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Balfour Beatty - Profits build as margins double

Nicholas Hyett | 15 August 2018 | A A A
Balfour Beatty - Profits build as margins double

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Balfour Beatty plc Ordinary 50p

Sell: 251.60 | Buy: 252.20 | Change -2.80 (-1.10%)
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Half year underlying operating profits were up 69% year-on-year to £66m, despite an 8.5% fall in revenue, with good results from Construction Services and the Infrastructure Investment portfolio.

Balfour Beatty's interim dividend rose 33% to 1.6p per share.

The shares rose 3.4% in early trading.

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Our view

CEO Leo Quinn began his career at Balfour Beatty. He went on to restore De La Rue and Qinetiq to something approaching good health, before returning to find his alma mater in dire need of the same treatment.

He diagnosed a business that sought to hide underlying difficulties through M&A and accepted excessive risks by bidding for work at low margins. That left too many contracts that were destined to generate losses, plus a cost base full of duplications, where acquired businesses had not been properly integrated.

Those problems will sound uncomfortably familiar to Carillion investors. That's because they're systemic problems in the sector. Balfour Beatty investors should be grateful for Quinn's tough love approach, and an investment portfolio that provided vital cash during the group's darkest days.

The group is now coming to the end of phase two in the 'Build to Last' turnaround plan. Having spent a painful period weeding out underperforming contracts and slashing costs the core construction business is back on an even footing.

Margins are at or approaching the industry norm, thanks to a more selective approach to bidding - aiming only for those set to generate a healthy return. UK construction remains a weak spot, but the group is confident of hitting its 2-3% margin target by the end of the year.

Phase three, building a premium into margins, gets underway in 2019. But with several divisions at the bottom end of average, it's a big ask. Convincing customers to pay a premium at all in an industry that's notoriously competitive on price will be a significant challenge.

At least market conditions seem to be swinging in Balfour's favour. Governments on both sides of the Atlantic are loosening the austerity purse strings to spend on infrastructure, and that seems to be helping the order book.

However, there's still some way left to go before profits return to historic levels. And that's assuming the economy behaves itself. Construction spending is cyclical, and Balfour is very exposed to slowdowns or changes in government policy - although with debt wiped from the balance sheet, the group is looking far more resilient now than in the past.

While some reasonable progress has laid the foundations, we think Balfour remains a work in progress. The prospective dividend yield is just 1.8% this year.

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Half Year Results

Half year revenue stood at £3.8bn (2017: £4.2bn), with an operating margin of 1.7% compared to 0.9% last year. All of Balfour's subsidiaries are now delivering industry standard margins, or on track to do so in the second half.

The Construction Services business delivered an underlying profit of £32m, up 33%, despite a 12.9% fall in revenue to £3bn. All three of Balfour's markets, the UK, US and Singapore, saw improvements in profit and margin. UK margins remain below the industry standard 2-3%, at 0.5%, thanks to additional costs associated with the Aberdeen Western Peripheral Route (AWPR). Excluding the AWPR costs UK margins would have been 2.1%.

The Construction order book rose 13% at constant exchange rates to £9.5bn. That reflects strong growth in the US, while the UK order booked was unchanged half-on-half.

In Support Services, revenues rose 4.6% to £543m with operating profits broadly flat. That puts margins at the lower end of the industry standard of 3-5%. The order book was dipped slightly to £3.1bn.

Underlying profits from the Infrastructure Investments portfolio more than doubled to £33m as Balfour posted greater profits from the disposal of a stake in Connect Plus, the company which manages the M25. The directors' valuation of the portfolio remains broadly unchanged at £1.2bn despite £108m of disposals.

Balfour expects all its businesses to be achieving industry standard margins by the end of the year - in line with the Build to Last strategy - with Phase Three of the strategy, starting in 2019, targeting growth to a premium over industry standard.

Group wide, the order book rose 10.5% to £12.6bn. Balfour finished the half with net cash of £366m.

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