In Monday’s disastrous first-half results, Costain reported an operating loss of £90m. Reported revenues were more than 20% below those of the year before. Some of this can be attributed to Covid-19, which has disrupted operations and affected profitability. But most of it comes down to a couple of exceptional items, namely issues with two major contracts.

Contractual issues hit the Costain share price

Together, these contractual problems have cost the group around £90m in lost revenue. In both these instances, there is the possibility that costs may be recouped. In fact, I think some of it will be. The problem is that these exceptional items have come so soon after last year’s exceptional items. If they start to become a regular occurrence, then they are no longer exceptional.

The thing is, Costain is actually not short of work. The group has a £4.2bn order book, with getting on for £1bn of that confirmed for next year. But what’s the point of doing work, if you can’t do it profitably. Operating margins for the group’s traditional complex delivery programmes are as low as 2%. This leaves very little room for manoeuvre. Anything but perfect execution results in a loss.

This is why Costain is now focusing on higher-margin consultancy services, with a particular interest in digital solutions. It sounds good, in theory, but whether it plays out in practice remains to be seen. More and more companies seem to be jumping on the digital solutions bandwagon. Success depends on there being enough work to go round.

It’s not all bad

Despite the negatives, Costain does have some strong tailwinds too. Its highways solutions have benefited from renewed investment commitments from the UK government. Infrastructure projects, like HS2, will be an important tool in kick-starting any economic recovery. In March, the government committed to investing £600bn in UK infrastructure over the next five years. Costain also looks set to benefit from the move towards a carbon-free society after developing its decarbonisation solutions. The group is involved in several noteworthy projects, involving carbon capture and storage, hydrogen and biogas.

Its recent equity raising diluted the ownership of existing shareholders and sent the Costain share price sharply downward. But it also gave the company a much-needed infusion of cash. Net cash now stands at around £140m and the balance sheet looks healthy.

Ultimately, I think Costain will be successful in its move into digital consultancy. But I don’t know how long the transition is going to take, or how bumpy the ride will be for its shareholders. It’s hard to see how the ‘new’ company will compare to the one we see today. The new Costain might be smaller but more profitable. With this uncertainty, I would steer away from the shares at this moment in time. While there is plenty of scope for the Costain share price to move upwards, I think there are much better companies to invest in.

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Should long-term investors treat this as a buying opportunity, or is more bad news likely? Let’s take a look…

An emergency admission

Four months ago, Craneware — which makes billing software for US hospitals — reported “strong sales activity and opportunities” and “increasing market engagement.” Unfortunately, things seem to have gone downhill since then.

In Friday’s profit warning, the company admitted “the timing and quantity of sales” have been lower than expected during the second half of the year. As a result, sales are only expected to rise by 6% this year, compared to forecasts of 18%.

Profit growth will also be lower. Earnings before interest, tax, depreciation and amortisation (EBITDA) are now expected to rise by 10% for the full year.

What does this mean?

Today’s guidance seems to imply Craneware’s growth has come to a halt during the second half. Reading between the lines, I wonder if the firm’s new Trisus product is taking time to gather momentum.

My sums suggest second half revenue is likely to be about $35m — unchanged from the first half of the year. For a company that’s delivered strong growth every year since 2014, that’s a concern.

Before today’s news, CRW shares were trading on a steep 55 times 2019 forecast earnings. I now estimate this forward multiple at about 32.

Although I admire this firm’s high-profit margins and strong growth record, I think the shares continue to look fully priced. Personally, I’d want to look for an opportunity to buy below 1,800p. I’d await further news before making any trading decisions.

Construction delays

I view infrastructure group Costain as one of the best quality stocks in the construction sector. But today’s news shows the company is still prone to the classic problems for investors in this area — delayed contracts and legacy contract costs.

The firm says projects including the M6 Smart Motorway, Preston distributor road and HS2 Southern Section have been affected by delayed start dates. An upgrade to the M4 motorway at Newport was cancelled by the Welsh government earlier this month.

