Keller’s shares crashed by 20% in May when it reported that full-year operating profits would be 10% below 2010’s figure of £43.3m. That’s not ideal, but this cyclicality is par for the course in the feast-or-famine construction sector. Keller is the world’s largest independent ground engineering specialist. It works on big building projects and is responsible for strengthening foundations to support the weight of bridges, roads, buildings and power infrastructure. For example, it dug the foundations and laid the piling for London’s Olympic stadium, and is an expert in reclaiming difficult-to-use brown field and other marginal land.
The profit warning was largely down to lower margins in its American unit (40% sales), combined with the floods in Australia and geopolitical issues in the Middle East and north Africa. Encouragingly, though, the order book was up 9% as it solidified its leadership position in America and Australia. In fact, the firm earns the vast majority of its revenues outside of Britain. Its typical contracts are small, of short duration and represent only 2% of total building costs. Importantly, too, Keller remains convinced that the outlook for infrastructure is favourable, especially given the dilapidated state of many countries’ roads, ports, railways and power systems. The group is already seeing improvements in Poland and southeast Asia.
Analysts are forecasting 2011 revenues and underlying earnings per share of £1.1bn and 36.5p respectively, with a 3.6% dividend yield. But this is arguably the earnings trough – we’re at the bottom of the cycle for this industry. As such, when the market recovers, profits should soar. For the purposes of valuation, I believe it is more representative to use a through-cycle operating profit multiple of eight, rather than fret about the immediate future. On this basis – after adjusting for the £94m of net debt and £20m pension deficit – you get an intrinsic worth of more than 700p a share.
Keller Group (LSE: KLR), rated a BUY by Investec
As with any international organisation operating in construction, investors need to keep tabs on various threats: strong competition, a possible double-dip recession, foreign-exchange volatility and any significant government U-turns over large-scale infrastructure projects.
All the same, Keller is a quality business and should generate substantial shareholder value for patient investors. Investec has a target price of 630p a share. Interim results are announced on 1 August.
BUY at 465p (market cap £300)