viewBalfour Beatty plc

Balfour Beatty bouncing back but under pressure to grow margins further

Many analysts believe Balfour Beatty's restructuring is working but margins in some divisions are at the bottom end of target ranges

Cost savings boosted Balfour's profits in the first half

Balfour Beatty PLC’s (LON:BBY) turnaround plan appears to be working but investors want to know what’s in store for the construction firm next.

The company posted a sharp rise in first-half profits as cost savings achieved under the so-called Build-to-Last transformation programme and higher margins offset a drop in revenue.

READ: Balfour Beatty hikes interim dividend 33% as it sounds confident note on outlook

Chief executive Leo Quinn said all of the businesses are now either achieving industry standard margins or are on track to do so in the second half.

The restructuring to simplify operations and improve margins began in 2015 after losses at its UK construction arm led to a series of profit warnings. As part of the turnaround plan, the company has sold off operations in Australia, the Middle East, and Indonesia to focus on core markets, including the UK, US and Ireland.

Restructuring paying off

Russ Mould, investment director at AJ Bell, said Quinn has done a good job of fixing Balfour’s balance sheet, bringing costs under control and boosting profitability.

He pointed out that Quinn has a well-earned reputation as a turnaround specialist at defence firm QinetiQ and printing outfit De La Rue.

“However, now that all of its divisions are either achieving industry-standard margins or are set to do so in the second half, attention will turn to where Quinn can take Balfour next,” Mould said.

“He may face a difficult task in an uncertain UK construction market despite a robust looking order book.”

Balfour said it expects profitable growth in 2019 and beyond, supported by tight cost control, a strong order book and a robust balance sheet.

Balfour under pressure to lift margins

But the company is under pressure to grow margins.

While margins in the US construction and support services divisions in the first half were in line with the firm’s expectations, the margin in the UK construction unit fell well below its target.

 “The Build to Last strategy, which has seen the group return from the brink, calls for above average margins beyond 2019 and at the moment many divisions are still lingering at the bottom end of their target ranges,” said  Nicholas Hyett, equity analyst at Hargreaves Lansdown.

“In an industry where pricing is notoriously competitive, convincing buyers that Balfour is worth a premium is a tough ask. At least government spending on infrastructure on both sides of the Atlantic provides a fairly benign backdrop.”

Balfour left its full year guidance unchanged as its order book grew in the first half after several wins in the US construction arm.

The outlook for the UK construction arm looks bright too as the government has a large pipeline of infrastructure projects.

Liberum thinks there should be opportunities on Heathrow’s third runway project, which is worth £14bn. “The plan was approved by MPs in June but is likely to face legal action, which could cause delays,” the analyst added.

Problem contracts 

The broker said there were still a number of problem contracts, including the Aberdeen Western Peripheral Route project for which Balfour took a £23mln write-down following the collapse of joint-venture partner Carillion in January. Balfour expects cash outflow of £135mln on the project for 2018, up from the previous guidance range of £105 -£120mln, based on completion in autumn.

“We see the risks at Aberdeen as evenly balanced; there is a risk that the contract slips from August, but there is also a possibility that accruals turn out to be too prudent,” Liberum said.

Liberum maintained a ‘buy’ rating on the stock and said it continues to expect full diluted earnings per share of 17.5p for fiscal year 2018. It raised its average net cash estimate to £145mln from £132mln.

“Leo Quinn has a good track record of driving strong cash flows and we believe Balfours can get to about £500mln spot net cash by 2020 (or around £250mln of average net cash),” Liberum said.

Quick facts: Balfour Beatty plc

Price: 259.2 GBX

Market: LSE
Market Cap: £1.79 billion

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