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Share tip: this infrastructure specialist is embedded in the UK’s long-term economy
A blossoming order book, increased margins and a higher net cash pile all mean that August’s first-half results from infrastructure specialist Costain make for pleasant reading. The shares trade at four-year highs as a result, to leave us with a healthy paper gain and a interim dividend of 0.4p per share on the way – and there could yet be more to come.
Costain continues to win contracts from water companies as they prepare for the eighth asset management period regulated by Ofwat. It remains well-placed in other areas of fundamental importance to the UK’s long-term economic development, such as energy, road and rail.
A combination of projects where the company is either a preferred bidder or the recipient of a firm order means management has visibility on more than £4bn in revenues, although the skill then is delivering these complex assignments profitably and without a hitch, especially as margins for the contracting work are relatively thin.
Chief executive Alex Vaughan’s goal is to drive return on sales from the 2.5pc reached in the first half of 2024 to 4.5pc during 2025 and ultimately 5pc or more. His strategy rests on improved project management and an increased portion of sales from more lucrative consultancy work.
It is here that the upside in the stock may lie. Revenues may not grow too quickly but a 5pc operating margin on £1.3bn of annual revenues could turn into earnings per share of around 20p given the net cash balance sheet, a 25pc tax rate and the effects of a £10m buyback programme on the share count.
The still-lowly margin probably means Costain would merit a rating no higher than 10 times earnings, but 10 times 20 suggests a share price of 200p, if all goes to plan. That would imply a stock market valuation of around £550m and adjusting that for the net cash pile would give an enterprise value of around £350m, or roughly one-quarter of annual sales. Again, this feels sensible given the margin profile of the business.
Such is the potential upside, but it is worth remembering that two problematic contracts took Costain into loss between 2019 and 2021. Adjust the Berkshire-headquartered company’s stock market valuation for a net cash pile and investors are in effect paying less than £90m for the entire business.
Questor says: hold
Ticker: COST
Share price: 104p
As regular readers will attest this column’s record with small-cap resource plays is chequered at best, so the appearance of a bidder for Canadian oil and gas producer I3 Energy provides us with a welcome opportunity to lock in a modest book profit, neatly supplemented by 3.18p per share accrued from a succession of monthly and then quarterly dividends.
In August, Toronto-listed Gran Tierra Energy offered one of its shares for every 207 shares owned in I3 Energy, plus 10.43p per share in cash and a 0.2565p dividend. That equates to 13.6p a share at the time of writing and could leave shareholders in the UK-quoted firm with a 16.5pc stake in Gran Tierra.
The stock trades at a discount to the implied offer price, as if to suggest some investors harbour doubts as to whether the bid will go through, even though it comes with the recommendation of I3 Energy’s board.
Questor says: sell
Ticker: I3E:AIM
Share price: 12.18p
Oh dear. Our investment thesis on challenger bank OSB is already facing a battering after the profit warning that accompanied August’s first-half results. However, we shall cling to the thought that the lowly valuation could offer some downside protection, since the stock trades at barely 0.7 times tangible net asset or book value, while an improved macro-economic environment in the UK could help to provide earnings and share price upside.
OSB owns the Kent Reliance, Precise Mortgages and Charter Savings Bank brands and is a specialist in buy-to-let, residential and commercial property mortgages. The alert from Andy Golding, OSB’s chief executive, that net interest margins on the loan book would decline in the second half of 2024 compared to the first, thanks to competition in the mortgage market, means profits may grow less quickly than expected – despite low levels of loan and asset impairments.
That rather overshadows the advance in first-half earnings, a dividend increase and a new share buyback programme, but we can at least farm a prospective yield of more than 8pc while we await further developments.
Questor says: buy
Ticker: OSB
Share price: 368p
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