Stockwatch: A beneficiary of Trump's bid to re-build America

by from interactive investor |

This stock coped pretty well during the downturn in 2009-10 and should prosper under Trump's infrastructure plan, argues companies analyst Edmond Jackson

How far should you look a gift horse in the mouth when this metaphor involves a cyclical stock?  

Keller Group, the world's largest ground engineering contractor, is listed in the FTSE SmallCap index yet, at 1,100p a share, it's capitalised around £800 million with a well-established financial record; earnings backed by a strong cash flow enabling consistent dividend growth despite quite hefty capital expenditure.  

Its chart is re-testing the top of a volatile-sideways range over the last four years, down as low as 644p at end-2016 amid challenges in Asia Pacific, but, unless the global economy – especially the US – disappoints, then its risk/reward profile weighs positively.

Mind its operating margin isn't great: the table shows down from an already modest 6.2% in 2015 to 2.5% in 2017, although such tables are prone to base on statutory than underlying results.  

Latest interims show an underlying operating margin of 4.6%, slightly up on 4.4% a year before, and last February’s 2017 prelims had 5.2% given Keller is second half-year weighted.  Such a ratio doesn’t make the stock ideal for growth investors and partly explains its see-saw share of recent years, if likely priced in given a price/earnings (PE) multiple around 10 times.    

Trump's America may continue to offer upside

Such an international contracting business has been doing well as the global economy enjoys cumulative benefits of central banks' stimulus programmes, most areas now enjoying growth.  

Macro-wise, the key question is how durable this can prove as trade tensions chip at confidence and debt levels climb ever-upwards, some analysts beginning to doubt the extrapolation of growth rates.  Around 50% of Keller’s revenue is US-derived, the group’s chief area of growth given the economy’s strong performance despite poor weather in January/February and President Trump appearing keen to support infrastructure improvements.  

Mind, the interims cite overall US residential construction growing 6% in the first five months, although June's figure (I noted last week) implied home starts stalling.  

Otherwise, US public expenditure on construction rose 4% year-on-year and private non-residential spend by 2%.  Managerially, Keller is "leveraging scale and expertise with increasing collaboration between the business units". 

Other chief regions are Europe, the Middle East and Africa around 30% (the UK only a small component, making Keller quite unaffected by Brexit) and Asia Pacific, which has had its difficulties but is nearing break-even.

Second half weighting yet management is confident

In the six months to end-June, underlying pre-tax profit is up 7% to £42.2 million on revenue up 8% to £1,075 million – or a higher 15% at constant currencies. Underlying earnings per share (EPS) advances 29% to 41p and, notably, the interim dividend by 24% to 12p per share.  

It's unclear whether this is prudently conservative - but at least marks confidence - than to review payout policy nearer the final dividend, as a breakdown of £367 million net debt for the period (up from £229 million at 1 January 2018) shows £71.4 million spent on acquisitions and £17.6 million spent on dividends.  

So, on the horse's mouth analogy, the gift of an interim dividend increase is being paid with debt, whether that reflects genuine confidence in H2 onwards or peak-cycle hubris.

Specifically the end-June balance sheet has near-term debt up 169% to £51.4 million and longer-term debt up 7.3% to £365 million.  

Probably management would say this is "optimising balance sheet structure" amid low interest rates: it cites net debt at 2.1% of annualised EBITDA (near to operating profit) as well within a covenant limit of 3.0x and, given seasonally much stronger cash flow in the second half year, is expected to reduce to 1.5% by end-2018.  

Financial growth benefiting from macro trends

Further progress is anticipated amid "broadly healthy markets" and, longer-term, "we remain positioned to benefit from the global trends of urbanisation and infrastructure growth..." as if cyclical fears are unjustified.  

I would dispute the table showing a projected fall in pre-tax profit from £123 million to £107 million this year as its 2017 normalised profit figure must have a different basis to the £98.7 million underlying pre-tax profit Keller reported last February.   

Last year's H1/H2 financial split was around 40/60% which, if reflected again, broadly supports the consensus for £107 million annual pre-tax profit.  

Keller's numbers and narrative are promising, although longer-term much depends on whether infrastructure spending can buck the risk around how private business investment is exposed to trade disputes unsettling confidence; and whether governments want to respect public debt constraints.  

President Trump seems unconcerned, deficit spending on infrastructure being a key element to "making America great again", hence Keller is a useful means of exposure to this, and also a hedge against Brexit undermining the UK and Europe.  We can debate the pros and cons of Trump but, in the medium term at least, it seems a fair bet he will spend to build.

Keller Group - financial summary           Consensus estimates
year ended 31 Dec 2013 2014 2015 2016 2017 2018 2019
               
Turnover (£ million) 1438 1600 1562 1780 2071    
IFRS3 pre-tax profit (£m) 52.0 28.2 56.3 73.9 111    
Normalised pre-tax profit (£m) 69.0 87.1 91.8 86.3 123 107 117
Operating margin (%) 5.1 5.8 6.2 5.3 2.5    
IFRS3 earnings/share (p) 42.6 -4.2 35.1 64.7 64.7    
Normalised earnings/share (p) 67.3 77.4 84.1 81.7 96.9 97.9 109
Earnings/share growth (%) 23.9 15.0 8.7 -2.8 18.5 1.1 11.6
Price/earnings multiple (x)         11.4 11.2 10.1
Annual average historic P/E (x)   14.7 12.4 10.2 10.7 10.3  
Cash flow/share (p) 156 179 89.8 144 31.5    
Capex/share (p) 62.8 85.7 97.5 110 110    
Dividends per share (p) 23.2 24.4 25.6 27.6 29.0 34.8 37.2
Yield (%)         2.6 3.2 3.4
Covered by earnings (x)         3.3 2.8 2.9
Net tangible assets per share (p) 254 223 237 353 407    

Source: Company REFS         

Cyclicality, but coped with 2009 relatively well

The risk of variability in construction related work is shown as recently as October 2016 when Keller had to warn how "very difficult" markets in Asia Pacific meant more losses in that Q3, recovery taking longer than expected.  But looking back, the 2010 annual report, at the low turning point of the economic cycle when construction markets were depressed in the US and much of Western Europe, Keller was coping pretty well.  

Pre-tax profit fell from £74.7 million to £39.6 million, and there was a £21.8 million impairment charge; yet the company was still paying dividends. Indeed, it raised its total payout by 5% to 22.8p amid 83% conversion of operating profit to cash, the group operating well within covenants linked to £94 million net debt.  Who knows what the next few years will bring, but Keller has been well-tested through one of the worst downturns.  

Bid target at any time

Conservative investors may see mounting risks for the global economy and an impossibility relying on anything Trump might do.  Admittedly, there's no specific driver to re-rate Keller - insiders have yet to add to their holdings now the company is out its closed period - although latest financials do support its stock near the top of its trading range.  

Note, however, this is "the clear market leader in the US, Canada, Australia and South Africa, with prime positions in European markets and a strong profile in many developing markets", which could appeal to a construction industry or other buyer, also with respect to its cash flows and as a play on the global infrastructure theme.  

The relatively open UK stockmarket has a long history of ceding quality firms to foreign control, and sterling could weaken further amid Brexit chaos.  Besides Keller's 2009/2010 record, this provides some comfort to portfolio buyers that its stock can be tucked away despite cyclical risks.  Speculative buy.  

Edmond Jackson is a freelance contributor and not a direct employee of interactive investor.

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