Balfour Beatty goes under a Fool's microscope.
If you trawl the stock market looking for shares on low price-to-earnings (P/E) ratios, then at some stage you'll come across the multinational civil engineering and construction company Balfour Beatty (LSE: BBY), which is a member of the FTSE 250 index.
Even after a substantial rise from last year's low of 214p to today's price of 273p, its shares are sitting on a headline P/E ratio of 7.9 while yielding 4.6%. Let's kick the tyres and see what's going on.
What does it do?
Balfour Beatty specialises in public sector infrastructure projects and, having bought the American engineering firm Parsons Brinckerhoff in 2009, it now operates in over 80 countries. So, unlike the vast majority of UK construction and engineering companies, it is heavily diversified away from the vagaries of the British economy.
About 60% of its sales come from Europe, a further 30% is produced by North America, while most of the remainder comes from South-East Asia and Australasia.
Infrastructure spending relies heavily upon government contracts, so investors will obviously have some concerns about this sort of business because of the pressure on the public purse in many of the countries in which Balfour Beatty operates.
But most of these worries will already be priced into the shares, and in troubled times governments of all political persuasions prefer to prioritise infrastructure spending to boost the economy, as we're seeing with the proposed High-Speed Two Rail link between London and Birmingham.
Always check the earnings
When I look at a company, one of the first things I do is to compare the headline earnings per share (eps) with the profit and loss account. Like many other companies Balfour Beatty produces two different eps: 'basic', which is nothing more than its statutory earnings, and 'adjusted', which excludes exceptional items and the amortisation (depreciation) of intangible assets.
There are good reasons why companies use an adjusted eps. For example, in theory exceptional items should not recur in the following years so, when looking forwards, you want to exclude them from the eps to get some idea of what the business is capable of earning.
Furthermore, when intangible assets -- such as goodwill -- are amortised, this often fails to reflect their true value (the accounting treatment of intangible assets is a very contentious topic).
A good example of this was seen with Marvel Entertainment, the company that owns many superhero characters such as Spider-Man and The Hulk. Marvel always argued that its goodwill (character brands and trademarks) didn't lose value over time, so it didn't amortise it.
I used to own shares in Marvel, so I'd spent a fair bit of time considering this policy and decided that I had no problem with it. The company was shown to be correct when The Walt Disney Company (NYSE: DIS.US) bought Marvel in 2009 for a sum that valued the goodwill at many times its unamortised balance sheet valuation.
Always check the eps
In Balfour Beatty's 2010 accounts, the adjusted eps of 34.7p is produced by excluding some £132 million worth of exceptional items and intangible asset amortisation. In contrast, the statutory eps is 21.0p. So given the current share price of 273p, the historic P/E is either 7.9 or 13.0 depending on whether you use the adjusted or basic eps.
The consensus forecast eps for 2011 of 35.3p puts it on a prospective P/E of 7.7. Don't ask me if any allowance is made in the forecast for the difference between adjusted and basic eps!
Show me the money
I've summarised Balfour Beatty's key figures for the last five years in the table below.
| | 2010 | 2009 | 2008 | 2007 | 2006 |
|---|
| Turnover, millions | £10,541 | £10,339 | £9,486 | £7,488 | £5,852 |
| Pre-tax profit, millions | £187 | £265 | £270 | £157 | £125 |
| Adjusted eps | 34.7p | 34.4p | 34.2p | 30.3p | 30.3p |
| Basic eps | 21.0p | 37.1p | 37.2p | 30.5p | 18.4p |
| Dividend | 12.7p | 12.0p | 11.1p | 10.0p | 7.9p |
As you can see, basic eps has grown by 14% during this period, which is a good performance given that includes the biggest global recession since the Second World War. Importantly, the company managed to grow its turnover and remain profitable even in the depths of the recession, which is a strong indicator that it is a well-managed business.
The half-yearly report for 2011 showed basic eps rising by 11% to 10.2p while the interim dividend was increased by 5%. The most recent net asset value per share is 177p. Full-year results for 2011 are due to be published on 8 March.
An alternative way to invest
Balfour Beatty is one of the few large quoted companies that have issued convertible preference shares, which gives investors a different way to invest in its shares. These are the Balfour Beatty 10.75% Cumulative Convertible Redeemable Preference Shares (LSE: BBYB), which currently trade at 125.5p.
They pay a much higher income than the ordinary shares, almost 8.6% gross, but because they'll be redeemed for 100p on 1 July 2020, then unless it ever becomes worth converting, today's investors will be stuck with a loss of just over 20.3% if they hold for the duration.
The terms of the preference shares allow holders to convert them into ordinary shares on certain dates at the rate of 24.69 ordinaries per 100. Currently, 100 convertibles worth £125.50 would become 24.69 ordinary shares valued at just over £67, so no-one should exercise the option at today's price.
The break-even share price is 508.3p, some 86% above the current level, although if and when the ordinaries reach 405p then their value on conversion will exceed the 2020 redemption payment.
When I first looked at the shares
Balfour Beatty appeared on my radar last October while I was trawling the market for shares on low P/E ratios. I ended up buying a different infrastructure specialist, the far smaller Morgan Sindall Group (LSE: MGNS) as it was on a lower statutory P/E and paid a bigger dividend (I was buying for income rather than capital growth).
Balfour Beatty remains on my watchlist.
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More from Tony Luckett:
> Tony owns shares in Morgan Sindall Group
