Kier is materially undervalued as pre-tax profits double

Despite posting flat revenue in the six months to the end of 2022, Kier Group (KIE) chief executive Andrew Davies argued that “underlying momentum in the business is strong”.

He pointed to the growth in its adjusted operating margin to 3.7 per cent, above its medium-term target of 3.5 per cent, just 18 months into a five-year plan as a sign that the business can “continue delivering for our shareholders”.

Its infrastructure services arm grew revenue by 5 per cent, but reported a slight softening of its adjusted operating margin to 4.1 per cent. Top-line growth came through a ramp-up of activity on HS2, where it is carrying out the longest section of earthworks between the Chilterns and Warwickshire. The fall in margin was attributed to higher mobilisation costs on utilities work, particularly for telecoms companies as the 5G network rolls out.

The construction arm reported 4 per cent revenue growth and a healthy increase in its adjusted operating margin to 4.6 per cent, from 3.9 per cent a year earlier. Activity increased as it began works on a new ‘net zero’ prison, HMP Full Sutton in east Yorkshire, and Davies said margin improvement followed from restructuring efforts completed last year. 

This work is ongoing but the costs associated with restructuring have “materially reduced”, chief financial officer Simon Kesterton said, which means statutory pre-tax profit doubled even as adjusted operating profit only grew by 6 per cent to £57.2mn.

Net debt of £131mn is similar to a year ago, but around £50mn of cash was used to repay a supply chain financing agreement. Kier expects to “generate positive operating cash flow” and to eliminate net debt by its June year-end. 

Inflationary pressures remain, and the impact of cost inflation marginally outweighed gains from increased prices and volumes over the past six months. Still, the fact that around 60 per cent of its work is done on a target cost or cost-plus basis, allowing for higher prices to be passed on, underscores the fact that Kier is a much lower-risk business than it once was.

Kier's shares still trade at under four times house broker Peel Hunt's forecast earnings of 18.3p, though. Perhaps unsurprisingly, it argues they are “materially undervalued” but given a 26 per cent increase in its order book to £10.1bn, which covers 96 per cent of this year's revenue, we find it hard to disagree. Buy.

Last IC View: Hold, 75p, 15 Sep 2022