Smart Investor Tip: a construction giant that's ripe for investment

With healthy profits and attractive dividends, construction giant Balfour Beatty ticks the boxes, says Smart Investor.

Market rally puts pressure on value

With the stock market having had a reasonable run of late, finding quality companies at reasonable prices is becoming a challenge for investors.

Of course, many investors become more confident the higher stock markets go, buying more and more shares as companies become less and less attractive.

As mentioned previously, a sensible means of avoiding buying at the top of the market (not that I am attempting to call the market) is to cost average.

Balfour Beatty under the spotlight

Today’s company under consideration, Balfour Beatty BALF.L), has its annual results due out in two weeks, so cost averaging may prove to be more prudent than ‘piling in’.

Balfour Beatty is a FTSE 250-listed infrastructure business that operates in more than 80 countries. Its business is split into four parts: infrastructure investments, professional services, construction services and support services.

Each of the four offers a range of services, including civil engineering, rail renewals and construction management. In addition, Balfour Beatty holds a portfolio of long-term public-private partnership (PPP) concessions in the UK and US. With a market capitalisation of £1.95 billion, Balfour Beatty is the 123rd biggest UK-listed company.

Performance

The past five years have seen Balfour Beatty produce a healthy net profit in each year, ranging from £91 million in 2006 to £211 million in 2009. Net profit grew at an annualised rate of 23.5% from 2006 to 2009 before falling to £143 million in 2010 as a result of challenging trading conditions, which saw revenue growth slow to 3.1%.

Exceptional items also helped to water down the bottom line in 2010. However, return on equity has been impressive over the five-year period, averaging 25.4% and hitting 13.3% last year.

Dividends, meanwhile, are attractive. The shares currently yield 4.5% from a payout ratio of 60%, with dividends per share having been stable for the past three years.

Free cash flow

Free cash flow averages £150 million per annum over the past five years versus average net profit of £158 million over the same period, which means a discounted cash flow calculation should be favourable (although low debt levels could mean a relatively high discount rate is used).

Focusing on viability, debt levels are very acceptable, with Balfour Beatty maintaining a net cash position (the amount of cash it holds exceeds total borrowings) and having a debt to equity ratio of 29%.

This affords the company substantial headroom when making interest payments, as shown in the interest cover ratio which is a healthy 7.3, and also makes the aforementioned return on equity figure appear to be more impressive.

Value analysis

So far, so good. Balfour Beatty continues to impress when the analysis moves onto value. With net assets per share of £1.69, the price-to-book ratio is an acceptable 1.67, while the price-to-earnings ratio at the current price of £2.83 is perhaps slightly generous at 13.5.

However, the combination of these two ratios shows that there is not excessive goodwill in the share price, and that Balfour Beatty should be considered fairly priced when its performance and viability are taken into account.

Smart Investor's verdict

With the FTSE 100 sitting pretty at 5,900, Balfour Beatty is no bargain-basement stock.

However, it offers quality in the form of an impressive profit track record, more than satisfactory return on equity, attractive yield and payout ratio, very manageable debt levels and acceptable free cash flow. Its price-to-earnings ratio is perhaps slightly generous, but not overly so.

With full-year results due out in two weeks, this is one to apply cost averaging to over the medium term. £2.83 per share is attractive, but a discount would be even better.