Interactive Investor

Stockwatch: I’m still happy to buy both these rival companies

They compete against each other, but analyst Edmond Jackson thinks there’s enough work around to make both businesses attractive investments.

19th January 2024 11:09

Edmond Jackson from interactive investor

Following my recent comments about Costain Group (LSE:COST), it is pertinent to note updates from Galliford Try Holdings (LSE:GFRD) and Kier Group (LSE:KIE) – whose shares rose this week after the infrastructure-related groups declared positive year-end updates. 

It’s as if such stocks are in a bull market since last year, which I think is explained by consistent demand from public sector infrastructure projects, versus still-modest ratings due to historic upsets on contracts. 

Since the companies operate on low single-digit margins, the question for long-term investors is whether these groups have learned from the past – so as to project manage and account better – and the industry landscape might also have improved as politicians compete to show they have infrastructure as a priority? 

Or, are they still just one bad slip-up away from a profit warning, and also not immune to UK recession? The extent of price/earnings (PE) ratings effectively hinges on such a risk/reward profile. 

Galliford Try sees strong momentum and numbers beat expectations 

This small-cap stock trades on 11x forward earnings versus Costain and Kier both on 6x, hence Galliford rose only from 240p to 250p following its update, despite a surprise element. Yet it has risen from around 150p a year ago and trades at an all-time high relative to highs of 155p in 2015 and 115p in 2007. Despite a dividend interruption over Covid, it sports a prospective yield over 5% with nearly twice earnings cover and a fundamentally strong cash flow profile – so something has to go seriously wrong for its chart to break down again.  

I made a “buy” case for Galliford at 97p equivalent (adjusting for share consolidation) in May 2018 after a three-year bear market, during which it had been afflicted by various exceptional costs from construction projects and time over-runs. The stock was recovering from a low, however and its narrative was improving. Galliford looked to be moving on from the Aberdeen Western Peripheral Route, absorbing £150 million of group cash and all divisions were on course for profit growth. 

Four years ago, it exited housebuilding when it sold Linden Homes and Galliford Try Partnerships to Bovis Homes for £1.1 billion overall – re-focusing on “building, highways and environment”. This has helped the group avert challenges other housebuilders have faced due to fluctuating mortgage rates and higher costs. 

While a 5% operating margin was achieved in 2018, relative to only 0.4% in the last financial year, back then UK housebuilding enjoyed a significant tailwind with the government help-to-buy scheme. 

Galliford Try Holdings - financial summary
Year end 31 Dec

 201820192020202120222023
Turnover (£ million)2,9321,4031,0901,1251,2371,394
Operating margin (%)5.2-4.7-3.60.80.20.4
Operating profit (£m)151-66.5-39.48.52.55.6
Net profit (£m)11886.93207.76.39.1
Reported EPS (p)121-46.5-29.49.15.58.1
Normalised EPS (p)1754.9-56.415.819.518.6
Operating cashflow/share (p)31.0-53.8-13755.919.731.6
Capex/share (p)4.73.31.31.94.32.0
Free cashflow/share (p)26.3-57.1-13954.015.429.6
Ordinary dividend per share (p)74.258.00.04.78.010.5
Covered by earnings (x)1.6-0.80.01.90.70.8
Return on total capital (%)15.1-7.5-27.55.81.73.9
Cash (£m)912591197216219220
Net debt (£m)-98.256.6-175-197-194-181
Net assets/share (p)614612109121119113

Source: historic company REFS and company accounts.

Presumably, Galliford has moved on from June 2018 profit being re-stated down by 22% due to errors in contract accounting, where the auditors received a reprimand from the Financial Reporting Council. A similar situation applied to Kier in respect of its 2017 accounts. I tend to think this as reflecting a low-margin industry, although public exposure of accounting discrepancies should have curbed motivation to cut corners. 

Revenue growth of 13% in the last financial year to June was significantly helped by increased “AMP 7 spending” – a latest phase of investment by the water industry. Management also cited “some delays to contract starts in response to rising inflation and delays in public sector decision making” – as if a chronic dilemma for contractors remained. Yet they added: “these delays have now eased and the resulting contract awards provide excellent visibility into the new financial year.”  

They now guide annual revenue to end June some 5% ahead of recent market expectations (£1,435 million up to £1,490 million) with similar effect to profit. Showing still how margin issues could affect the outcome; recent consensus has been for net profit to more than double in the current financial year from £9.1 million to £21.0 million. It hardly implies much operating margin. 

