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Costain Group plc: buy the dip?

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Technology-based engineering solutions provider Costain Group (LSE: COST) has a lot going for it including a reasonable valuation, a decent dividend yield and operational momentum.

At around 465p, the shares are up 27% since the beginning of the year reflecting the firm’s progress. However, since peaking at 481p or so, the price has eased back during May. Should I buy the dip?

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In line with expectations

The most recent market update came with the AGM statement on 8 May. Chief executive Andrew Wyllie CBE told us that current trading is in line with expectations, which we can gauge by looking at what City analysts following the firm are saying. They anticipate that earnings will push up 10% during 2017 and 5% in 2018, so growth remains on the agenda.

Yet the shares are not expensive. The forward price-to-earnings ratio sits just below 13 for 2018 and the forward dividend yield runs just below 3.5%. Those anticipated forward earnings should cover the payout more than 2.2 times, which looks comfortable.

One thing I like about the firm’s forward earnings predictions is that more than 90% of turnover comes from repeat business, suggesting that forward earnings and cash flow may have stability and good visibility.  Costain has embedded itself as a critical cog in the ongoing building and maintenance of much of Britain’s infrastructure in the areas of energy, transportation and water, and deals with blue-chip clients as a trusted partner.

Strong, lower-risk order book

I reckon the sheer size and the complexity of Costain’s contracts mean that competition could be limited to just a few other companies with sufficient capabilities to execute the work. On top of that, clients may be reluctant to switch from using a trusted and experienced partner company that has developed processes and working relationships that may be difficult to rebuild from scratch.

So, it’s no surprise to see the firm recently reporting a significant number of new orders and contract extensions, such as development of the M4 corridor around Newport for the Welsh government, a compressor station upgrade for National Grid, and a contract for the East works package of the Thames Tideway Tunnel in London among others.

The order book at the end of 2016 stood at £3.9m, a figure unchanged from the year before, which demonstrates the consistency of the firm’s workload. The directors explain that more than 90% is for lower-risk work utilising target cost, cost reimbursable contracts, which Costain’s customers recognise as the most appropriate contract form to deliver their often complex and changing requirements.

Outlook

The directors assert that the referendum and ongoing Brexit process is not affecting the firm adversely. It sees more opportunity than threat from political changes, referring to an “increased emphasis from the government on the vital role infrastructure plays in promoting economic growth.” This, the directors say, presents Costain with additional opportunity.

My one reservation is that there is an element of cyclicality to its operations, but right now the trading environment seems robust, so I do think it could be worth picking up the company’s shares on any dips.

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Kevin Godbold has no position in any 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.

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