It gets relatively little attention, but more investors are recognising this company’s true potential and possible resilience in a downturn, writes analyst Edmond Jackson.
Perhaps the chart break-out at infrastructure and construction servicer Kier Group (LSE:KIE) is no flash in the pan on a sudden shift in sentiment – that supposedly inflation and interest rates will be coming down.
While plenty of investors are jubilant at UK retail price inflation marginally lower than expectations, I suspect core inflation will be stickier.
Kier shares have rallied 20% this month to 90p following a stronger-than-expected performance and prospects – with a string of serious contract wins. Serving a range of markets such as highways, rail, infrastructure and nuclear, an ultimate public sector bias may well be helping – versus private firms deferring commitments during uncertainty.
Mind, however, contracting is a fundamentally low margin business where any material setbacks mean losses. I have included data going back to 2014 in the table below, showing how the operating margin has never reached 2% and was negative in a third of those years. It may only need one major setback in a plethora of projects constituting £3-4 billion annual turnover, to result in a profit warning.
Low valuation and speculative resumption of dividend
Such inherent risks are why a low price/earnings (PE) applies. However, it’s unclear quite whether 4.8 times the recent consensus for Kier’s June 2023 year, reducing to 4.3 times the 2024 expectation, overdoes fear. Interestingly, a 4p dividend is targeted for 2024, five times covered by earnings, implying a near 4% yield.
Kier is currently capitalised at £400 million, barely 13% of annual revenue although, again, this relates to margins.
It is quite hard to rely on net asset value as a prop, given an end-2022 value of 108p a share was “backed” 136% by intangibles. And while a latest update cites better-than-expected net debt of £230 million, if higher interest rates persist then possibly Kier should prioritise debt reduction rather than restoring the pay-out.
Such factors, as well as Kier nearly failing in 2020 due to high debts, have made investors profoundly cautious. Yet this year’s stock recovery from 59p looks a classic case of “climbing a wall of worry”.
Kier Group - financial summary
Year ended 30 Jun
|Turnover (£ million)||2,907||3,276||3,998||4,112||4,220||3,966||3,423||3,261||3,144|
|Operating margin (%)||1.0||1.7||-0.3||1.1||3.1||-5.2||-5.9||1.3||1.4|
|Operating profit (£m)||29.0||57.3||-10.2||45.3||129||-205||-201||43.7||45.1|
|Net profit (£m)||10.0||4.4||-17.6||10.7||87.3||-210||-273||-0.3||12.7|
|Reported EPS (p)||15.8||39.3||-25.3||12.8||75.5||-126||-90.9||11.6||2.8|
|Normalised EPS (p)||56.1||58.0||72.9||65.3||81.7||98.7||80.8||51.7||17.8|
|Earnings per share growth (%)||-10.5||3.4||25.7||4.7||25.1||20.9||-18.2||-35.9||-65.6|
|Operating cashflow/share (p)||-8.5||168||172||130||111||-53.5||-37.9||22.8||16.3|
|Free cashflow/share (p)||-86.5||109||118||77.6||57.3||-73.8||-42.0||19.8||14.8|
|Dividend per share (p)||56.5||54.2||63.4||56.7||58.0||4.2||0.0||0.0||0.0|
|Covered by earnings (x)||0.3||0.7||-0.4||0.2||1.3||-30.0||0.0||0.0||0.0|
|Net debt (£m)||210||181||143||146||213||195||510||171||163|
|Net assets/share (p)||545||603||587||439||517||274||127||97.8||124|
Source: historic company REFS and company accounts.
Trend of improving operations and financial narrative
Interim results in March declared a significantly increased order book “reflecting a large number of contract wins across our divisions...this provides us with good, multi-year revenue visibility.”
Yesterday’s update in respect of the full financial year cites “strong growth in construction in the second half” (to 30 June), with the year-end order book remaining over £10 billion. So revenue and profit expectations are affirmed, despite recessionary fears, justifying a stock price fillip – up 6% on the news.