These setbacks mean underlying operating profit for the year is expected to fall by more than 20%, to between £38m and £42m.

In addition to this, the company will face a one-off £9.8m charge relating to remedial works on a contract that was completed in 2006. The sub-contractor that actually did the work has long since gone bust, leaving Costain carrying the can after all this time.

Profit slump

The latest broker note I’ve seen suggests today’s profit warning is likely to result in Costain’s adjusted earnings per share falling by about 30% in 2019, and by a similar amount in 2020. A matching dividend cut is also expected.

These forecasts price the stock on about eight time earnings, with a dividend yield of 5.7%. Given the uncertain outlook and the risk of a construction downturn, I think the shares look fully priced for now.

For long-term shareholders prepared to ride out the storm, I might hold onto the stock. But otherwise, I’d view this as a sell… until better news emerges.

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Roland Head has no position in any of the shares mentioned. The Motley Fool UK has recommended Craneware. 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.

Among those shares to have fallen in recent months is Morrisons (LSE: MRW). The retailer has been hurt by investor sentiment towards the wider sector coming under pressure as consumer confidence has weakened ahead of Brexit. But this could represent a potential turnaround opportunity. Alongside another recovery stock which reported news on Thursday, Morrisons could be worth buying in my opinion.

Improving prospects

The company in question is technology-based engineering solutions specialist Costain (LSE: COST). It released a trading update for the 2018 financial year, with it continuing to perform well in the second half of the year. It has made further progress on its strategy as it seeks to differentiate itself from peers through its long-term strategic relationships and technology-enabled services.

It has finished the year with an order book which stands at a record level of £4.2bn. Its net cash position of £110m suggests that it has the financial strength to continue to invest in its product offering during what remains an uncertain period for the wider sector.

With Costain’s share price having fallen by 29% since May, it now trades on a price-to-earnings (P/E) ratio of around 9. This suggests that it may offer a margin of safety. With earnings growth of 6% forecast for the current year, it could deliver improving share price performance over the medium term.

Turnaround potential

As mentioned, Morrisons has experienced a challenging period. Its shares are down by 20% in the last four months, with investors becoming increasingly concerned about the outlook for UK retailers. Consumers seem to be cautious about spending, and this may be due to fears surrounding the performance of the UK economy post-Brexit. Although employment levels have been high for a number of years, political risks could weigh on business confidence over the coming months. Therefore, it would be unsurprising for an increasingly price-conscious consumer to emerge.

Competition within the supermarket sector is already high. However, Morrisons appears to have a sound strategy which is delivering improving sales and profitability. For example, it is focusing on growing its wholesale operations as it seeks to leverage its status as a major food supplier. This could provide it with access to growth in the convenience store segment. And with it seeking to boost customer retention through loyalty schemes, it could improve its competitive advantage versus peers.

Since the company now has a P/E ratio of around 16 and is forecast to post high single-digit profit growth in the next two years, it could offer good value for money. With debt levels falling and the potential for further special dividends, the stock may provide recovery potential over the long run.

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For this piece I’ve picked out a cluster of lesser-known shares whose long-term outlook remains just as compelling. Take a look, they could make you a fortune!

Insurance services star

Small-cap Charles Taylor’s (LSE: CTR) latest financials released this month may have prompted fresh selling, but I believe that market-makers may have been a bit hasty in their actions.

Sure, news of a 95% pre-tax profit drop from January to June was a shocker, but this was a reflection of one-off costs including charges relating to acquisitions and office moves. I’m more interested in the announcement that revenues blasted 21% higher to £123.4m in the first half, a result that shoved adjusted profit before tax 10% higher to £8.5m.

The result was encouraging enough to prompt Charles Taylor, which provides professional services to the insurance industry, to raise the interim dividend to 3.48p per share. City analysts think that the full-year dividend will rise to 11.7p per share, a figure that yields a fatty 4.7%. With the business strengthening through M&A to bolster its global footprint, I am confident that dividends should keep on barging higher along with profits.

