Stockwatch: Bosses buy into this 6.7% yield

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Stockwatch: Bosses buy into this 6.7% yield

Now the air is somewhat cleared by Carillion (CLLN) declaring a liquidation, is it time to consider other infrastructure and support service stocks, hard hit as this fiasco mounted?

Part of the dilemma is anything "PFI-related" staying in the frame for threats of Labour re-nationalisation or a windfall tax - as mooted last autumn.

Labour is already exploiting the Carillion debacle after the government continued to award it big contracts despite last July's profit warning.

The stock that currently intrigues - if quite horrifies - me is £1.1 billion Kier Group (KIE) in the FTSE 250 index (MCX), apparently yielding 6.7% covered 1.7 times by projected earnings and a robust cash flow record.

Its stock has just risen about 20p to 1,100p in response to declaring "no adverse financial impact" on joint ventures with Carillion on HS2 and the Highways England smart motorways programme.

Kier has changed quite a lot since I looked at it a good many years ago, the dilemmas of thin construction margins prompting diversification into PFI contracts and the like.

It has an accountant chief executive and, not surprisingly, has been busy with acquisitions, exceptional costs and running up debt/intangibles on its balance sheet. Yet the last update on 17 November was good, so let's kick the tyres.

AGM update affirmed double-digit profit growth

This was guided for the current year to end-June, in the following context. Services, 51% of profit in the last financial year, said to have an order book constituting over 95% of targeted revenue for the year, being "well-placed to benefit from new opportunities arising in the UK highways market".

Construction, 28% of profit, had likewise achieved over 95% of targeted revenue, "underpinned by the regional building business and delivering margins in line with expectations."

Property development, 13% of profit, was "performing well, with a return on capital over 20% and a development pipeline over £1.4 billion." Residential housebuilding, 9% of profit, cited strong sales aided by an extension of Help to Buy.

There was nothing in this update to suggest any weakening trends and the last acquisition - of utilities and infrastructure contractor McNicholas last July - was said to be "performing well".

Net debt had increased, if to a professed fair ratio to EBITDA of less than one times - though, as I shall explain, appears to be one amber light.

Insider buying; broker says 'buy'

On 17 November there were three buys of about £20,000 each, including the chief executive and his wife, then on 22 November another executive director's wife bought nearly £9,000 worth of Kier shares. Such trades were at prices from 1,022p up to 1,047p though the stock still dropped to 994p at end-November.

Investec had advised "sell" in October, albeit with a dividend forecast of 73.1p for the year to end-June 2018 and 75.3p in 2018/19; then, on 21 November, Peel Hunt advised 'buy', targeting £140 million pre-tax profit for the current financial year and £167 million in 2018/19.

Two other analysts had said 'buy' back in September with similar numbers, quite whether all this mainly reflects guidance.

Kier has stayed off short sellers' lists except for Old Mutual Global Investors which raised its short exposure by 0.02% to 0.5% on 3 October, and is also 0.61% short of Babcock International (BAB) and 0.9% short of Debenhams (DEB) as of 26 October - such positions showing adeptness, although Old Mutual has not appeared short of Carillion, which lately had 14.3% of its equity loaned out.

Published operating margins matched Carillion

Kier is quite similar in size to Carillion in respect of annual revenues rising from about £3.5 billion over £4 billion.

Delving into Kier's annual accounts to end-June 2017, the Company REFS table's operating margin of 0.7% appears harsh. After deducting £97.4 million costs (down from £148 million) relating to a two-year "portfolio simplification programme", the margin was 1.2% and, disregarding these costs, it was 3.5%.

The current critique is Carillion having assumed too many loss-making contracts and debt, its income statement apparently covering over them.

REFS citing £42.2 million normalised pre-tax profit for Kier's last year seemingly refuses to overlook these restructuring costs.

The company reported £126 million underlying pre-tax profit, which is more in line with consensus for £140 million this year, and should be far less weighed down by exceptionals.

