Shares digital

Engineering firm’s strong worldwide presence more than offsets US difficulties

by Carlo Svaluto Moreolo

Keller (KLR) 703.5p, Stop Loss 563p

Shares summary

Good niche positioning and exposure to growing economies should help Keller ride out a downturn

Business:

Provider of ground engineering services to heavy construction and resources industries

Vital stats:

Market value: £452.3 million

Historic PE: 7.2

Prospective PE 2008: 7.0

Prospective PE 2009: 7.3

Sector PE (next 12 months): 8.5

1-month relative strength: 16.8%

1-year relative strength: -13%

Yield 2008: 3.0%

NMS: 1,250

Spread: 0.3%

Exposure to the sagging US economy is a potential drag on ground engineering specialist Keller, but those who look only at its American operations are missing out on an opportunity, as this ignores the excellent growth the £453 million cap is generating in other geographical regions.

Ground engineering is a service which is increasingly needed as the world wakes up to a desperate need for new infrastructure, both in the developed and the developing world. In emerging economies the development of infrastructure is both a consequence of, and catalyst for, economic growth and Keller has a strong presence in such economies.

At this week’s interim results (28 July), the company showed a 28% increase in revenue from continuing operations to £568.7 million, which it attributed to ‘excellent organic growth outside the US’.

The increase in pre-tax profits was more muted – 19% up from the same period last year to £54.2 million. Nevertheless Keller still delivered a 0.9p increase in the dividend to 6.9p, in line with its promise to increase payouts by 15% per year.

In the US, Keller’s biggest headache is its Suncoast unit, where exposure to the housing market meant margins and the whole US division’s profit dropped. A further complication is a steep increase in steel prices, which the operation will have to try and pass on to customers. Keller noted last week ‘the fortunes of Suncoast in the second half of the year will be affected by its ability to pass on any further increases in its raw materials’, but added that ‘nonetheless, the business is expected to remain profitable.’

US exposure is likely to remain problematic, but a 40% share price decline over the past 12 months and a single digit PE must by now price in a lot of the difficulties. Such a valuation also neglects Keller’s strong presence in the Middle East, Eastern Europe and Australia, which this year will generate 60% of group profit, up from 30% three years ago.

The benefit of investing heavily in expansion in these regions is already feeding through, but the fragmented nature of these markets means there should be a lot more to come. Analysts at Numis point out Keller’s estimated share of the e3 billion European market is just 8%.

Acquisitions should supplement organic growth as Keller grabs a greater market share. The London firm has a history of acquiring businesses and, according to Numis, now generates over $1 billion in sales from firms it has snapped up since it made its first purchase and entered the US market in the early 1980s.

The shares peaked at £11.68 in September last year and bottomed in January around 500p mark. They have since rallied back to 703.5p, but upside remains. Numis’ below-consensus forecast of pre-tax income of £95.1 million leaves the stock on a prospective PE of 7. A yield of 3.5% may be lower than many construction companies but it is a lot safer, as the board has committed to maintain coverage of at least three times while the payment grows at 15% per year.