Build a fortune

Building materials giant Costain Group (LSE: COST) is also a business that has been lifting dividends at quite a pace in recent weeks.

The infrastructure specialist raised the half-time dividend by 8% on the back of August’s sunny financial update, to 5.15p per share. Revenues ducked 12% between January and June to £772.9m on the back of “a lower level of large capital project activity” at its Infrastructure division. But this could not stop underlying pre-tax profit rising 17% to £21.4m to reflect the work Costain is undertaking to boost margins.

Investors need not worry about the sales drop-off in the first half either because its order book remains strong. According to the small-cap it boasted a “higher quality order book” of £3.7bn as of June, nine-tenths of which related to repeat business.

City brokers believe Costain will have the strength to raise the dividend to 15.5p per share this year. And this results in an inflation-mashing 3.7% yield.

A clear view

Tyman (LSE: TYMN) has proved to be a dream for investors seeking dividend growth in recent years, the manufacturer of door and window parts having almost doubled the annual payment during the past half a decade.

I’m confident that its major exposure to the strong trading territories of North America and Europe, allied to its growing footprint in the emerging markets of Asia and Africa should keep both profits and dividends growing at quite a rate as well.

And City brokers share my optimistic take, an anticipated 12p per share reward yielding a not-too-shabby 3.4%. With Tyman also having the financial strength to embark on additional earnings-boosting acquisitions I am confident that the small-cap should also prove a lucrative investment in the years to come. Just this month its SchlegelGiesse arm splashed out on Italian door-and-window-handles-and-accessories manufacturer Reguitti, along with its sister brands Tropex Design and Jatec, to boost its product portfolio still further.

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However, could it now offer turnaround potential? Or are investors better off focusing on other options, such as this dividend growth stock which released positive news on Tuesday?

Weak performance

Compared to the FTSE 100, BT’s performance has been hugely disappointing in the last year. It has underperformed the wider index by 26% during that time period. And with the FTSE 100 experiencing a volatile year, which has seen investor sentiment come under pressure at times, this highlights just how poor the company’s performance has been.

Looking ahead, the catalysts for BT’s disappointing performance look set to remain in play. The uncertainty that has surrounded the business in recent years concerning areas such as restructuring, Openreach, pension liabilities and the investment it’s making in sports rights, could still cause disruption regarding its operational and financial performance.

In turn, they may prevent the stock from delivering high earnings growth at a time when the wider telecoms sector is enjoying a relatively strong performance. For example, net profit growth of 2% this year and 1% next year seems unlikely to significantly shift investor sentiment. As such, further underperformance of the wider index could be ahead.

Value proposition

Of course, BT seems to be a very cheap stock at present. It has a price-to-earnings (P/E) ratio of around 9.5, as well as a dividend yield of 6.4%. These figures suggest there could be a wide margin of safety on offer for new investors, but may also indicate a value trap. Poor earnings growth forecasts may mean that it’s fairly valued and with pension costs and the investment it’s making in pay-tv acting as a drain on its financial resources, dividend growth could be somewhat lacking.

As a result, the prospects for BT seem to be challenging. While it could deliver a sustained recovery in future, the chances of it doing so in the next couple of years seem limited. Due to this, there may be better income and growth options available elsewhere. One example is Costain (LSE: COST), which reported positive news on Tuesday.

Improving performance

Costain’s trading thus far in the current financial year has been in line with expectations, with the smart infrastructure solutions company remaining confident about its outlook. And with it also announcing a contract win to supply Motorway Incident Detection and Automated Signalling technology systems on Tuesday, it seems to offer an improving performance.

Looking ahead, the company is forecast to post a rise in its bottom line of 6% per annum over the next two years. This is expected to prompt dividend growth of 10.5% per year in the same time period, which puts the stock on a forward dividend yield of around 3.7%.

