Stockwatch: One to back amid regime change and spending boom

Ahead of interim results next month, our companies analyst thinks this big name is worth the risk.

Shares in diversified construction company Kier Group (LSE:KIE) have leapt around 50% from 100p (currently down a few pence at 142p), on speculation about how a replacement chancellor relates to Boris Johnson’s priority for infrastructure spending over fiscal rectitude.  

Rash it may seem, yet it reflects a truth about how Kier is a binary play between its liabilities weighing on equity value, versus improved trading tipping its financial trend positively as a restructuring concludes. 

It can swing either way, but I sense the likely trading environment and a recent board overhaul are tilting the balance. This raises interest in Kier when it declares interims on 5 March.

Kier’s risk/reward profile may have swung positively

It’s possible that a torrid 12 months or so for Kier shareholders has set up a major inflation point if the new CEO is close to getting this outsourcer honed for the new climate. From late 2018 to 2019, bears had the upper hand as political uncertainties conflated with fears for Kier’s finance, chiefly around the extent to which a radical-left government might tear up relations with the private sector.

Kier shares plunged from over 1,000p to below 100p, testing the 70p range, and some 5.1% of the issued capital remains out on loan - being shorted. All four such hedge funds (with disclosed short positions of over 0.5%) did however trim their exposure from November to January, and my sense is that the current rebound is being accentuated by further buying back. 

Data last night implied Kuvari Partners – one of the prime bears – cut its short position by 12% to represent 1.52% of Kier’s issued equity, at the end of last week. That represents £3.7 million at risk for a trade that’s massively in profit. 

Source: TradingView Past performance is not a guide to future performance

Cashflow remains a chief concern, justifiably

Market consensus – for what it’s worth – is for around £71 million of net profit in the current year to end-June and £75 million in 2020/21, implying a forward price/earnings (PE) ratio of barely 3x. 

Interim results should provide clues as to underlying trends, where investors have become more concerned by deteriorating cashflow since the 2016 year (see table).

The June 2019 interim cashflow statement showed a 12% slip in operating cashflow to £123.3 million. Then, among financings, there was a £24 million contribution to the pension fund deficit, a £116 million increase in contract assets, £88 million of the whopping £1.3 billion-plus trade payables paid down, and a £61 million decrease in contract liabilities, more than wiping out operating cashflow.

Additionally, over £54 million went out as dividends, helped by the November 2018 rights issue generating a £250 million inflow.

Questions over the transparency of true debt  

Net asset value per share of 320p looks superficially attractive, but last June’s balance sheet had £767 million of intangibles comprising near-150% of net assets. Some of this could be legitimate commercial value, paid for when making acquisitions of service type businesses, but unless someone buys them, it’s a guess.  

Net debt was cited down 10% at £167 million in context of “average month-end net debt” of £422 million, as if the trend is improving. Short sellers who have called the stock well in the last year or so, do however allege off-balance sheet arrangements you cannot discern from the accounts.  

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A 16 January trading update for the six weeks to end-December cited trading in line with the board’s expectations, with new contracts awarded across Kier’s markets, including being appointed to all 20 lots of the four-year Procure Partnerships last November.

Net debt at end-December was cited in line with board expectations and “good progress” has continued with restructuring - office closures, outsourcing and job cuts – for annualised cost savings of at least £60 million in the financial year to June 2021.

Finances must improve to cope with an upturn

While the new Conservative government appears well-disposed for a boom in infrastructure services, it could push any financially stretched companies over the edge unless their working capital can cope – what’s technically called “over-trading”.  

So, the 5 March results will need to show improvements enough, bearing in mind interims are not audited, hence will not incorporate any “going concern” judgment.

Despite 162 million shares in issue nowadays, I would not be surprised in due course to see Kier tap shareholders again (or make a placement), especially if commercial opportunities increase – the approval of HS2 offering substantial long-term work. It’s hard to speculate though, ahead of seeing what the new chief executive has managed to achieve since properly settling in.

Regime change should herald benefits

Andrew Davies became CEO last April, leading a strategic review aimed at simplifying the group and improving capital allocation, cash generation and the debt profile. Investors may feel cynical given his predecessor promoted a “Future Proofing Kier” programme (said to be continuing), while statistical bankruptcy indicators such as the Altman Z-Score cite Kier on the verge of distress. But give him his chance in a fortnight or so, to show what’s better.

Davies had previously been CEO of Wates from 2014 to 2017 and before that spent 28 years with BAE Systems (LSE:BA.). He had been due to lead Carillion a week before it collapsed in January 2018 and thereafter kept a low profile – seemingly with just a non-executive directorship at Chemring. So, his appointment can come across as someone who had time on his hands when no-one else wanted to step into the role, though one should not pre-judge.  

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Last June, his review declared Kier has “high-quality, market-leading businesses in regional building, infrastructure, utilities and highways, underpinned by long-term contracts and government/regulated clients.” Besides its house-building operation being divested (which drags on) the property, facilities management and environmental businesses were said to be up for exiting; it’s unclear quite how much money all this can raise.

A new chief financial officer became effective from September; then at October’s AGM the chief operating officer stepped down, his role absorbed by the CEO and CFO, and a new chairman has assumed the role from 1 January. So, it appears institutional shareholders have got their regime change – a substantial plus, to capitalise on potential improvement in the trading environment.

A £46,000 “buy” has been the only relevant insider trade

While Kier has lots of “Director/PDMR Shareholding” RNS’s, these relate chiefly to share incentive plan matters: the last proper trade being a purchase of 50,000 shares at 92p last November by the managing director for Kier’s utilities and rail side. I would not interpret a lack of buying among directors – if the stock is genuinely at an inflection point upwards – as a negative, given the strategic review targeted disposals, hence trading restrictions would apply especially at board level.

Strictly, Kier is off-limits for disciplined investors, who should await better evidence that the new CEO’s actions are getting required results. By the time that may happen though, and especially with short-closing underway, the stock may be higher still given drivers to restore value are coming into place (notwithstanding the risk of further dilution).  

Much remains to be proven and it is also possible that this spike on short closing, slumps initially at the sight of interims results. Yet a combination of new government policy, a new board and the short position unwinding, can shift the overall trend better. Kier is therefore one to watch and consider averaging into. I’ll swallow the risk to assert broadly: Buy.

Edmond Jackson is a freelance contributor and not a direct employee of interactive investor.