Cheap shares are lying all around us at the moment. Steve Scott looks at a profitable construction group on a miserly rating.
Last week the construction firm Keller (LSE: KLR) announced its latest results. The headline numbers looked pretty good; turnover up 25%, profit before tax up 10%, earnings per share up 14% and dividend up 15%. Not only that, but the results were well ahead of analyst forecasts.
Despite the good news, the shares immediately fell by 15% to 450p, leaving Keller on a measly price earnings ratio of 4.1 and a dividend yield of 4.6% (although the price has subsequently recovered slightly to 475p). That's another blow to long term holders, i.e. me, who've seen the share price collapse from over £11 a share in little over 15 months. What is going on?
There are a number of obvious reasons:-
1. The sector – Keller operates in the construction sector. It provides specialist ground engineering services (often in niche areas such as soil nailing) across a range of international markets. With private funding for large infrastructure projects drying up, investors have largely shunned the sector in favour of more defensive opportunities.
2. North America – although an international business, in 2008 Keller generated 45% of its sales and 42% of its profits in the US. Profits there have declined consistently over the last two years and without the benefit of exchange rate movements during 2008 would have fallen even further.
3. Margins – despite the growth in profits, Keller saw operating margins fall from 11.2% to 10.0% and drew attention in its results to the inevitability of further pressure on margins.
Keller's chairman was suitably cautious about the short term prospects -- “We are certainly encountering tougher conditions in almost all our markets and we expect this to continue for some”.
It's worth nothing though that Keller has a history of under promising and over delivering. In its 2006 results Keller said "whilst the outstanding 2006 result is unlikely to be matched this year, we are confident that 2007 will be another good year for the Group". In fact, profits in 2007 were 23% higher.
In its 2008 interim results Keller said "the Board anticipates that the Group's results for the year as a whole will be broadly in line with last year's excellent performance." In fact profits were 10% higher.
With most of its profits earned in foreign currencies, profits in 2009 should continue to benefit from the fall in sterling which took place during 2008. Keller translates its foreign currency profits in to sterling at the average exchange rate during the year. If exchange rates remain at the same level as they were at the end of 2008, this should add up to another 27p per share to earnings of 111.1p in 2008. Under these circumstances current analyst forecasts for 2009 of 85.8p earnings per share look on the low side.
Indeed it is against this backdrop that Keller revealed “the Group order book, however, has been substantially mitigated by the weakening of sterling over this period. Accordingly, at the end of January, our order book was around 10% below its January 2008 level on a constant currency basis, but slightly ahead in sterling terms.”
Longer term Keller should be a beneficiary of increasing infrastructure spend. Substantial investment is necessary to upgrade crumbling infrastructure in the US, whilst emerging areas such as the Middle East and Asia will drive new investment. Keller is a geographically diverse business. Furthermore Governments are increasingly looking at investment in public infrastructure as a way of kicking starting their economies. Keller drew attention in their 2008 results to "a shift towards more publicly-financed projects”.
Keller is also well financed. Debt at the end of 2008 of £84.6 million represents only 18 months forecast earnings. The Group has £225m of committed facilities which expire between 2010 and 2014. It is therefore well placed to weather any downturn and to still make opportunistic bolt on acquisitions to strengthen its product and geographical coverage.
In the meantime investors can look forward to an increasing dividend income through Keller's commitment to raise its dividend annually by 15% until it reaches 3 times cover. That should increase Keller’s dividend yield next year to 6.0%.
It's hard to predict where share prices are going in the short term. However for investors, with a longer term view, who are looking to pick up quality companies ahead of any recovery in the markets Keller looks good value.
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Disclosure: Steve Scott holds shares in Keller