in UK customer numbers to 33,495, a 24% uplift in order book growth, to £50.2m, demonstrating improved productivity given the 6% rise in consultant headcount, and a closing order book of £28m (+9%). Of the closing order book, 89% is expected to go live in the next 18 months.
Exhibit 2: UTW H117 financial performance, before exceptional items, share-based payments and amortisation of intangible assets
|
|
H117 |
H116 (restated) |
Change (%) |
Revenue |
£m |
46.1 |
41.6 |
11% |
Adjusted EBITDA |
£m |
9.7 |
9.7 |
- |
Depreciation |
£m |
(0.4) |
(0.4) |
- |
Adjusted PBT |
£m |
9.4 |
9.1 |
4% |
Diluted EPS |
p |
9.6 |
9.6 |
- |
DPS |
p |
2.3 |
2.2 |
5% |
Exceptional Items
UTW incurred an exceptional charge in H117 of £14.4m. The most significant portion (£13.4m) related to an impairment charge to the carrying value (goodwill) of t-mac Technologies. While management remains confident of the longer-term prospects of the business, a more cautious attitude towards the short-term revenue generation potential has led to a diminution of value (as derived from UTW’s DCF model of the business). A smaller amount, £1.2m, related to legal restructuring and other costs. Set against the exceptional charges, UTW released provisions worth £0.25m (historic dilapidations provision).
Business practice, accounting treatment and cash flow
The new management team also made an important strategic decision regarding business practice, which has resulted in accounting changes and in turn prior year adjustments to the level of net debt. The changes to business practice will also lead to a one-off lower cash flow in H217.
Henceforward UTW will discontinue the practice of taking cash advances from suppliers. Historically, these advances took two forms: advances against future commissions earned on the sale of contracts from that supplier, and quasi loans. As commissions were earned on sales, the level of the advance was correspondingly reduced. The second form of advances, which were not dependent on commissions, took the form of loans, repayable at pre-defined times and levels.
As at 31 July 2016, UTW cash advances totalled £10.4m. UTW has decided those advances not related to commission sales, but that include cash repayments to the client that are not in UTW’s control, should more properly be regarded as debt and have therefore been reclassified as such in the balance sheet. Further, commission-related advances of £4.5m will be repaid in H2 and additional cash advances, totalling £9.2m, will not be pursued in the period, ensuring that by year end UTW will no longer have any volume related supplier advances on balance sheet. These changes, while not having a significant impact on FY17 income, have increased historic debt balances (Exhibit 3) and our forecasts for FY17, but should ensure a stronger relationship between cash earnings and reported earnings in the future. By putting its sales business on a more transparent basis, UTW believes it will enhance its competitive position and increase the rate of customer capture.
UTW also made prior period adjustments in respect of some of its own shares repurchased through an employee benefit trust as a hedge against share option exercises. The shares, formerly held as cash (£0.75m), will now be classified as equity “own shares reserve”. Despite the accounting changes and the resultant higher level of net debt, UTW remains comfortably within its revolving credit facility (£25m) and within its banking covenants (2.0x net debt/EBITDA).
Exhibit 3: Accounting adjustments
£m |
January 2017 |
January 2016 |
July 2016 |
(Net debt) prior to restatement |
(4.1) |
(10.2) |
(0.2) |
Supplier loans reclassified from trade payables to net debt |
(4.7) |
(5.3) |
(4.0) |
Loan value adjustment |
- |
(0.5) |
(0.5) |
Own shares reclassified out of cash |
(0.8) |
(0.8) |
(0.8) |
Net debt after restatement |
(9.6) |
(16.8) |
(5.5) |
The Enterprise Division is still responsible for generating the majority of UTW’s revenue (83% of group revenue in H117) and profits. After a record year in FY16, the Enterprise Division increased profits again in H117. Revenue rose by 20% in total in H117 (vs H116) and EBITDA increased by 18%, with the nascent European business moving into profitability. Significantly the business demonstrated improved productivity, with revenue and EBITDA growth achieved with only a 6% increase in consultant headcount (clients +12.7% during the same period). The rise in headcount, after limited growth in FY16 (+15 during the year), was achieved by a reduction in attrition rates from 39% in H116, to 25% in H117.
