Balfour widens profit margin but remains pricey

Following Liz Truss’ disastrous mini-Budget late last year, government finances were in such a state of disarray that the future earnings potential of construction companies such as Balfour Beatty (BBY), which depend so much on state contracts, looked in doubt. In its results for the last calendar year, however, the company gave investors some reasons to be hopeful.

First, it managed to widen its usually wafer-thin margin from its underlying earnings-based business from 2.3 per cent to 2.7 per cent. It’s an incremental increase, but helped produce a 42 per cent leap in underlying profit.

Much of this came from improvement in its UK construction arm, which swung from a £2mn underlying loss in 2021 to a £59mn underlying profit last year compared with broadly flat figures for its US and Hong Kong businesses. The company put this down “increased volumes at HS2 and Hinkley Point C more than offsetting reduced regional volumes”. 

However, this is where the bear case comes in as 91 per cent of its UK construction revenue last year was from public sector and “regulated industry clients”. The question is whether that UK government gravy train will stay on track.

On the one hand, the company has this year been awarded a chunky £1.2bn government road building contract at the Lower Thames Crossing. What’s more, the company has revenue streams beyond the UK to keep it going, such as its $242mn road improvement contract in North Carolina and roughly HK$10bn (£1.06bn)-worth of projects from both the public and private sectors in Hong Kong. This is probably the reason why Peel Hunt believes the group will continue to increase its revenues over the next two years. 

But even with Balfour Beatty's overseas operations, the UK government is responsible for a large chunk of its revenue stream. As such, the threat of policymakers dramatically pulling back on infrastructure spending remains a valid concern. Peel Hunt's forecasts give a forward rating of 11 times earnings. That's pricier than some of the construction group's peers, but given the forward visibility, we upgrade our rating for this stock, but advise caution. Hold.

Last IC view: Sell, 295p, 27 Oct 2022