The model portfolio is filling up nicely (12 out of 20 slots taken) and now it’s time to buy another company.
I’ve scoured the market for the best high quality, high value shares and top of the pile for now is Balfour Beatty, the diversified engineering, construction and infrastructure services company.
It operates in the UK, Europe, US and many other regions around the globe and its story began in 1909 with the construction of a new tramway system in Dunfermline in Fife.The company has been shaping the world’s infrastructure ever since, growing to be the 15th largest construction firm in the world.
In the short term the infrastructure business is under a lot of pressure from government spending cuts, both current and expected. In the longer term though, infrastructure may still be a good place to be. The world’s ever growing and ever wealthier population will still need power, water, food, transportation and much more, and it’s companies like Balfour Beatty which will help supply them.
At a price of 231p, the dividend yield is 5.8%, the price to adjusted earnings ratio is 6.7 and the market cap is £1.5 billion. Balfour is in the FTSE 250.
My strategy is to only invest in companies that have a long, steady history of revenue, profit and dividend growth. For Balfour Beatty the results in these areas have been solid, with all these measures more than doubling in the last decade.Other factors are more mixed though.
For example, return on equity is typically over 20% which is above average, but this has been trending downward in the past few years. Margins are quite thin, with earnings per share being around 2.5% of revenue per share. This does seem to be a feature of the business and hasn’t stopped their consistent growth, and they are now making efforts to move into higher margin areas.
Overall it seems to be a good, consistent company which is growing over time at a reasonable pace.So how does it stack up against the FTSE 100, the benchmark most investors are trying to beat?
On all counts it beats ‘the market’, which means it may well be an above average company (higher growth rates and returns on retained earnings) at a below average price (higher yields).
The market doesn’t usually give away good companies on the cheap without reason. Generally there’s some kind of situation which makes other investors nervous.
With Balfour Beatty there are a few possible reasons. Starting from the top, investor appetite for most equities is weak. The economic environment isn’t good at all. Fears about a double dip recession and the debt troubles of the west are everywhere. Most shares outside of a few high-tech companies are trading at relatively low valuations, which can be seen in the FTSE 100 price to earnings ratio being below 10 and its dividend yield being around 4%.
Specific to Balfour Beatty, those western government debt problems are a major source of concern. In both the US and Europe, the major markets for the company, spending cuts are already on going. This is expected to continue for several years and is also expected to make life very tough for the company.
The key question is, can it survive these issues and if it does, will its long term success be damaged?
Regarding survivability, it’s highly likely that Balfour Beatty will be around in 10 years, and it may well be around in 100 years too. They have low debt, a diversified revenue stream and a great brand name to see them through tough times.
A more realistic concern is whether or not the current level of earnings and dividends can be sustained and whether growth will fall far short of previous expectations.
As with most companies, there is a plan to mitigate much of the loss of revenue from existing markets. In recent years operations have expanded across the globe and efforts are now focused on the areas of greatest opportunity, such as India, Australia and Canada. Recently implemented cost efficiencies are now expected to save around £30 million a year as well.
Whether this will be enough to keep earnings and dividends on an upward trend remains to be seen.
If the current issues are survivable, then what might the future look like? As ever it’s hard to say but I can see the case for growth in the global infrastructure business in the coming years, as does management. I certainly don’t think this is a declining industry.
As for returns to shareholders, I like to project total returns over 5 years since this is a sensible minimum holding period for any equity investment. From a price of 231p, if earnings grow at the ‘potential’ rate above, if dividends are paid out at the historic rate and if the PE returns to its historic average of almost 11, then the share price could be 560p. Add in dividends totalling 74p in that time and you get an estimate for total returns of 403p, or 174%. That’s quite a bit more than the 85% return estimate I get from the FTSE100, although that in itself is a pretty good figure.
You have to remember that these projections will never be correct, but that is not the point. They can provide a reasonable guide to the attractiveness of one investment against another.
This approach of always looking at what the total returns might be over 5 years helps create the right mind set. My opinion is that 99% of today’s news is irrelevant. It’s as irrelevant as next year’s news that you don’t even know about yet.
When you’re investing for 5 years at a time what matters is picking companies that are likely to prosper, regardless of what tomorrow may bring.
John Kingham says
Noticed a couple of Motley fool articles about Balfour Beatty and construction:
You have written about BB before, haven’t you?
John Kingham says
Hi Eugen, not that I’m aware of; I think this is the only post. Did you want to know something?