Oddities within the claim of £110 million net debt

The 2017 results emphasised net debt up modestly from £99 million, being at the lower end of forecasts, yet the end-June balance sheet showed longer-term debt up from £303 million to £582 million, and there was also £50 million new short-term debt where none before.

The reason Kier proclaims stable net debt is period-end cash up from £187 million to £500 million, but the cash flow statement does not explain this satisfactorily.

Total net operating cash flow was £150 million, if benefiting from £66.6 million non-underlying items. Investing absorbed £82.1 million of this and dividends £49.4 million, but the £314 million increase in cash tallies only with a £368 million inflow from new borrowings.

It may underwrite dividend prospects in the short to medium term, but total debt is up from £303 million to £632 million, thus net interest costs are liable to rise from £19.5 million last year.

Negative net tangible assets have persisted since the 2014 year when £294 million intangibles arose from the acquisition of support services provider May Gurney, which "transformed the group's scale and diversity" e.g. in highways maintenance and utility services.

Mismatch of trade payables versus receivables

The Carillion fiasco has involved claims of 120-day payment periods slapped on suppliers; quite whether government was dragging its heels on payment also, but allegedly it helped Carillion cover black holes and report decent accounting period-end cash - e.g. circa £380 million at end-June 2016/2017.

So, it struck me as prudent to compare the balance of trade receivables versus trade payables, where year-to-year last June Carillion showed a fall in receivables from £1,439 million to £1,185 million (possibly better debt collection), while payables rose from £1,747 million to £2,000 million (despite a 10% fall in turnover) - on the face of it, affirming claims about delayed payments.

Comparing Kier's end-June 2017 balance sheet, trade receivables were quite flat at £531 million, also trade payables - but which at £1,434 million were 2.7 times trade receivables.

The only reason Kier escaped a negative ratio of current assets to current liabilities was the big jump in cash. All this cried out for clarification in the financial review, but there was nothing. At least a £70.2 million pension deficit is not as bad as £680 million at Carillion.

Kier Group - financial summary           Consensus estimates
year ended 30 Jun 2013 2014 2015 2016 2017 2018 2019
Turnover (£ million) 1,943 2,907 3,276 3,991 4,129    
IFRS3 pre-tax profit (£m) 25.9 15.4 39.5 -34.9 25.8    
Normalised pre-tax profit (£m) 33.8 49.8 64.3 58.4 42.2 140 156
Operating margin (%) 1.4 1.9 2.2 1.2 0.7    
IFRS3 earnings/share (p) 49.5 12.9 40.0 -25.7 15.2    
Normalised earnings/share (p) 62.6 46.7 74.4 72.3 29.2 117 129
Earnings per share growth (%) -40.2 -25.4 59.3 -2.8 -59.6 301 10.1
Price/earnings multiple (x)         37.0 9.2 8.4
Historic annual average P/E (x)   27.0 23.1 17.0 29.4 36.8  
Cash flow/share (p) -10.4 -23.6 150 154 136    
Capex/share (p) 50.2 51.9 57.1 43.7 60.9    
Dividend per share (p) 52.7 55.1 73.5 57.5 65.5 70.9 74.4
Dividend yield (%)         6.1 6.4 6.8
Covered by earnings (x) 1.2 1.1 1.3 1.3 0.5 1.7 1.7
Net tangible assets per share (p) 252 -24.7 -217 -230 -302    
Source: Company REFS              

'Speculative' buy is the only buy-tag possible

Kier, therefore, intrigues with a positive narrative and reasonable insider buying. As a matter of behavioural finance, directors' wives' buying says more than mere tax planning. Yet, to a detached observer there's a series of amber lights by way of margin, debt and trade payables.

With the shadow of Carillion over the sector, unsurprisingly the market exacts a high yield. However, if trading statements remain robust then, in time, the business can overcome these issues and its stock re-rate nearer the 1,500p highs it's enjoyed in a volatile-sideways trend.

'Speculative buy' if you trust the directors, otherwise follow as a case-study in determining risk from accounts.


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