Costain (COST) has come a long way in the last 20 years, and the most beneficial change has been to the core business model. Instead of operating as a pure construction contractor, Costain has evolved into a one-stop shop for buidling services, covering planning, project delivery, and operation and maintenance. Customers like the idea of dealing with one provider, which is why over 90 per cent of the current order book is repeat business from existing clients.
- Attractive yield
- Record order book
- Integrated service offering
- High percentage of repeat orders
- Cash pile likely to decline
- Natural resources division loss-making
Significantly, most new work is now agreed on a target cost, cost reimbursable form of contract. Rather than receive a traditional lump sum, payment on such contracts come much later but can be much more lucrative and less risky. True, the change in model is a drain on cash, and broker Liberum forecasts a £141m working capital outflow over three years, but believes there will still be net cash of £22m at the end of the process in 2015. The big advantage of the new type of contract is that both sides adopt a more collaborative approach to agreeing a target price, and if Costain delivers below budget, then the savings are shared, as usually are any cost overuns.
Costain has focused its attention on acquiring blue-chip customers in sectors where major spending is underpinned by regulation and strategic national needs, such as water, rail, nuclear and waste. The approach is paying off. The forward order book at the end of June were up 20 per cent on the year and has since hit a record £3bn, with a further £400m in the preferred bidder pipeline.
| COSTAIN (COST) | ||||
|---|---|---|---|---|
| ORD PRICE: | 291p | MARKET VALUE: | £194m | |
| TOUCH: | 290-292p | 12-MONTH HIGH: | 307p | LOW: 226p |
| FWD DIVIDEND YIELD: | 4.1% | FWD PE RATIO: | 10 | |
| NET ASSET VALUE: | 53p | NET CASH: | £64.3m | |
| Year to 31 Dec | Turnover (£m) | Pre-tax profit (£m)* | Earnings per share (p)* | Dividend per share (p) |
|---|---|---|---|---|
| 2010 | 925 | 15.4 | 16.7 | 9.25 |
| 2011 | 869 | 23.1 | 27.9 | 10.0 |
| 2012 | 848 | 17.6 | 22.8 | 10.8 |
| 2013* | 869 | 21.8 | 25.0 | 11.3 |
| 2014* | 884 | 24.3 | 27.9 | 11.9 |
| % change | +2 | +11 | +12 | +5 |
Normal market size: 1,000 Matched bargain trading Beta: 0.58 *Liberum Capital estimates, underlying PTP and EPS figures | ||||
Two core operating divisions were created at the start of the year. Rail, highways, power and airport work became the infrastructure division, where adjusted profits at the half year were up 50 per cent at £14.4m. However, the new natural resources division - that covers water, hydrocarbons, chemicals, nuclear processing and waste - has taken a bit longer to bed down. Additional costs to complete a project together with restructuring and business development costs meant a small half-year loss. However, new work secured has boosted the forward order book by a third to £1.2bn.
Headline pre-tax profits will be down this year, but only because last year's numbers were boosted by £10.5m of PFI disposals, whereas there has been none this year. So on an adjusted basis, Liberum believes that profits should be up by around 24 per cent at £21.8m. This year's numbers will also include a one-off cost of £3.7m associated with the aborted merger with May Gurney, after the agreed all-share merger was beaten by a better offer from Kier. Sensibly, management elected not to chase the game by making an increased offer, believing that doing so would not have served shareholders' best interests.
In valuation terms, Costain's shares are trading on 12 times 2013 forecast earnings, falling to 10 next year - that's cheaper than Kier and Balfour Beatty, although more expensive than Carillion. There is a decent and growing dividend on offer, too, with a prospective yield of 3.9 per cent this year, rising to 4.1 per cent in 2014 and, based on Liberum's forecasts, 4.3 per cent the year after that.