Telesales still accounts for the majority of the sales activity (c 72%) but only 23% of business is now generated from same supplier renewals (vs c 45% of total business in FY14). Nevertheless, given the nature of UTW’s business and the continued growth achieved, accrued revenue rose to £46.1m in H117. Encouragingly the number of UK Enterprise customers rose to 31,978 (vs 30,552 at FY16) and the closing order increased to £28m (£25.6m FY16). Of the closing order book, £13.7m is scheduled to unwind in the current year and 89%, in total, by the end of FY17.
Exhibit 4: Enterprise division
£m |
H116 |
H117 |
% increase |
Revenue |
|
|
|
UK |
29.2 |
34.5 |
+18% |
Europe |
3.4 |
4.6 |
+37% |
Total |
32.6 |
39.1 |
+20% |
Adjusted EBITDA |
|
|
|
UK |
8.0 |
9.1 |
13.% |
Europe |
N/A |
0.4 |
N/A |
Total |
8.0 |
9.5 |
18% |
Source: Utilitywise, Edison Investment Research
After a tough FY16, the Corporate business also suffered a difficult H117 (revenue down 19% and EBITDA down 87% vs H116). The performance did, however, show some improvement (EBITDA +£0.7m) versus H216. While energy procurement remained broadly flat, energy services, which comprises a much greater share of the business in the Corporate division than it does for Enterprise, suffered greater pressures. Revenue declined as a result of a deferral of some client plans for the roll-out of UTW’s technology and the loss of ESOS revenue (£0.6m), which benefited H116. The ongoing investment in the business, which depressed H216, also weighed on the H117 figures.
Despite the tough conditions there were some grounds for optimism and the management team remains confident on the outlook, pointing to continuing pipeline growth. Customer numbers continued to grow and the number of SmartDash meters rose to 11,811 (+119%). WiseLife, which is due for commercial roll-out in H217, is currently being trialled by 193 customers.
Exhibit 5: Corporate division
£m |
H116 |
H117 |
% increase |
Revenue |
|
|
|
Procurement |
4.3 |
4.2 |
-2% |
Energy services |
5.1 |
3.6 |
-30% |
Total |
9.4 |
7.8 |
-19% |
Adjusted EBITDA |
|
|
|
Procurement |
1.1 |
1.1 |
- |
Energy services |
0.6 |
(0.9) |
N/A |
Total |
1.7 |
0.2 |
|
Source: Utilitywise, Edison investment Research
A record of sustained growth
While H117 demonstrated growth over H116 (revenue +11%, PBT +4%), it also represented an extension of the period of growth achieved by UTW since its foundation in 2006 and its market listing in 2012. The progression of the FY revenue and profitability is shown in Exhibit 6.
Exhibit 6: UTW progression of revenue and PBT since 2009
|
|
Source: Edison Investment Research, Utilitywise
|
UK market opportunity for energy procurement
Although UTW is active in extending the scope of its business into other services and geographies in its search for growth, it continues to see a significant opportunity in the UK energy market for its procurement activities, in spite of the strong growth achieved in recent years. The potential market is estimated to consist of c 2.45m customers. The vast majority (over 2.1m) of these businesses are what UTW classifies as micro-businesses and would be serviced by the Enterprise Division. Large and upper-mid market clients would number only c 7,500 and would be serviced by the Corporate Division. With a total UK customer base of c 32,000, UTW believes it has significant scope to expand.
