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As the Kier share price jumps 10%, here’s what I’d do now

Investors following the Kier Group (LSE: KIE) share price will presumably have been pleased to see it picking up Monday morning. At one stage it had gained as much as 10% and, at the time of writing, the shares are still up a tasty 6.5% at 150p.

We need to see that in perspective, mind, as the shares have lost 85% over the past two years. Still, they’re up on their low point and, so far in 2020, have gained 58%.

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In valuation terms, the current price puts Kier shares on a P/E multiple of just 3.4. And that’s way below what I’d expect to see from a healthy company in that sector. It’s based on a forecast 24% drop in earnings for the year to June, though there’s a tentative 6% gain suggested for 2021.

Going bust?

That valuation, however, shows the market isn’t convinced by the case for Kier Group. It suggests big investors are afraid it will go bust. Remember Carillion?

Carillion went into liquidation in January 2018 after debts spiralled and working capital ran out. There really was no way of securing a rescue. And, right now, Kier looks scarily similar to Carillion.

My colleague Roland Head looked at Kier’s low valuation in December, making the apt point that sometimes things are cheap for a reason.

The key risk Roland identified is Kier’s very substantial debt. Kier was weighed down by average month-end net debt of £422m during the 2018/19 financial year. For a company forecast to make a pre-tax profit of only £89m in the current year, that’s not good.

It’s not all doom and gloom though, and there could be light at the end of the tunnel. Chief executive Andrew Davies, who took control in April 2019, has applied a severe ‘new broom’ approach. He’s been selling off various assets, reducing costs, and refocusing the firm.

Perhaps, ironically, Davies had been due to take the helm at Carillion. But it went bust a week before his planned commencement. Is that an omen? I hope not.

Upbeat in 2020

The company started 2020 with an upbeat trading update. Kier, apparently, has made it onto a shortlist of approved contractors for future government contracts, though it would take some time for that to translate to any income.

Disappointingly, there was no real update on the debt situation other than to say it’s “in line with the board’s expectations.” Whatever they are, I guess we’ll have to wait for interim results, due on 20 March.

I’ve often found recovery situations tempting through my investment career, and Kier is definitely on my list to watch. But lately, considering collapses of firms like Thomas Cook (plus, of course, Carillion), I’m keeping a very close eye on the downside.

I wouldn’t touch Kier without seeing the recovery convincingly under way, and the threat of liquidation receding. Should that happen, I expect the share price would rise significantly before I’d buy. So I’d miss the bottom with that approach, but it should minimise my chance of a wipeout.

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Alan Oscroft 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.