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Keller builds on strong foundationsAugust 16 2014, 7:00am
Stocks recovered as waning geopolitical tensions and optimism of further central bank stimulus helped recapture some of the previous weeks losses.
News that Russian military exercises near Ukraine’s border had ended and an agreement for an international humanitarian convoy to eastern Ukraine lifted sentiment. Meanwhile, US aid to Kurdish forces appears to be stalling the advance of Isis in northern Iraq, sending the price of Brent oil to its lowest level for over 12 months.
On the macro front, a flood of soft economic data, perhaps caused by political tensions, heightened investors aspirations of ongoing stimulus from major central banks. An economic contraction in Japan, a fall in Chinese loans and housing data, an unexpected drop in US retail sales and a surprisingly dovish turn by the Bank of England all indicate monetary tightening is a distant prospect.
Investors also suspect further action will be needed from the European Central Bank after industrial production contracted unexpectedly in June, as the region feel the effect of conflict in Ukraine, Iraq and Gaza. Factory output fell 0.3% after a 1.1% drop in May, below market expectations of a 0.3% rise and the lowest annual reading since August 2013.
The German economy suffered a surprise contraction in the second quarter, its first in more than a year, after foreign trade, traditionally a driver of German growth, led to a 0.2% decline in gross domestic product. Other recent data has disappointed, with industrial orders suffering their sharpest fall in nearly three years, while investor and business morale darkened. Neighbouring France also slashed its growth forecasts for both 2014 and 2015, urging its European peers and their central bank to boost faltering growth.
In its August inflation report, the Bank of England dented expectations of its first interest rate hike this year after slashing its forecast for wage growth, while inflation is expected to remain below the 2% target by the end of this year. The Bank of England and the US Federal Reserve are now forecast to start raising interest rates next year, although the expected slow pace of any such tightening remains a key support for equity valuations.
Technical analysis of the FTSE 100 displays the sharp falls experienced last week after support at 6640 was broken, triggering a retracement to the historical 6530 level. An abrupt bounce back over initial support at 6640 illustrates the underlying demand for equities, with the rising oscillators indicating an improvement in momentum. A move back above 6835 is needed to facilitate the next move higher.
In conclusion, it would appear that recent geopolitical events have prolonged the goldilocks environment of modest growth, low inflation and low interest rates, an ideal combination for equities. Despite the apparent improvement in market mood, sentiment looks to remain somewhat fragile as events in Ukraine and Iraq are likely to linger over the coming months.
Delayed concerns over interest rate hikes boosted the housing sector, with construction and materials companies among the highest movers this week. A related stock I have been monitoring is Keller Group (LON:KLR), the ground engineering specialist, after interim results on 4th August revealed the underlying strength of its core markets.
The company, which built the foundations for the London Olympic stadium, recovered after it said that adjusted pre-tax profits increased by 21% to £32.5 million, significantly higher than its peers, while revenue rose 22% to £788.2 million in the six months ended 30th June.
On a geographical breakdown, North America accounts for just under half of group revenue and almost 60% of operating profit, with better than expected construction activity boosting profits by nearly 25%. The company’s Australian business showed a good recovery, driven by work on the Wheatstone gas processing plant in Western Australia, enabling profits to increase by a fifth after a subdued resource sector weighed on demand earlier in the year.
Despite a challenging backdrop in Europe, the group said markets in Germany and Poland delivered good results, while its first contract win in the Middle Eastern Emirate of Qatar facilitated the Europe, Middle East and Africa division to report profit growth of 50%.
Keller’s recent share price performance has, however, been overshadowed by a dispute over a contract its UK business completed in 2008. The dispute relates to alleged defects in a floor slab at a £40 million wine warehouse for which Keller completed the piling work. The claims are currently the subject of litigation, although Keller vigorously denies any wrongdoing and made a provision of £30 million in the first-half to cover any reparations. The amount is stated before taking account of recoveries under applicable insurances which are yet to be agreed.
Profit margins improved to 4.5% from 4.4% a year ago, although the cyclicality of Keller’s business and the fact that the sector is still in the early stages of recovery should allow margins to jump to more than 6% next year, still well below the group’s peak margins of 11.2% achieved in 2007.
Chief executive, Justin Atkinson said; “We expect the group’s results for the full year to be in line with current market expectations and looking further ahead we remain optimistic about our long-term prospects.”
After losing a third of its value since February, the shares trade on just 9.2x prospective earnings, which looks cheap given analysts forecast 21% growth next year, putting them on a PEG of 0.44. The company also offers a steady dividend, with an unbroken 29 year record of increasing or maintaining the dividend. Keller raised the interim dividend this year by 5%, providing a prospective yield of 3.3%, which looks safe as it is covered three times by earnings.
The chart of Keller illustrates the recent slide, with the shares falling to levels last seen in April 2013 when the demand for construction was below current levels. The bullish divergence seen from the relatively stable oscillators indicates the sell-off could be overdone, while historical support at 850p appears to have contained the weakness.
Keller has solid foundations for a recovery, with improving core markets and I believe the shares have been oversold on concerns surrounding the dispute. At the time of writing the share price is 858.5p, with near-term targets seen at 910p, 955p and 1095p. Trader might consider a tight stop-loss below the recent closing low at 824.1p to minimise any downside.
This report was written by Mark Allen – Head of Derivatives at Simple Investments Stockbrokers. The writer does not hold a position in Keller Group, but client accounts may. The material in this report has come from Simple Investments internal data sources, Simply Charts and Keller Group’s corporate website.