Figures produced by the energy regulator, Ofgem, support UTW’s assumption. According to Ofgem’s figures, 37% of the potential market for energy procurement contracts has never switched supplier, with 47% of those eligible to switch having done so directly. Only 16% of the market has used a TPI, and of this segment UTW estimates it has a c 12% share. Assuming that 80% of the combined FY16 turnover of the Enterprise and Corporate divisions related to UK energy procurement (80%×[£15.6m+£68.8m] = £67.5m) and assuming UTW services c 1.9% of the total market (12%×16%), then the total market would be in the region of c £3.6bn (£67.5m/1.9%). Of course it could be that the customers that have switched represent larger companies within the designated market, yielding greater revenue to the TPIs and overstating the size of the market in monetary terms. However, the figures suggest that there is still a significant proportion of the market that remains untapped by TPIs.
The strategic goals and priorities
Following recent changes to the management team, UTW has developed a new strategic plan, designed to capitalise on the opportunities in the UK energy procurement market but remaining aligned with the overarching target of continued growth. At its capital markets day, held at the beginning of March 2017, UTW set out the key elements of this new plan, including not only its strategic priorities but also the initiatives designed to deliver on its objectives. Exhibit 7 sets out UTW’s plan and we provide additional information in the following section.
Exhibit 7: UTW’s strategic plan for growth
|
|
|
Below is a summary of the key initiatives to be undertaken to provide the targeted growth.
■
“Optimising the Core” focuses on the approach to market (developing alternative sales channels), improvements in the operating model and productivity, some of which is already evident (H117 order book +25%, headcount +7%).
■
A “Digital Initiative” will seek to exploit the untapped market of 1.5m SME customers (84% of the market) that have never switched energy supplier.
■
The “Multi-Utility” initiative is designed to allow businesses to manage all their interactions with utilities on a single platform (UTW’s research suggests that 70% of customers want a multi-utility service). Currently UTW is working on adding water procurement services to its existing energy platform. We examine this opportunity in more detail in a later section of this report.
■
The “Service Proposition” will seek to drive recurring revenue from developing customer service plans using UTW’s IoT “Wiselife” platform, which is scheduled for rollout in the summer of 2017.
■
“Energy Services” is seen as an opportunity for developing UTW’s internet-enabled control devices, while “International Expansion” remains a medium-term objective.
UTW has identified a number of “enablers” that are crucial to the successful implementation of its new plan. The list of “enablers” includes people, organisation, technology, culture and brand. In this section we focus on technology as a key enabler and how UTW believes technology will allow it to capture new customers, increase productivity, diversify its route to market, deepen its relationship with the customer and differentiate itself from the competition.
We expect UTW to develop a digital interface with its client base that would allow the customer to sign procurement contracts online. Analysis carried out by UTW indicates that over 50% of SME customers choose online as a preferred source of information and UTW has observed that SME customers are behaving in an increasingly similar manner to domestic customers who use online switching sites to secure the most advantageous deals. Online switching capability would allow UTW to develop another route to market to complement its existing telesales partner channel and field sales and improve the efficiency of the business.
SmartDash, which is already operational and is currently deployed at c 11k clients, will also play a significant part in UTW’s digital strategy. SmartDash is UTW’s energy and water monitoring system, enabling consumers to monitor usage on an annual, monthly, weekly and daily basis, and enabling clients to receive a comprehensive consumption profile and insight, which can facilitate money saving behavioural changes. SmartDash can be used to monitor a whole business, a site only, or just part of a site, identifying peaks, spotting anomalies and reducing waste.
The WiseLife product is seen by UTW as a first step into the Internet of Things (IoT). WiseLife enables the user to control electrical devices from their phones or tablets, enhancing customer energy efficiency. For half hourly billed sites, strategies can be put in place to reduce demand at times of peak consumption, thereby reducing costs. In addition, alarms can be set to notify customers of irregular consumption patterns. WiseLife sits above existing Building Energy Management System (BEMS) and can be linked to other asset management systems including security and stock control. The product is designed to be easy to connect (10 minutes according to UTW) and is due to be launched formally this summer. In the meantime UTW is trialling the system with c 200 clients with a view to enhancing its usability. WiseLife will be available to customers as part of a subscription service, which will allow UTW to begin to develop a stream of recurring revenue.
