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Monday, 13th June 2016 10:18 - by David Harbage
Last week’s article looked at two strong trends – in the price of crude oil (Brent) and an AIM listed company share, Private & Commercial – and begged the question: acknowledging that the respective commodity and stock markets had placed new significantly higher valuations on each asset of these assets, did this indicated that further strength was likely?
Technical analysts look at various price movements and trends in valuation, examining graphs that show certain patterns (such as a ‘head and shoulders’) which, historically, can have a habit of being repeated. On balance, the writer would prefer to make stock selection judgement based on fundamental considerations – first examining a business, then assessing if the market is valuing its prospects fairly, taking a longer term (of years, rather than days) view – rather than by following chart precedent or anticipating a repeat of history.
Over the shorter term, anomalous pricing does occur, with the emotive forces of greed or fear contributing to push company shares either higher or lower than is merited or deserved. Extreme moments of despair (sometimes termed capitulation) or, alternatively, euphoria are usually short-lived but do provide opportunity for the nimble investor to either top slice or add to a stock which he or she already possesses or wishes to own. There is a real possibility that in the course of the next few days ahead of the 23 June referendum on Britain’s continuing membership of the EU, volatility will increase dramatically. In particular, poll or other empiric evidence that the ‘Leave’ campaign is gaining ground and set to achieve a so-called ‘Brexit’ could see the FTSE100 index below 6,000, and perhaps nudging the 5,500 level. In such circumstances, long term investors must have clear belief about what they own and why (in both asset allocation and stock selection) and day traders should have clear strategies in place.
While the UK equity market, dominated by multinational businesses, represents the global economy – it is the domestic firms that have been most obviously flagged as being ‘at risk’ of a Brexit outcome. This may or may not be fair but, leaving that aside, it is certainly true that a number of industry sectors have borne the brunt of investor neglect since May 2015, when the UK’s last general election result signalled that a referendum would occur. One domestic stock that has caught the eye as being particularly neglected over the past year has been Galliford Try – since achieving an all-time high of 1813p in August, the builder’s shares have retreated to a new 12 month low of 1265p, a level not seen since 2014. Chartists might be able to offer worthwhile comment on why a series of attempts to stabilise the share price have not succeeded (most recently in the second half of May 2016), but clearly many existing holders have decided to exit and prospective investors have chosen not to get involved.
The company’s business is two-fold: first, in building houses (for private consumption under the Linden Homes banner and, at much lower margin, as an affordable housing and mixed-tenure use contractor via Galliford Partnerships). The other division is construction (private and public works, including building, civil engineering, and infrastructure) in a wide range of industries from transport to utilities. The Linden Homes business, which is focused on the South of England but is developing an increasing presence in the Midlands and the North, looks similar to many of its pure house building peers – via operating margins of 17%, a near 4 year land bank, a high level of forward sales - is the prime contributor to profits (80% of total). By contrast, the other parts of the business feature low margin, in part legacy, contracts as well as public private partnerships. Having said that, their profitability is improving: partnership margins rose from 2.3% to 3% as at end of 2015 and are targeted to reach 4% by 2018, similarly construction margins improved from 1% to 1.2% with 2% the target.
In April this year, the company took some media flak when an external wall collapsed in an Edinburgh school which had been built ten years previously by Miller Construction (a business Galliford Try acquired in 2014). Miller was involved in building four schools in that city and Galliford is obliged to carry out remedial work – which management advised is nearing completion, with costs ‘not being material’ to the group. The shares fell £1 on the day of the announcement, as investors were reminded of the nature of this part of the firm’s operations. However, while the contracting and construction activities appear underwhelming and a drag on the Linden Homes division, the order book has risen rapidly over the past 18 months (to £875m in Partnerships and £3.7bn in construction, with newer contracts providing better returns) and – for those fearful of a ‘bubble’ in the housing market - makes the overall group less dependent on the domestic consumer and building private homes. The company’s own presentations focus on its reduced reliance on any one business activity, market or the economic cycle itself and its complimentary financial profile, as evidenced by the lead times & long contracts in construction, which generates regular cash to support the purchase of land for house building.
Results for the company’s full year to 30 June should show useful progress: with earnings per share (EPS) of 129p, representing annual growth of 11%, and the prospect of an 80p dividend would mean that the shares offer an income yield of 6%. The major advance is likely to arise in the following year, where a consensus of 6 brokers (including Barclays, Deutsche, HSBC, Jeffries, Numis and Peel Hunt) anticipate EPS of 155p and a dividend of 98.5p – to put the shares on a PE ratio of 8 times and a dividend yield of 7.4%. While the share price fall indicates a potential ‘value trap’, this fear is assuaged somewhat by the fact that profit and dividend pay-out forecasts for both the current year and 2016/17 have only been rising over the past week, month, quarter and half year. Historically, debt has been particularly low – gearing was just 3% a year ago, rising to 16.8% by December 2015 – but increasing spend on new land for Linden Homes over the coming two years could see gearing approach management’s cap of a more efficient 30%. Over the past three years, this hybrid construction group has enjoyed a premium rating, compared to house builders and most contractors. If the prospect of Brexit is looming larger, the appeal of Galliford Try’s more diversified business and its undervalued stock (compared to the wider UK equity market) could prompt outperformance of other single activity builders.
David Harbage 13 June 2016
The Writer's views are their own, not a representation of London South East's. No advice is inferred or given. If you require financial advice, please seek an Independent Financial Adviser.
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