Rebuilding Great Britain: Post-Brexit, UK construction firm makes further progress on its turnaround
Post-Brexit, UK construction firm makes further progress on its turnaround
London-listed Kier Group is a construction and infrastructure services group in the United Kingdom. Kier has leading market positions in two areas in the UK. The first is regional construction while the second is infrastructure services, with a focus on three areas: The building and maintenance of highways; repairs for essential services and utilities such as water, energy and telecommunications; and high-value infrastructure construction and civil engineering projects across sectors such as nuclear power, roads and rail.
Given that Kier operates across sectors that are vital to the economy, many of the services it provides have government support, as government projects are usually taken up by the company. The support comes in the form of grants and the capacity to defer taxation payments. The construction company is also well recognised and sought-after by the UK government.
Our case for Kier, which was also in the previous year’s pick, is that the company is a turnaround play showing good signs of progress. Kier has been riddled with debt and other financial concerns caused previously by Brexit, and recently, the Covid-19 pandemic. The company was hit with a string of unfavourable news, with some of its peers like Carillion going bust in the wake of Brexit. Kier was lucky enough not to declare bankruptcy, and we think the company is on the right and best path to recovery, at least to its glorious pre-Brexit days when the share price was around 20 times its current trading price.
However, this may take time but Kier has correctly identified what it needs to turn itself around. Some of the strategic actions the company has taken and is taking include appointing a new senior management team; implementing a cost-saving programme involving headcount rightsizing; exiting loss-making businesses; and investing in areas and businesses that synergise with its main construction business to save costs.
Presently, the effects of Covid-19 are mostly negative to the business. The significant effects include reduced worksite productivity as a result of revising operating procedures to reduce transmission of the disease, delayed starts on new sites, and lower levels of working capital.
Despite these challenges, Kier was able to maintain its liquidity levels, thanks to its strong relationship with key customers and debt providers. The company also implemented selfhelp measures to contain the adverse effects of the pandemic to the business, including temporary pay reduction for employees, deferring certain taxation payments, and bringing forward the sales of unproductive assets such as its former headquarters.
In addition, Kier is doing well on its supply chain front, particularly for its payment practices, which include average payments days and percentage payments made to suppliers. The improvement in payment metrics over the latest reported period by Kier will help maintain and grow its relationship with key stakeholders and long-term partners of the company, and eventually aid a turnaround.
An important performance metric to monitor for the business to turnaround is its order book and contracts won. Kier, for the latest reporting year, has won a place on 16 longterm framework projects across a number of key sectors, including health and education. The company’s highway business was also successful in winning contracts with clients from multiple counties in the UK.
Furthermore, Kier has won contracts in the regulated sector, such as being appointed to carry out network delivery works and telecommunications infrastructure. In the latest reported results, Kier’s order book came in at GBP7.9 billion ($14.5 billion) compared to the previous year, reflecting the large value of contracts it has won over the year, which totalled GBP3.3 billion. There are also significant growth opportunities for Kier, given how its business is aligned with the UK government spending, which should provide the company with better earnings visibility. The company’s cost-saving programme as implemented by the new management for the latest report period has also supported the delivery of strategic priorities of the company. These include structural changes such as increasing the level of divisional accountability; removing layers of management; and outsourcing its IT and fleet management functions. The company is also reorganising its assets to save costs, for example, by moving its headquarters to a smaller and cheaper location.
Kier’s results for the FY2020 ended June 30, 2020, were decent despite the effects from the pandemic and showed good strategic progress. The company’s revenue fell 15% y-o-y, while operating profit was down 51.7% in the same period. The company also managed to turn a positive free cash flow from a negative, which is a good indication that Kier’s management strategy is effective. Net debt increased for the period, but it was mainly due to Covid-19 which delayed the company’s goal of net debt reduction. Cost savings are expected to be around one third of its current net debt for the upcoming financial year, which is an achievable target.
In addition, the company still has significant liquidity headroom under borrowing facilities and the stress test it had conducted concluded positively even after running severe downside scenarios. Chart 1 shows the default probability. This probability includes metrics such as leverage ratios, interest coverage ratio and quality of assets. These are then compared against industry peers to arrive at a default risk probability. Kier’s default probability appears to be lowering over the last quarter, indicating higher likelihood of a turnaround.
Analysts have given a target price of GBP1.57, more than double its current trading price of GBP0.78, as they are confident that the company will turn around. Our in-house valuation of the company indicates that if Kier is able to turn around and maintain its progress, it should give upwards of 50% returns over the next four to six quarters.
Kier’s strategy to turn around, in a nutshell, involves simplifying its structure, better allocating its capital resources, identifying ways to improve cash generation, and most importantly, to reduce net debt. It is important to have an active management for turnaround companies and Kier is executing their strategy of reviving the company well. That is good news for investors willing to take significant risk to bet on the stock.