Can margin focus put Costain back on track?

A profits warning in June wiped 50% off its value, but is infrastructure group Costain over the worst?

Hopes of a rebuilding job at Costain (LSE:COST) were boosted today when interim results put shares in the infrastructure group back on the right road following June's hefty profits warning.

The stock rose 12% to 163.4p, although Costain is far from the 300p level seen prior to it losing of 50% of its value in the latest blow to fragile confidence in the sector.

Costain blamed June's warning on delays to the timing of contract start dates and new awards, particularly projects for the M6 smart motorway and southern section of HS2. Additionally, the M4 corridor improvement scheme at Newport was cancelled by the Welsh Government.

In today's interim results, new CEO Alex Vaughan sought to inject a note of optimism by reporting strong momentum in securing new work. Costain achieved £1.1 billion of new contract awards and extensions to existing contracts in the first half, with the order book now up to £4.2 billion from £3.7 billion a year earlier.

An ongoing drive towards services-led business meant operating margins edged up from 3.5% to 4%, but underlying earnings per share were still lower at 15.4p, from 16.6p for the same period a year ago. As expected after the profits warning, Costain cut the interim dividend from 5.15p a share to 3.8p to reflect a target for earnings cover of 2.5 times.

Investec Securities said today's pay-out implied a full-year dividend closer to 11p than the current forecast of 10p a share. With shares on a price-earnings multiple of 5.9x, Investec said Costain was trading at a deep discount to its five-year average alongside a 7% dividend yield.

Analyst Kellie McAvoy said:

"While it may take time for the track record and rating to fully recover, the extent of the sell-off appears overdone to us – and this morning's statement should be taken positively in that context."

Costain continues to expect a return to growth in 2020, with Vaughan's recently launched Leading Edge strategy set to accelerate the deployment of higher margin activities.

Complex programme delivery projects currently account for 65% of profits, but Costain wants to reduce this to 45% as business areas capable of achieving margins of between 8% and 10% achieve greater prominence. These include consultancy and advisory services and digital technology solutions.

Costain has also re-organised its divisional structure around two divisions of transportation (rail, highways and aviation) and natural resources (water, energy and defence).

It believes its markets are evolving at a rapid pace due to factors such as population growth and climate change, resulting in the need for clients to upgrade their investment priorities.

Vaughan said:

"With this enhanced strategy and strong market backdrop, underpinned by a robust balance sheet, we are focused on significantly enhancing the value of Costain."

Net cash is expected to be about £40-£50 million for the full year, with an anticipated increase in 2020 to £50-£60 million. The group also has total banking facilities of £191 million, which mature in June 2022.