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Peter Stephens 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.

Reach for the cloud

The Glasgow-based group has rapidly grown into one of Europe’s leading cloud computing companies, having become one of the most widely respected and most trusted providers of business-critical cloud and managed hosting services. In a nutshell, these services enable customers to reduce the cost, complexity and risks associated with maintaining their own web and online applications.

The majority of the group’s sales are generated by its Cloud Services segment, which has continued to perform well, delivering an overall revenue growth rate of 13%, helped along by contributions from Christie Data which it acquired in August 2016, and the more recent purchases of Dediserve and Simple Servers in May and July of this year. Last month the group also acquired Salford-based eCommerce specialist Sonassi for £16.5m.

Iomart’s smaller segment, Easyspace, also performed well delivering a more modest 2.3% rise in revenues to £6.7m, all of which was organic. Easyspace provides a range of products to the small and micro business community including an ever wider range of domain names, shared hosting, emails and dedicated servers. Total group revenues for the six months to 30 September came in 12% higher than in FY2016/17 at £47m, with adjusted pre-tax profits rising 9% to £11.6m.

Proven track record

Despite its rapid growth, Iomart is still a relatively small software company when compared to the likes of industry giants Sage and Micro Focus International, but the AIM-listed business is profitable, cash generative and well placed to capitalise on the growing cloud computing market through a proven successful strategy of both organic and acquisitive growth.

Iomart’s shares are up by a third already this year and trade on a pricey earnings multiple of 20, but I reckon this isn’t too demanding for a technology company with a proven track record of solid growth.

Long-term relationships

Another small-cap stock that looks great value right now is engineering group Costain (LSE: COST). The Maidenhead-based firm deploys technology-based solutions to meet urgent national needs across the UK’s energy, water, and transportation infrastructures.

Costain’s strong market position, reputation for innovation, and wide range of integrated services has enabled it to secure over £600m of new contract awards and extensions to existing contracts so far this year. Consequently, the group’s order book now stands at a whopping £3.7bn, 90% of which comprises repeat business, proving again that building long-term relationships can be highly lucrative for any contract-based business.

Costain’s rapid growth has led to the shares doubling in value over the past five years, but despite this, they still trade on a fairly modest price-to-earnings ratio of 13. I think they’re worthy of a higher rating.

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Bilaal Mohamed 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.

To give you a taste of what’s on offer, I’m going to take a look at two potential income buys from the FTSE SmallCap index.

58% profit growth

City of London Investment Group (LSE: CLIG) is an asset management group which invests at least 90% of its funds in emerging markets. The group’s pre-tax profit rose by 45% to £11.6m last year, while after-tax earnings rose by 58% to 36.9p per share.

However, shareholders shouldn’t get too excited by these dramatic figures. Last year’s results were given a big boost by the pound’s fall against the US dollar, and by a reduction in the group’s tax rate. Neither of these factors is likely to repeat this year, in my opinion. So does the group’s underlying performance justify further gains?

A cash-backed 6.2% yield

City of London’s funds under management rose by 17% to $4.7bn last year. Although that’s less than the 24% gain logged by the group’s benchmark index over the same period, management says that this is a result of clients taking profits on their emerging market funds and shifting some money elsewhere.

What’s certainly true is that the group’s cash generation continued to be very strong. Net cash rose from £10.2m to £13.9m last year, meaning that 13% of the group’s £106m market cap is now covered by net cash.

Cash reserves are now high enough to pay two years’ dividends at the current level of 25p per share. So the company should be able to pay a stable income through lean years as well as good years, providing more reliable returns to shareholders.

After today’s results, City of London Investment Group shares trade on a P/E of 11 with a dividend yield of 6.2%. In my view this continues to represent good value for investors looking for a long-term income. I’d be happy to buy at current levels.

Best in sector?

