Costain recovery gathers pace

I think most people have been surprised by the level of positivity being shown in domestic financial statements this summer. Yes, the likelihood of a technical recession following the shock Brexit vote is still a possibility further down the line, but confidence reigns supreme while the sun is out. In a nod to the health of the UK economy, the latest to report positive momentum is construction firm Costain.

Revenue surged by over a quarter to £791 million in the six months to 30 June and operating profit jumped over 20% to £15.8 million. But widening losses on its Greater Manchester waste Private Finance Initiative (PFI) contract, awarded in 2007, capped the increase in pre-tax profit at 13% to £11.3 million. Strip out one-off items and profit rose by nearly a quarter to £14.1 million.

The infrastructure division is responsible for the lion's share of growth, as customers continue to invest in the UK's transportation networks. This more-than-offset the £8.5 million loss from Natural Resources, weighed down by the £11.4 million loss from the Manchester waste contract.

Each of the 46 facilities has been handed over, but Costain is still spending time and money fixing issues within the defect warranty period - a common aspect in these contracts. As the plants are in operation, it's taking longer than usual, but Liberum analyst Joe Brent reckons this will finally be over in 2018.

However, in a sign that the UK construction industry is in good health, Costain boasted a record order book in June of £3.9 billion, 90% of which is repeat business. This gives it near 100% visibility for the rest of the year, and the confidence to boost the interim dividend by 15%. It had also secured £1.4 billion of revenue for the full-year by 30 June, £200 million more than this time last year.

There's also confidence regarding a post-Brexit world, too. In the short time since the EU referendum, Costain hasn't seen any impact on business, although it warns it's still too early to tell.

"However, we believe that, as a consequence of our strategic focus on the major customers who are continuing to spend billions of pounds addressing critical UK infrastructure needs, we have a resilient business and can see as much significant potential opportunity as any downside in the new environment," said chief executive Andrew Wyllie.

With its £17 million acquisition of hardware and software provider SSL after the period end and the successful integration of its £36 million Rhead Group buy last August, Costain is focusing on both organic and acquisitive growth to drive the company forward.

Mergers and acquisitions cost money, and Costain's cash pile shrank from £127 million to a £69.2 million during the period. It's expected to fall further to around £48 million following its SSL acquisition.

Outgoings also included higher working capital outflows as a result of its higher revenue, final dividend and pension contributions.

Attractively positioned

"The shares are attractively positioned to benefit from increasing infrastructure investment, as well as from management’s continuing focus on driving further earnings quality," explains Peel Hunt analyst Andrew Nussey.

"Moreover, the underlying FY 2016 net cash position of circa-£60 million provides management with options to not only maintain the pace of organic growth, but support further modest bolt-on acquisitions. The shares offer significant value."

Under pressure from the bearish trend line officially established in January this year, Costain's share price lost 16% from its 2015 high by the time of the EU referendum, after which losses doubled to over a third.

However, the share price has since bounced from the 267p low and broken above downward trend-line. Jumping 6%, the shares are changing hands for 369p. Liberum reckons the recovery can continue back to 2015 highs, with a 405p target price representing double-digit upside.

The shares are currently trading on 14 times forward earnings and with a 3.3% yield, changing to 12 times and 3.8% next year, respectively.

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.