UTW intends to measure its progress towards meeting its targets against a range of benchmarks. These benchmarks include: new customers, WiseLife Customers, Customer base, order book, water contracts, SmartDash customers conversion, cross-selling and net promoter score (currently +59). While UTW has not revealed explicit targets for each of these benchmarks, it has established clear targets for two important objectives: customer numbers and revenue from the energy controls market.
Specifically UTW aims to increase UK SME customer numbers to 130,000 by July 2021, equivalent to a market share of 7% of the micro SME and SME market combined. To put these targets into context, UTW had c 32,000 SME customers at the end of FY16 (c 2% of the market) and therefore UTW will need to achieve a CAGR in customer numbers of 33% in the period 2016-21 to meet its target. The target for revenue from the corporate energy controls of 5% (ie £75m), of the £1.5bn UK market by 2021, appear similarly ambitious.
Exhibit 8: Customer growth (UK only) and Enterprise division order book additions
|
2012 |
2013 |
2014 |
2015 |
2016 |
H117 |
Customer numbers |
|
|
|
|
|
|
Enterprise (n) |
10,000 |
15,333 |
19,966 |
25,185 |
30,552 |
31,978 |
Corporate (n) |
N/A |
550 |
662 |
991 |
1,427 |
1,517 |
Total |
10,000 |
15,883 |
20,628 |
26,176 |
31,979 |
33,495 |
Order book additions (£m) |
|
|
|
62.7 |
84.5 |
|
Source: Utilitywise, Edison Investment Research
The plan is designed to be implemented in the period 2018-21 and there are likely to be few short-term indicators of success. In turn, the market is unlikely to accord any short-term valuation uplift based on these targets. They do, however, remain useful in monitoring the progress of UTW towards its strategic objectives and provide a clear indication of the management’s view of the scope for further growth.
Developing the multi-utility model
Beyond targeting growth in its core UK energy procurement market, UTW is extending its multi-utility offering into the water market. UTW market intelligence shows that 70% of customers want a multi-utility offering. The entry into the water market marks UTW’s first step outside its traditional energy market core, but could be followed, over time, by forays into the telco, webservice and insurance markets.
Water
From 1 April 2017 the water market for non-domestic users in England and Wales opened to competition (Scotland deregulated 2008). The opening of the market has increased the number of customers eligible to source competitively supplied water from c 26k to c 1.2m. The size of the market, at £2.5bn, is large in absolute terms, but is significantly smaller than the UK energy market (£55bn).
To provide a broad brush indication of the opportunity available to UTW, we assume that the market of £2.5bn operates on a retail margin of c 3%, ie £75m. If UTW were to capture just 5% of the available market (£3.75m), and this were to be shared equally between the wholesaler and UTW, the potential additional revenue would be worth in the region of £1.5-2.0m. The figure of £2m, while not game-changing for a company the size of UTW, would provide an attractive addition to its revenue stream and could be augmented by the opportunity to sell gas and electricity contracts to any water clients not already using UTW’s energy procurement services.
UTW increased the H117 DPS by 5% as a mark of continuing confidence in the future of the business. Based on our normalised and fully diluted EPS figure of 19.5p for FY17, a 5% increase for the year would be covered 2.8x. We have reduced our FY17 forecast for DPS to reflect H117’s 5% increase but given the high level of cover and the improving cash flow that we are forecasting beyond FY17, UTW remains in a strong position to continue delivering attractive DPS increases.
Exhibit 9: UTW DPS – historic and forecast growth
(p/share) |
FY13 |
FY14 |
FY15 |
FY16 |
CAGR 2012-16 |
FY17e |
FY18e |
DPS |
2.6 |
4.0 |
5.0 |
6.5 |
36% |
6.9 |
7.3 |
EPS |
8.7 |
14.6 |
17.9 |
19.4 |
30% |
19.5 |
21.2 |
Cover (x) |
3.4 |
3.7 |
3.6 |
3.0 |
N/A |
2.8 |
2.9 |
Source: Utilitywise, Edison Investment Research