Continuing the theme that biggest isn’t always best, my pick of the stocks in the FTSE Construction & Engineering sector is Costain Group (LSE: COST), a £458m firm that was founded in 1865.

Unlike several of its rivals, Costain has avoided financial problems and delivered steady profit growth in recent years. One reason for this, in my view, is the company’s focus on large infrastructure projects where it can take consultancy and management roles, rather than low-margin contracting work.

To help improve its financial credibility when bidding on large projects, Costain raised £75m in a share placing in March 2014. This raised some eyebrows at the time, but has since proved wise. The firm’s revenue and its profits have both risen by more than 50% since then, suggesting management was right to strengthen the balance sheet.

Although Costain’s share price has risen by 30% over the last year, strong earnings growth means that the stock still looks reasonably priced, with a 2017 forecast P/E of 12.9 and a prospective yield of 3.3%. This company is certainly my top pick in this sector, and I believe it remains good value by any standards.

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Sixth year of growth

The Kettering-based group supplies the UK construction market with a wide range of products and services, including solar shading & architectural screening, roofing & walling, water management, and housebuilding & ancillary products. All of the group’s businesses enjoy strong positions and brands in their individual specialist markets, with 80% of sales driven by building regulations and specifications due to the performance characteristics offered.

For the financial year to June, the group delivered a 14% increase in revenues to £104.8m, reflecting strong export sales growth as well as continued growth in the domestic market. Here in the UK, revenues grew by 4%, comparing very favourably to the overall construction market growth rate of just 1.8%. Group earnings advanced for the sixth consecutive year, with underlying profit before tax up by 9% to £9m, compared to £8.3m for FY2016.

Squeeze on margins

It wasn’t all plain sailing, however. The combination of weaker sterling and a recovery in certain commodity prices raised costs for many of its products, which in turn impacted on margins, particularly for work already in the pipeline. While able to respond to these cost increases to various degrees, particularly with regard to future work, there was an inevitable squeeze on margins in the earlier part of the year.

But despite the relatively high level of political and economic uncertainty at the present time, I’m still optimistic about Alumasc’s future. Its chosen businesses have strong strategic positions in specialised market segments capable of growing faster than the overall construction market. Alumasc’s shares not only look grossly undervalued trading at just eight times forecast earnings, but also come with a nice little bonus yield of 4.5%.

Another strong performance

Small-cap engineering group Costain (LSE: COST) is another London-listed firm whose shares can be picked up for less than a fiver each. The business deploys technology-based engineering solutions to meet urgent national needs across the UK’s energy, water, and transportation infrastructures.

Interim results announced last month revealed another strong performance in the first half of the year, with 34% growth in underlying operating profit to £21.2m and a 10% interim dividend increase. Total group revenues (including share of joint ventures and associates) increased to £874.5 from £791.4m in the previous year, with underlying pre-tax profits up 30% to £18.3m.

Smart infrastructure solutions

Costain is transforming rapidly to become the UK’s leading smart infrastructure solutions company. Underpinned by legislation and regulation, the group is providing the technology-based solutions demanded by its clients who are spending billions of pounds to meet the UK’s ever more complex infrastructure needs.

The shares are up by a third in the last 12 months, and currently trade on a fairly modest P/E rating of 13 for the year to December.

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Growth potential

Reporting on Monday was engineering company Costain (LSE: COST). It released an AGM statement which said that the company is trading in line with expectations and it is confident of making further progress in future. Clearly, this is encouraging news for investors and shows that its strategy is performing well despite an uncertain macroeconomic outlook.

While Costain currently yields just 3.1%, it has significant dividend growth potential. Its dividend is covered 2.4 times by profit, which suggests shareholder payouts could rise at a faster pace than the company’s earnings. And with its bottom line forecast to rise by 10% this year and by a further 5% next year, there seems to be scope for a double-digit rise in dividends on an annualised basis over the medium term.

