Contractors are almost always in demand. Local and central government need someone to build and maintain the nation’s roads, railways and infrastructure, especially as the population expands.
Water companies need contractors’ building and engineering expertise to upgrade their assets. The public’s tolerance of sewage spills has long since been torn to shreds. Being a contractor used to be much more of a hair-raising business — it probably still is for smaller firms picking up shorter, fixed-price contracts but for big listed players, such as Kier, Costain, Galliford Try and Balfour Beatty, conditions have improved since the terrible antics of the industry brought down a giant.
Carillion’s collapse several years ago exposed short-sighted practices. The priority for the government appeared to be getting work done on the cheap, forcing contractors such as Carillion to take excessive financial risks. The fallout affected KPMG too, with slapdash audits costing it £21mn in fines.
These days things appear less precarious with big building and engineering contracts, often multiyear long, mostly drawn up on a cost-plus basis, so bidders are not required to shoulder rising costs that are beyond their control. Meanwhile contractors have focused on building their balance sheet strength and improving margins.
The work isn’t risk-free. Costain’s involvement in HS2 survived former prime minister Rishi Sunak’s decision to axe parts of the project but it could easily have been a different story. Costain is, however, dispersing risk by building up its water and sewerage expertise and it’s been winning significant contracts in the sector.
BUY: Costain (COST)
The construction firm has a strong pipeline of new work as water companies increase infrastructure investment, writes Jemma Slingo.
Construction and engineering group Costain seems to have both these matters in hand. Its adjusted operating margin edged up from 2.3 per cent to 2.5 per cent in the first half of this year, and it is on course to hit margin targets of 3.5 per cent and 4.5 per cent in 2024 and 2025 respectively. Newer contracts, increased volumes of work and a bigger mix of consultancy are all helping with this.
Meanwhile, Costain sits on a net cash pile of £143mn (including lease liabilities) and generated adjusted free cash flow of £14.2mn in the period. Analysts at Panmure Liberum argued that the strength of Costain’s balance sheet is “a differentiator as it allows the company to help its supply chain, especially in a tough trading environment”. According to their analysis, Costain is the fastest payer of invoices in the industry.
The strong balance sheet — helped by a new pension surplus — is also benefiting shareholders. Management reintroduced dividends last summer, and has announced another interim dividend of 0.4p a share today. It has also launched a £10mn share buyback.
There seems to be plenty more work on the horizon. Costain’s total order book and preferred bidder book sits at $4.3bn, up from £4bn last year, helped by a surge in demand from water companies. It won a further £500mn of new work from Southern Water post period end.
Costain has a chequered past, and contractors are still viewed with suspicion by many. However, the group trades on a very reasonable forward price/earnings ratio of 7.3 times, and Panmure Liberum thinks its free cash flow yield will jump to over 13 per cent next year.
HOLD: Antofagasta (ANTO)
Weaker production knocks interim sales but coincides with record gold and copper prices, writes Alex Hamer.
A copper and gold miner ought to have made out like a bandit in the first half due to record prices for both metals, but accounting adjustments and higher spending knocked Antofagasta’s interim profits. The Chilean miner reported a 5 per cent increase in Ebitda for the first half, at $1.39bn (£1.07bn). This was ahead of the $1.1bn consensus estimate thanks to a sales beat in the period. Full-year copper production is guided at the low end of the previous 670,000-710,000 tonne guidance, due to lower grades and recoveries at the Centinela mine.
That lower production outlook has also pushed up cost guidance to $1.70 per pound (lb) from $1.60 per lb, even with gold byproduct credits, which are deducted from costs rather than added to revenue on the balance sheet. The biggest mine in the portfolio, Los Pelambres, was able to capture the uptick in copper through consistent production. Its Ebitda climbed 17 per cent to $885mn.
Copper traded near $10,000 a tonne at times during the period and gold is sitting comfortably over $2,400 an ounce (oz), which also helped the balance sheet, given Antofagasta is in the process of an expansion programme that will raise output, at a cost of $6.4bn out to 2027.
The interim dividend is down a third on last year, at 7.9ȼ, but well ahead of Peel Hunt’s forecast of 6ȼ. The broker said a “conservative interim dividend” was salient, given the upcoming spending. Peel Hunt forecasts full-year Ebitda of $3.3bn, a 6 per cent rise on 2023. Antofagasta has largely held on to its gains from the first-half copper bull run. While it remains below the five-year average EV/Ebitda ratio of 11 times at 8.5 times, this is fair value given the capex plan.
HOLD: Mobico (MCG)
There was no return of the dividend as the focus remains on cutting painfully high leverage, writes Christopher Akers.
Mobico shares rose 13 per cent after the National Express owner confirmed it had kicked off a formal process to sell its North America school bus business and maintained annual guidance on the back of passenger growth and price increases.
A potential disposal of the school bus unit, which increased revenue by under 1 per cent in the half, was announced last October as a means of helping with debt reduction. The process is “progressing in line with expectations”, according to management.
Deleveraging the balance sheet is certainly key for long-term prospects. The debt position led to the suspension of the dividend last year, and the interim payout wasn’t reinstated here as the focus is on trying to get leverage down to a range of 1.5-2.0 times by 2027. Gearing was flat at 2.8 times at the half-year point.
Adjusted operating profit rose 24 per cent to £71.2mn against the same period last year, a result driven by growth in Spain and North America as losses were posted in the UK and Germany. The Spanish business, ALSA, delivered record first-half results as both regional and long-haul progress underpinned double-digit revenue growth and a 43 per cent surge in profit.
Management reiterated guidance for an annual operating profit of £185mn-£205mn. RBC Capital Markets analyst Ruairi Cullinane cautioned that “reaching the midpoint of Mobico’s guided range would require an unusually [second-half] weighted year”.
Across the year, the company expects to deliver about £40mn of cost savings, while pricing action benefits should flow through in the second half.
The long-term performance for investors has been dire, with shares down 85 per cent over five years. A lowly valuation of just five times forward consensus earnings reflects a cocktail of headaches, but tentative steps are being made in the right direction.
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