“Kier has won new, high quality and profitable work in its markets reflecting the bidding discipline and risk management embedded in the business.”
These have involved an appointment to a £5 billion “estate optimisation” contract with the Ministry of Defence, and also a £4.5 billion construction framework.
It means 85% of expected 2024 revenue is secured: quite an achievement barely a month into the new financial year.
As ever with contractors, specific margins are not disclosed; you have to assume responsible management takes on only what is value-enhancing, although there is hardly much “margin of safety”.
Despite inflationary pressures, management remains confident it can mitigate them going forward.
The update had further positives: year-end “net cash” of £60 million better than expectations, with “average net debt” of £230 million. A strict interpretation would be £456 million bank debt at end-2022 was significantly reduced towards the June year-end, and also cash of £317 million boosted. I find this hard to assume, and it should be better clarified. Mind also, £198 million leases (as of end-2022). At least the direction of balance sheet travel sounds good.
Moreover, a triennial pension scheme valuation has resulted in materially decreased deficit payments – reducing progressively from £10 million this latest financial year, down to £1 million by June 2028.
Balance sheet still regarded as quite weak
The fixed asset aspect is relatively modest: at end-2022, £32 million property, £122 million right-of-use assets, and £89 million investment properties. Intangibles comprised £655 million.
I am wary that trade payables may remain objectively high, despite a 5% reduction (end-2022 on 2021) to £886 million within current liabilities, while turnover remained a constant £1,536 million.
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This was 4.3 times the £207 million trade receivables within current assets. There were £34 million further trade payables under non-current liabilities. It leaves an impression that Kier has had a culture of thriving off suppliers and others’ credit.
At least this imbalance looks to be improving. Cutting trade payables was a key reason why interim operating cash flow up 35% to £66 million became a net £73 million outflow after working capital movements.
In the second half-year, a seasonal inflow of capital – particularly in construction – helped repay a £56 million, supply chain finance facility, pension obligations and a remaining £6 million HMRC Covid support.
Where does this leave the net interest charge?
At interims, net interest charge was £13 million and took 34% of £38million operating profit. That’s hardly the kind of base you want to see should the UK persist in a “stagflation” scenario with interest rates over 5%, instead of this week’s hope that inflation will now materially fall.
This is why it hardly helps for ambiguity on the net debt/cash position, although financial debt was overwhelmingly long-term, hence less exposed to interest rate variability.
We can but wait for the mid-September preliminary results.
Two years into a medium-term value creation plan
This followed a restructuring and recapitalisation in the 2021 financial year – aiming to cut the cost base, re-build the order book and raise performance measurement.
Progress this year appears slightly better-than-expected unless guidance was conservative, but again, management needs to update better on how the plan is evolving relative to challenges and opportunities.
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The context is a UK government commitment to spend £650 billion on infrastructure over 10 years, which seems unlikely to alter even if Labour takes power in 2024.
It may be relatively less risky than private housebuilding – where expiry of past support such as Help to Buy and the Covid stamp duty holiday, now conflate with mortgage uncertainty. Housebuilder equities have rallied this week, but for example S&P Global Ratings has just warned the effect of higher interest rates has yet to work through into mortgages, when fixed-rate deals need renewing.
Risk/reward profile should continue to improve
This stock has the benefit of remaining quite off-radar, with little attention given to yesterday’s update, due to a disruptive history. From 2014 to 2017, it traded nearer 1,200p but two big re-financings have meant dilution.
Barring a serious recession, I think Kier stands a good chance of proving relatively resilient despite “construction and engineering” coming across as cyclical.
With the stock up again this morning, with trades firmly on the “buy” side, possibly more investors are recognising that if Kier achieves earnings per share around 20p this financial year, then a multiple of six implies the stock can rise by another third. My concerns over the balance sheet may be quibbling when bigger factors look positive. Buy.
Edmond Jackson is a freelance contributor and not a direct employee of interactive investor.
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