With Costain trading on a price-to-earnings (P/E) ratio of 13.8, it seems to offer excellent value for money. While there may be cheaper options available within its wider sector, Costain’s upbeat growth prospects and dividend growth potential could allow it to deliver outperformance in 2017 and beyond. While not without risk, it appears to be a logical buy at the present time given the outlook for higher levels of inflation.

Dirt-cheap valuation

Also offering income and capital return potential is fellow engineering company Keller (LSE: KLR). Its shares have become more popular among investors in the last six months, which has helped to push them around 32% higher. This means that they now yield roughly 3.2%, which is below the FTSE 100’s yield of 3.8% after the index’s recent pullback.

Despite this, there is scope for a faster-rising dividend than for the wider index. Keller’s payouts are covered over three times by profit at the present time. Certainly, dividend payouts are unlikely to ever equal profits, since some reinvestment for future growth will always be required. But such a high coverage ratio could be reduced and still leave the business in strong financial shape. As such, it would be unsurprising for Keller’s dividend payments to continue to rise following their 32% increase of the last five years.

With Keller trading on a P/E ratio of 10.1, it seems to offer a wide margin of safety. This could mean an upward rerating is on the cards. When combined with its impressive yield and significant scope for increasing dividends, Keller seems to be a sound investment for the long term.

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Today I’ll highlight some of the problems that were flagged up in Carillion’s results. I’ll also explain why I’d prefer to invest in one of the group’s smaller peers, despite its much lower dividend yield.

This 9% yield hides problems

Carillion’s dividend rose by 1% to 18.45p last year. At the last-seen price of 206p, that gives a yield of 9%. But yields this high normally signal problems, and in my view this is no exception.

The value of Carillion’s order backlog plus probable orders fell by 8% to £16bn last year. Revenue visibility for the year ahead is just 74%, down from 84% at the same point last year.

Chairman Philip Green promised today that Carillion will “accelerate the rebalancing of our business into markets and sectors where we can win high-quality contracts”. But with 26% of this year’s revenue still unaccounted for, my concern is that the firm will accept anything it’s offered in order to hit revenue forecasts.

In my view, the risk for investors is that the good part of this company — support services — is being weighed down by a number of problem areas.

Revenue from support services rose by 7% last year. The underlying margin on this work rose from 5.8% to 6.7%, lifting profits by 25% to £182.7m.

Unfortunately, this strong performance was cancelled out by a 43% decline in profit from Public Private Partnership projects and a 36% drop in profit from Middle East construction work. Although revenue from other construction projects rose by 21% to £1,520m, the profit margins on this work fell from 3% to 2.7%, negating some of these gains.

Carillion’s balance sheet looks increasingly weak to me. Average net debt was £586m last year, more than four times group profits. The firm’s £810m pension deficit currently requires cash contributions of £47m per year.

The dividend wasn’t covered by free cash flow last year and in my view is unsustainable. In fact, I suspect Carillion may need a larger-scale restructuring if trading doesn’t improve. I’d stay away for the time being.

A more attractive option

Carillion’s smaller peer Costain Group (LSE: COST) also reported its 2016 figures on Wednesday. They were a pleasure to read. The group’s revenue rose by 25% to £1,573.7m. There was a corresponding increase in underlying pre-tax profit, which rose to £37.5m.

Reported earnings rose by 18% to 25.7p per share, while year-end net cash rose from £108.2m to £140.2m. This made it possible for Costain’s board to justify a 15% dividend increase to 12.7p per share, which gives a 3.2% yield at current levels.

Although there’s a pension deficit requiring annual payments of £10m, I think the group’s cash balance de-risks to a fair extent.

Why I’d buy

Costain’s business is different to that of Carillion. The group focuses on infrastructure projects and aims to offer specialist skills that enable it to take leading roles in complex areas.

In my view, this value-add approach helps reduce risk and increase long-term growth potential. Costain shares now trade on a 2017 forecast P/E of 12.4, with a prospective yield of 3.6%. I’d rate this stock as a buy.

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