Re-rating overdue as Costain builds back better

Shares in Costain (COST) have fallen by 90 per cent over a five-year period, hit by several years of losses on problem contracts.

Its performance for 2022 was ahead of analysts’ expectations, though, with revenue up by a quarter. Although its adjusted operating margin was flat, fewer write-downs meant its statutory operating margin grew from a negative 0.8 per cent to 2.5 per cent. And even after paying £43.4mn to settle a contract dispute, it generated net cash from operations of £16.7mn. Group chief executive Alex Vaughan expects adjusted margins to keep improving to 3.5 per cent over the next two years and 4.5 per cent by 2025, driven by “extensive changes” to its business practices. These include being more selective in bidding, choosing to work only for “tier one blue-chip customers” on long-term programmes in less cyclical sectors such as transport, water, energy and defence. 

Robust infrastructure spending by government and utility companies means there’s a strong pipeline of work “at margins we aspire to”, Vaughan said. Although its order book at the end of last year was lower, at £2.8bn, than the prior-year close of £3.4bn, it has been named as preferred bidder on £1.6bn of other schemes (2021: £900mn) for which contracts are being finalised.

We highlighted Costain’s potential in our ideas section in September on the basis that its valuation looked completely bombed out. Although it has picked up marginally since, Costain is still only worth a fraction more than the amount of cash it holds (it has a market cap of £129mn and cash excluding leases of £123mn). At just 4.4 times broker Peel Hunt's forecast earnings of 10.8p, a rerating seems overdue. Buy.

Last IC view: Buy, 41p, 1 Sep 2022