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High-yielding Carillion underpinned by strong orders

Carillion has an enormous order book and also pays out a nice dividend
August 29, 2013

Shares in Carillion (CLLN) took a tumble earlier this year as investors fretted over the cost and implications of a significant downsizing in the UK construction side. But recent half-year results, while not free from problems, suggest the worries are overblown and the shares' near 6 per cent yield offers the chance to lock in income while waiting for the longer-term prospect of a significant re-rating as the capital investment cycle turns up.

IC TIP: Buy at 290p
Tip style
Income
Risk rating
Medium
Timescale
Long Term
Bull points
  • UK operation set to improve
  • Strong order book
  • PPP disposals continue to generate profits
  • Attractive dividend
Bear points
  • Green Deal off to a slow start
  • Strong competition in Middle East

In the first half, UK construction accounted for just 26 per cent of Carillion's revenue compared with 29 per cent in 2012. And while construction margin did slip somewhat, the planned downsizing of the business has helped management keep it at around the 4 per cent target, well above the sector average. And visibility for the rest of the year of 90 per cent is impressive following a rise in the first-half order book from £2bn to £2.3bn. Indeed, order wins across the group as a whole should provide comfort to a market that seems nervous about cash flows and profits. Total orders and probable orders rose to £18.4bn, with a further £37.5bn of contract opportunities in the pipeline, thanks to increased outsourcing by local authorities. Meanwhile, 2013 earnings visibility for the group as a whole has edged up from 92 per cent to 93 per cent.

Carillion has also been realising profits from its portfolio of Public Private Partnership (PPP) projects, which more than made up for first-half weakness elsewhere. Disposals generated profits of £31.3m. In addition, the 20 financially-closed projects held were estimated to be worth around £82m. Carillion is using some of the proceeds to invest in new projects, with notable wins including selection as preferred bidder for the £335m Royal Liverpool Hospital project. And while PPP work was put on hold in the UK for a year as a result of a government review, Carillion has been busy picking up PPP work in Canada, and is currently shortlisted for four hospitals there as well as one in Turkey.

By far the biggest of the group's operating divisions is the support services side, which accounted for 56 per cent of sales last year. The operation covers facilities management and energy, railroad, maintenance and utility services, as well as consultancy work in the UK, Canada and the Middle East. And while revenue fell at the half year, mainly as a result of two customers taking their contracts in-house, new contract wins are expected to recoup much of this. Crucially, new work secured three new contracts with oil giant Shell worth £400m over the next eight years, with hopes that this will lead to more work from the oil sector. And turnover in the division would have been higher without a disappointingly slow start to the government's Green Deal operation designed to improve housing insulation. Energy service contracts of £150m have already been secured, and this should start to accelerate as Green Deal gathers momentum.

CARILLION (CLLN)
ORD PRICE:290pMARKET VALUE:£1.25bn
TOUCH:289-291p12M HIGH:334pLOW: 240p
FORWARD DIVIDEND YIELD:5.7%FORWARD PE RATIO:8
NET ASSET VALUE:229p*NET DEBT:27%

Year to 31 DecTurnover (£bn)Adjusted pre-tax profit (£m)**Earnings per share (p)**Dividend per share (p)
20105.1418839.415.5
20115.0521243.016.9
20124.4021543.017.3
2013**3.9319337.616.6
2014**4.2219437.516.6
% change+8+0-0-

Normal market size:10,000

Matched bargain trading

Beta:0.88

*Includes intangible assets of £1.5bn or 357p a share

**Peel Hunt forecasts, adjusted PBT and EPS figures

Middle East construction services have performed well, given that margins took a hit as negotiated contracts (when new work exceeded the supply of contractors to do it) were replaced by competitive tendering (as the supply of contractors exceeded demand). So while Carillion has managed to boost turnover and profits, margins in the first half slipped from 6.7 per cent to a still impressive 4.5 per cent. And management reckons that it can get this back up to 6 per cent. The group is also increasing its geographical spread, picking up its first contract in Saudi Arabia, worth around £120m.

Group finances saw net debt increase from £155.8m to £270.8m, mainly as a result of net cash outflows associated with the final stages of restructuring the UK construction side. Debt levels are expected to be lower at the full year, as the group moves back to generating a positive cash flow, and is currently working comfortably within its committed borrowing facilities worth £1.1bn.

Trading should improve in the second half, and while turnover may shrink, Carillion has resisted the temptation to chase low-margin work. In fact, underlying operating margins for the group as a whole rose in the first half from 4.3 per cent a year earlier to 5.1 per cent.