We recently initiated research coverage on Fulcrum Utility Services and met with Nexus Infrastructure. Both are listed on the AIM market and both operate in the utility connections space. We believe there are a number of attractions in this industry.
Contractors in the utility connections market typically achieve a higher margin than general contracting businesses. Utility connections are more technical and tend to involve a higher proportion of skilled labour vs. a higher proportion of tradespeople in general contracting. Nexus Infrastructure’s connections business (TriConnex – 33% of its operating profit) generates an operating margin of 12%, with Fulcrum’s (91% of operating profit) exceeding this at 16%.
Payment terms in the industry also tend to be attractive, with revenue from developers typically received either upfront or in staged payments in advance of work for each stage commencing. In a growing market, utility connections businesses therefore tend to generate cash.
Historically, all new buildings across the UK were connected to the gas and electricity grid by the now Fulcrum Utility Services as a subsidiary of British Gas then National Grid. In 2000, in order to increase competition in the distribution market, Ofgem established rules for independent companies to provide connections and own/operate installed electricity and gas assets.
Now, the utility connections market is highly fragmented, with a large number of independent operators. Competition is generally segment (i.e. gas or electric) or region specific.
Whilst the UK economy is only expected to grow modestly in the next three years (Bank of England expects UK GDP to grow at 1.7% in 2018, 1.8% in 2019 and 1.7% in 2020), we believe there are significant opportunities for utility connections operators which offer a multi-utility service across a number of geographies to win market share. On top of this, there are brighter spots of the UK market such as housebuilding activity which continues to grow ahead of the wider economy.
Both Fulcrum and Nexus have clear strategies to win market share and grow organically. With entrepreneurial and ambitious management teams, both companies are also exploring M&A opportunities.
Fulcrum Utility Services
- Fulcrum already offers national coverage in the UK.
- Traditionally a gas business (12% market share), around two thirds of its connections business’ sales are for gas services only. Fulcrum is expanding its electricity capabilities, acquiring Dunamis for £20m in February 2018 (now 5% market share). It now offers a multi-utility service and has an aspiration to grow the electricity business to represent 50% of the connections business’ sales.
- 89% of Fulcrum’s connections business is generated in the industrial and commercial end markets, with the remainder from the residential sector. The residential sector is a growth area for the Group. It already counts a number of the larger housebuilders amongst its customers and we believe it is well placed to leverage these relationships in order to expand across the UK.
- Fulcrum has actively diversified its services, most recently adding Electric Vehicle Charging. There are opportunities to upsell this service.
- Alongside its core connections activities, Fulcrum has the ability to own the gas pipelines and electricity cables it installs, holding Independent Gas Transporter (IGT) and Independent Distribution Network Operator (IDNO) licences from Ofgem. Once owned, it can take recurring revenues from the gas and electricity that flows through its pipes and cables. Margins are extremely attractive here (46% operating margin in FY17) and assets require limited investment across their useful lives (>100 years). Fulcrum is investing in these assets, adding another element to the growth strategy.
- TriConnex, Nexus’ connections business, has offices in Braintree and Bristol. It is targeting geographic expansion into other regions, with the ambition to become a national player. The business is planning to open a third office in the Midlands in 2018. TriConnex already has a strong reputation with the large, national housebuilders in its current geographies. We believe it is well placed to leverage these relationships in order to expand into other regions.
- TriConnex has diversified its service offering to offer a full multi-utility service. Currently 100% of contracts take electricity connections, 97% take gas, 8% water and 20% fibre. There are clearly opportunities to increase the number of utilities provided on each contract. Electric vehicle (EV) connections is a recent addition for the Group and it is exploring battery storage.
- Currently 100% of TriConnex’ revenue is generated from the residential sector. It is exploring expansion into the industrial and commercial sectors.
- The Group’s second division Tamdown is a contractor providing infrastructure, civil engineering and reinforced concrete frame services to the residential sector. Tamdown is growing through diversification of its customer base (increasing focus on affordable housing and build to rent for example) and geographic expansion, amongst other things. Some of Tamdown’s largest customers do not currently use TriConnex’ services. Likewise, others only represent a small proportion of TriConnex’ revenue. We believe there are clear opportunities to increase market share by cross selling across both divisions.