A Good Company Selling Cheap

Published in Company Comment on 4 November 2011

Although cheap now, this consultancy group could re-rate as economies recover.

At the end of 2007, WS Atkins' (LSE: ATK) share price had the company, which describes itself as 'one of the world's leading engineering and design consultancies,' on a forward price to earnings multiple of nearly 18. Today, that multiple has been compressed to around seven, so what happened?

You might assume that trade must have fallen off a cliff, along with the share price, but not a bit of it. The business has performed well recently and, as far as I can see, the only thing that has changed is its year-on-year growth expectations -- it's amazing how much investors will pay for that.

The world needs Atkins

Atkins has shown that, even in these austere economic times, there is demand for its offering. True, there is a cyclical element to its business as economies ebb and flow, but it also has defensive qualities. Life goes on; the built environment still needs maintenance and development, whatever the economic tide. To me, Atkins looks like a good company selling cheap.

The FTSE 250 constituent has operations in Europe, North America, the Middle East, India and the Asia Pacific. It operates in a vast range of sectors and this diversification appears to have helped it through recent lean times, as its financial record shows:

 2008200920102011
Revenue (£m)1,3141,4871,3881,564
Net profit (£m)1008410273
Net cash from operations (£m)7311711157
Diluted earnings per share97p85p103p73p
Dividend24p26p27.5p29p

In common with many companies, Atkins has kept a close eye on cash flow in these straightened times, reducing head count where necessary, yet also continuing with targeted acquisitions.

The strategy seems to be paying off, with generally increasing revenue dropping down to net profit and cash flow. There's no sign of the kind of sudden collapse in the figures that marks out highly cyclical businesses in recessions. That's probably why the directors have continued with the progressive, cash-backed dividend policy over the period.

Current valuation

At the recent share price of 554p, Atkins has a trailing dividend yield of around 5.2%, roughly two-and-a-half times covered by net earnings. This rises to 5.4% for 2012, according to analysts' estimates. Meanwhile, the trailing price to earnings ratio is about 7.6, falling to around seven in 2012.

This is a world away from the heady days of 2007 and compares well with peers like RPS Group (LSE: RPS), which has a historical yield around 3% rising to about 3.4% in 2012, at the recent share price of 184p, and a trailing P/E of 11, falling to 10 for 2012.

The full-year results in June carried the most recent balance sheet, which shows cash of around £121m offset by a debt figure of £53m. This being a people business, there is no big tangible asset figure to provide downside protection. In fact, another consequence of two-legged assets -- the dreaded pension scheme deficit -- drags the net asset value down to a negligible £16m or so.

The shrinking elephant

It's tempting to view a large pension deficit as the proverbial 'elephant in the room'. After all, it's a liability, a debt to repay, a drain on profits, right? Well, yes, but it's a little more complex than that as the 'debt' can be a variable number, affected by actuarial assumptions and the pension funds' asset performance, for example.

In 2009, Atkins' year-end accounts showed retirement benefit liabilities of around £298m. In 2010 that figure had risen to 440m, but by 2011 it had fallen again to about 338m. Most of the fall in the current year was due to actuarial gains. Amongst other initiatives, Atkins has been shifting employees from final salary schemes to defined benefit arrangements, wherever it can. Nevertheless, the company is expecting to contribute around £26m to fund the actuarial deficit during 2012, so it is a significant, if potentially reducing, problem.

What's the outlook?

Most recent guidance came with an interim management statement on 3 August. The directors put the company's continued resilience down to its diversified exposure to a range of well-funded end markets. Most regions had experienced a good start to the year although its North American business, which contributes about 17% to group revenues, had been slow and margins are not expected to grow in that area during 2012.

Overall, trading seems to be holding up well. If growth returns, I think there's every chance of these shares re-rating upwards. In the meantime, investors may enjoy the well-covered, upwardly- mobile dividend, which shows no sign of disappearing anytime soon. We'll learn more about recent progress on 17 November with the interim results.

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Comments

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Crawfish123 04 Nov 2011 , 10:44am

Agreed this a good company selling cheap! I would say 18 p/e was a heady rating but currently i reckon 10-12 p/e is a fair price. So there's good upside potential here.
Check out the director dealings, a few have been buying in at way above the current price in the last year.
There is also ongoing consolidation going on in this sector, small outfits are being bought out my mostly larger US firms.
For a smaller Cap play with better geographical spread also have a look at Hyder: HYC

vinchainsaw 04 Nov 2011 , 2:27pm

Nice tip, thanks Mr. Godbold, will investigate further.

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