Could these outsourcers be in the foothills of a big recovery? And should I buy shares in them today?
When Kier and Babcock shares were overpriced
I turned bearish on the outsourcing sector in 2016/17. Having analysed a number of companies’ accounts, I concluded that with debt and worrying signs of aggressive accounting, their balance sheets were likely a lot more fragile than they appeared on the surface.
A few other analysts had reached the same conclusion. But more were to follow. Disclosable short positions in outsourcers began to rise steeply. Hedge funds were increasingly betting that Kier and Babcock shares (among others) were overpriced and set to collapse. At peak, almost 9% of Babcock’s shares and 14% of Kier’s were being shorted.
Aggressive accounting and weak balance sheets were ultimately exposed. However, much has changed at the two firms. These changes are why I’m considering whether to buy the stocks today.
Boardroom clear-outs and accounting clean-ups
Kier and Babcock have new management teams and I think these changes bode well for their share prices. The clear-outs of the old executives alone wouldn’t be sufficient for me to consider investing. But there have been other important changes.
Both companies have taken steps to improve what were previously opaque financial statements. Kier has implemented recommendations, on things like revenue recognition, made following an enquiry by the Financial Reporting Council’s Corporate Reporting Review Team. Management has also made other changes. These include the presentation of non-statutory profit “to improve the transparency and clarity of the group’s financial performance.”
At Babcock, new management has conducted a “contract profitability and balance sheet review.” This has identified impairments and charges totalling around £1.7bn. The company’s preliminary results for its financial year ended 31 March are currently delayed. This is in part because of “the large number of potential adjustments under consideration.”
Would I buy Kier at the current share price?
In addition to the management changes and accounting clean-up, Kier has substantially strengthened its balance sheet recently. It has raised £241m of new equity and sold its house-building business for £110m. The CEO has said this represents “the final milestone” in reshaping the group.
Kier trades at 4.6 times forecast earnings at a current share price of 129p. I think the stock looks very buyable on this valuation. However, I do have to accept the risk the shares may not perform well, if ‘new’ Kier’s strategy falters and it fails to meet its medium-term financial targets.
Would I buy Babcock at the current share price?
“We aim to return Babcock to strength without the need for an equity issue,” the company’s CEO has said. This will depend on the success of its self-help measures. These seem to include disposing of assets of at least £400m by next April.
Babcock is rated at 8.9 times forecast earnings at a current share price of 295p. This enough to put the stock on my watchlist. I await further details on the company’s financials and plans when those delayed preliminary results are published
Finally, its perhaps worth noting there are no longer any disclosable short positions in Kier and only one (0.59% of the shares) in Babcock.
G A Chester has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.