Earnings per share (EPS) of 21.1p were expected for June 2024, then 24.2p in 2025, hence some upgrading looks due there also. EPS should be modestly assisted by a recent buyback programme of 7.5% of issued share capital. 

End-December cash is up from £196 million to £209 million, although the 30 June accounts showed cash quite constant over those 12 months at around £220 million. Remember, contractors usually need that sort of cash to underwrite their ability to deliver on projects. Galliford’s cash generative profile does however mean no debt beyond £15 million of leases, although with goodwill/intangibles at 83% of £119 million net assets, net tangible assets per share are just 20p. 

I think a “buy” case still exists on a two-year view, if better to be diversified across the three contractors cited in this piece than focused on any individual stock.  

Kier rallies 11% after £100m drop in net debt 

Yesterday’s update cited the first half to end-December in line with expectations, driven by strong volume growth especially in construction. At £10.7 billion, the order book is up 6% on June and encouragingly 92% of revenue for the current financial year is secured. This excludes long-term framework aspects which present an additional opportunity.  

As for margin, there is reassurance about how “bidding discipline and risk management embedded across the business continue to drive the high quality and profitable order book.”  

Combining such revenue and margin aspects, a mid-single-digit PE looks harsh.  

But like Costain’s dividend being constrained a little longer by pension deficit funding, Kier’s weak balance sheet compromises medium-term pay-out recovery even though an interim dividend is guided for.  

Yes, net debt has fallen by £100 million to £141 million due to contract wins and adept cash management, but last June’s balance sheet had £1,240 million current liabilities – which did not involve borrowings – versus £1,012 million current assets. Quite the demon was £1,075 million trade payables (versus £189 million trade receivables) which begs the question if long payment processes aid operating profit. 

Management is highlighting recent debt reduction, but non-current debt rose anyway from £267 million in June 2022 to £319 million a year.  

Deducting £645 million intangible assets meant £132 million negative net tangible assets as of last June.  

The stock rating is only going to improve so far until the balance sheet does; the rating also affected by whatever sentiment prevails. 

Kier Group - financial summary
Year ended 30 Jun

 2014201520162017201820192020202120222023
Turnover (£ million)2,9073,2763,9984,1124,2203,9663,4233,2613,1443,381
Operating margin (%)1.01.7-0.31.13.1-5.2-5.91.31.42.4
Operating profit (£m)29.057.3-10.245.3129-205-20143.745.181.5
Net profit (£m)10.04.4-17.610.787.3-210-273-0.312.741.1
Reported EPS (p)15.839.3-25.312.875.5-126-90.911.62.89.3
Normalised EPS (p)56.158.072.965.381.798.780.851.717.818.3
Earnings per share growth (%)-10.53.425.74.725.120.9-18.2-35.9-65.63.1
Operating cashflow/share (p)-8.5168172130111-53.5-37.922.816.341.6
Capex/share (p)78.058.753.952.154.120.34.13.01.51.5
Free cashflow/share (p)-86.510911877.657.3-73.8-42.019.814.840.1
Dividend per share (p)56.554.263.456.758.04.20.00.00.00.0
Covered by earnings (x)0.30.7-0.40.21.3-30.00.00.00.00.0
Net debt (£m)210181143146213195510171163124
Net assets/share (p)54560358743951727412797.8124115

Source: historic company REFS and company accounts.

I drew attention to Kier as a “buy” at 90p last July with the rationale that a “status change” appeared under way as management declared a string of serious contract wins. If managed adeptly, Kier has a spread of markets in highways, rail, infrastructure and nuclear – a public sector bias helping, where privately–owned projects could be deferred during uncertainty. 

A triennial pension scheme valuation had also resulted in materially decreased deficit payments – reducing progressively over five years – after strong contract wins and cash management. 

Scope to take different views is shown by M&G selling half its near-10% stake on 3 January when the share price was 107p. This seems a manifestly duff decision, but the fund manager could argue, if essential risks remain, that the only way to reduce exposure materially is in a rising market. 

I also noticed amid yesterday’s price jump that if trade reports are vaguely accurate, then the magnitude of selling was well ahead of buying. Yet this can reflect essential dynamics of a bull market: buyers need supplying. If liquidity was poor, they would buy elsewhere. Given various “sells” of 200k to 500k, it will be interesting to see if a RNS soon shows M&G continuing to reduce – or whether it is content with halving their position. 

Like I made a “buy” case for Costain earlier this week, I think the same can continue to apply to Kier with fresh money.  

While M&G might not seem intelligent to some shareholders, it is a reminder how investor sentiment can remain edgy towards contractors. Yes, infrastructure is an attractive theme but consider diversifying within it.  

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

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