Can G4S's growth continue and are the shares cheap?
Capital appreciation is surely the goal of many investors. One method of achieving that is to buy companies with steady earnings growth. If bought when the shares are cheap, two drivers could move the share price up:
- growth in earnings, and
- an upwards P/E re-rating.
Highly successful fund manager Peter Lynch classified steady growers as Stalwarts, which he typically traded for 20% to 50% share-price gains. But whether buying for gains like that or holding for the longer term, we need to know if reliable earnings growth can continue, and whether the shares are cheap.
Seeking durable growth
Not all companies achieve stable growth as you can see by the aggregate performance of those in London's premier FTSE 100 index (UKX), where the compound annual earnings-growth rate has been just 0.7% over the last five years:
| Year to June | 2007 | 2008 | 2009 | 2010 | 2011 | 2012 |
|---|
| FTSE 100 index | 6608 | 5626 | 4249 | 4917 | 5946 | 5571 |
| Aggregate earnings per share | 537 | 503 | 427 | 397 | 527 | 557 |
Consistent, cash flow-backed growth in profits is a promising characteristic in today's markets so, for this series, I'm examining firms with annual earnings growth between 4% and 20%.
One contender is G4S (LSE: GFS), which is an international security services firm. This table summarises the company's recent financial record:
| Trading year | 2007 | 2008 | 2009 | 2010 | 2011 |
|---|
| Revenue (£m) | 4,484 | 5,929 | 7,009 | 7,258 | 7,522 |
| Adjusted earnings per share | 13.3p | 16.6p | 20.2p | 21.9p | 22.8p |
So, earnings have grown at an equivalent 14.4% compound annual growth rate putting G4S in the Stalwart category.
Despite the company's newsworthy difficulties over its London Olympics contract, growth appears to be on the agenda for 2013 and beyond. G4S has around 657,000 employees and operations in more than 125 countries. It derives around 47% of its revenue from Europe, 23% from North America and 30% from what it calls developing markets, which includes places like The Middle East, Latin America, Africa and the Asia Specific.
The company has grown both organically and by acquisition; now, its sheer size makes it one of the few bidders capable of servicing some big contracts. If reputational fall-out from the summer's Olympic disaster is manageable, further steady earnings growth seems likely, despite what looks like being a flat financial performance during 2012.
G4S's earnings growth and value score
I analyse five indicators to determine whether earnings growth can continue and if the shares offer good value:
1. Growth: revenue has grown steadily; cash flow and operating profits peaked in 2009. 2/5
2. Level of debt: net gearing is around 119% with borrowings about six times earnings. 1/5
3. Outlook and current trading: mixed recent trading and a cautiously positive outlook. 4/5
4. Enterprise value to free cash flow: 26 and above adjusted earnings growth rate. 2/5
5. Price to earnings: a trailing 11-or-so and below historic adjusted earnings growth rate. 3/5
Overall, I score G4S 12 out of 25, which inclines me to be cautious about this stalwart's ability to continue earnings growth that out-paces that of the wider FTSE 100. The price of the shares seems fair when compared to the FTSE's price to earnings ratio of around 11 and the firm's growth predictions.
Foolish Summary
G4S's acquisition programme continues to boost top-line growth. However, debt has been increasing and, recently, margins have softened. Cash flow seemed to peak during 2009. The positive outlook is reassuring.
Right now, forecast earning growth is 13% for 2013, and the forward P/E ratio is 9.7 with the shares at 249p. Considering that and the other factors analysed in this article, I think that looks like a fair price, but G4S can stay on my watch list for the time being.
G4S is one of several steady-earnings-growing stalwarts on the London stock exchange, each with the potential to deliver significant capital appreciation when purchased at sensible prices.
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> Kevin does not own any shares mentioned in this article.
