Costain (COST) has changed over the years from being a construction group into an engineering solutions provider. It may not seem much, but the change has had significant consequences, not the least being its ability to take on much bigger and more complex contracts that in turn improve visability. As investors warm to the changes, we expect the shares to outperform.
- Record order book
- Attractive dividend
- Net cash position
- Enhanced ability to chase bigger contracts
- Weak Natural resources division
- Cash holdings expected to shrink
Costain's customers like trading with one contractor who provides a whole range of services that cover planning, construction, maintenance; it makes sense and saves a lot of paperwork. And as a result of more work procured through ‘target cost, cost reimbursable’ contracts, there is a greater level of collaboration with clients. Furthermore, although the higher upfront cost of winning these types of contracts is causing a big one-off cash drain, it means there is increased visibility over long-term projects and a significantly enhanced risk profile. Concentrating on water, nuclear and transport work also makes sense because these are less vulnerable to the vagaries of work in the private sector.
The new contracts mean that Costain is paid for its costs and then shares in any savings or cost overruns. The point here is that both parties have access to the books to ensure that the figures agreed upon are credible. The system works well, with over 90 per cent of the £3.2bn forward order book representing repeat business. The downside is that the new system affects cashflow, and net cash is expected to shrink.
Costain’s management attracted criticism earlier in the year from small shareholders over the dilutive effects of a £70m share placing in March. But Costain has moved to allays fears by pushing up the half-year dividend pool by a third. Although this still meant that the interim dividend fell on a per share basis, Investec reckons that after falling from 11.5p last year to 9.4p this year, this will increase to 10p a share in 2015 then 11.1p in 2016, equivalent to a 3.9 per cent yield. EPS should follow a similar trajectory picking up from 20.1p in 2015 to 22.5p in 2016 as the growth reasserts itself at the per share level.
| COSTAIN (COST) | ||||
|---|---|---|---|---|
| ORD PRICE: | 288p | MARKET VALUE: | £291m | |
| TOUCH: | 286-288p | 12-MONTH HIGH: | 299p | LOW: 241p |
| FORWARD DIVIDEND YIELD: | 3.5% | FORWARD PE RATIO: | 14 | |
| NET ASSET VALUE: | 97p | NET CASH: | £134m | |
| Year to 31 Dec | Turnover (£m) | Pre-tax profit (£m)* | Earnings per share (p)* | Dividend per share (p) |
|---|---|---|---|---|
| 2011 | 986 | 25.5 | 30.0 | 10.0 |
| 2012 | 935 | 28.1 | 37.9 | 10.8 |
| 2013 | 960 | 31.0 | 42.4 | 11.5 |
| 2014* | 985 | 24.9 | 20.8 | 9.4 |
| 2015* | 1019 | 25.9 | 20.1 | 10.0 |
| % change | +3 | +4 | -3 | +6 |
Normal market size: 1,000 Matched bargain trading Beta: 0.72 *Investec Securities forecasts, adjusted PTP and EPS figures | ||||
Finances are in good shape following the share placing, and Costain now has net cash of £134m which will allow it to shoulder the big up-front costs associated with taking on more complex and larger projects. Investec currently forecasts net cash to level out at about £90m in 2015 and 2016. On top of this, the group has in place flexible financing of nearly £500m with a maturity date of June 2017. Crucially, much of the contracted work is focused on high profile infrastructure projects, such as nuclear decommissioning at Sellafield and the redevelopment of London Bridge railway station.
Some parts of the group continue to underperform however. Natural Resources, which concentrates on oil and gas, nuclear and water markets, saw revenue at the half-year drop from £199m a year earlier to £169m, with operating losses widening from £100,000 to £2.6m. Much of this reflects increased costs from a legacy Greater Manchester Waste Disposal Authority PFI project - the group stopped engaging in this type of fixed-price contract in 2009.
