With Brexit almost done and dusted, this UK construction company could be a turnaround story but is not for the faint-hearted
SINGAPORE (Jan 23): London Stock Exchange-listed Kier Group is a construction company that works on projects of all sizes, complexities and sectors spanning the UK. Over the past two years, Kier has been riddled with debt and other financial concerns caused by Brexit. No surprise then that business, earnings, and of course the share price suffered drastically over the past two years. Following the Brexit referendum, article 50 was invoked in March 2017, giving the UK two years to Brexit. As of Jan 17, the UK still has not Brexited, but light is at the end of the tunnel and a clear Brexit timetable should support sentiment around Kier Group.
In FY2019, Kier’s fell 38.9% y-o-y but remained positive. The cash flow, both operating and free, however, turned negative. Kier’s share price too, over the period of 12 months and 15 months have dropped 84.4% and 92.3% respectively. Chart 1 from Bloomberg shows Kier’s share price against its one-year default probability. The default probability includes metrics such as leverage ratios, interest coverage ratio, and quality of assets; which is then compared against industry peers to arrive at a default risk probability. The chart shows a very telling relationship between the share price and default probability – as the default probability increases, the share price falls. We think this is a good reason to believe that in order for Kier to turnaround, it must fix its default probability, which comprises of the previously mentioned factors.
In December 2018, Kier underwent a rights issue to raise GBP250 million ($439 million) because the banking sector indicated its intention to reduce exposure to the construction sectors. Additionally, the focus on service providers’ balance sheets such as Kier and the pressure to improve the company’s supply chain payment terms increased, hence a large portion of the money raised was utilised to accelerate payments to the supply chain. This not only diluted shareholder value by causing a drastic drop in share price, but also put the company in a more financially precarious position. Further, Brexit hit the entire UK construction industry, along with Kier hard due to concerns of an economic slowdown, higher labour costs, government budget cuts and weaker investments into infrastructure.
In June 2019, the management announced a strategic review and identified the need to further simplify the business of the company, increase its focus on cash generation and reduce net debt. The first step to solving the company’s problem is to recognise there is a problem. Management has been able to identify the key problem and its solution, increasing cash flow and reducing debt.
As part of the restructuring, Kier shrunk its workforce, and will incur exceptional expenses in the short term – but over the next six to eight quarters, Kier should achieve breakeven from these expenses and see significant net positive cost savings, which will aid the solvency of the company. There were significant management changes to the company as well, with the previous chairman and CFO stepping down in Sept 2019.
Selling its loss-making business
Implementation of the strategic review involves shuttering unprofitable and volatile businesses. Hence, Kier has announced intentions to sell its loss-making environmental services business, and downsize its property business. Other major sales plans to improve near-term cash flow include its housebuilding business (Kier Living) and its underperforming facilities management business. Moving forward, the new direction of future projects will be to focus on low-risk projects over a long period of five or more years, which will provide earnings visibility, and more stability to the business. This is definitely a step in the right direction, and Kier is very capable of achieving this and eventually turning around.
So what are the positive qualitative factors aiding Kier’s turnaround? For one thing, over 70% of Kier’s business is based on complex procurement processes and long-term spending frameworks. These well-established longterm spending frameworks help to provide a stable and visible cash flow. Secondly, Kier’s focus on long-duration contracts for maintenance of essential assets along with targeting low-risk and non-speculative projects outside London should help contain the risks from Brexit. Kier is also the key strategic supplier to the government and has long been the UK’s leading regional builder of medium-scale projects in education, health and community facilities. Also, Kier’s recent additions to its order book were mostly longer, smaller sized contracts, which carry less risk than large civil engineering projects and should enable Kier to deliver stable and attractive margins moving forward.
The next few quarters might be tough. However, Kier should show accelerated signs of turning around in the next four to six quarters if these plans are effective. Kier has been hit continuously with bad news especially over the past two to three quarters, and even a small glimmer of stable performance and improve the share significantly in our view. While turnarounds usually pose the highest investment risk, the payoff is definitely worth that risk. Analysts have a 12-month target price consensus of GBP1.38, well above its GBP0.78 current share price.
