Balfour pivots from UK construction to maintenance

The success of Balfour Beatty (BBY) depends on whether the strength of its support service arm outweighs the underperformance of its UK construction business.

This division slipped to a loss due to Covid-related disruptions to private sector projects in London. Although revenue was up 28 per cent to £1.26bn, the business's underlying loss came in at £23m. This hit has clearly scarred the company, which has said it “will no longer bid for fixed price residential property projects in London”.

It’s good that Balfour has eventually corrected the mistake of fixed price private projects but, as Nicholas Hyatt at Hargreaves Landsdown says, “it continues a trend of Balfour restricting where it operates”. This creates a vulnerability if demand for its remaining businesses softens.

The performance of support services, which provides power, road and rail maintenance, has offered some balm for the UK construction wounds. Support service revenue increased 17 per cent to £555m and underlying profit increased to £54m from £10m in the same period last year. As a result, Balfour has therefore upgraded its full-year margin target from 3-5 per cent to 6-8 per cent. Given both the UK and US government’s infrastructure investment pledges, the company’s promise of a “positive market outlook” is believable.

The result of all this is that group revenue has remained flat, but underlying operating profit was up to £60m from a loss of £14m last year. Strong cash conversion meant period-end cash was up to £833m (from £797m last year), even after a £100m share buy-back program. This extra cash has enabled management and the board to bring back an interim dividend, after it was suspended this time last year.

The order book was slightly down at £16.1bn, compared to £16.4bn 12 months ago. Management cautioned that the replacement rate has stalled because the company is looking for “profitable managed growth strategy through selective bidding”, hence the shift away from UK private construction and towards support services.

Peel Hunt thinks this is a positive, with its higher than consensus forecast reflecting the “improving mix of earnings”. The brokerage has maintained full-year profit before tax guidance for Balfour at £150m, which it expects to rise to £205m at the end of 2022, above the broader consensus of £191m.

The shares' 12-month forward earnings ratio of 12.6, according to Factset, makes the stock slightly more expensive than peers. However, its strong cash generation and exposure to government infrastructure investment is appealing. Buy.

Last IC View: Hold, 236p, 9 Sep 2020