Smart Investor: are Carillion shares a 'buy'?

FTSE 250-listed Carillion (CLLN.L) has been involved in numerous construction projects over the years: Covent Garden in 1830, Liverpool Street Station in 1891, Heathrow Airport in 1946 and the Thames Barrier in 1984.

Of course, the companies that built these historic projects did not operate under the Carillion banner. This name was chosen in 1999 for a collection of companies that formerly operated as part of the Tarmac Group, with the building materials company demerging from the support services and construction services divisions. These latter two became Carillion.

With operations in the UK, Canada, the Middle East and North Africa, Carillion offers a variety of ‘integrated solutions’ for buildings and infrastructure. These include project finance, design and construction as well as lifetime asset management. With a market capitalisation of £1.15 billion, Carillion is the 179^th-biggest listed company in the UK and employs 45,000 people worldwide.

Performance

The past five years have seen impressive growth in the bottom line, with net profit increasing from £76 million in 2007 to £135 million in 2011. This is an annualised growth rate of 12.1%, and is highly impressive given the challenging economic circumstances of the period. Furthermore, return on equity averages 15.2% over the five years, hitting 13.8% last year. This is encouraging, but by no means among the premier league of UK listed companies.

The shares currently yield a highly attractive 6.3% from a payout ratio of 53%. This is a sensible payout ratio, with shareholders benefitting from the company’s success, but with the company retaining adequate cash to reinvest in the business.

In addition, dividends per share have increased at a brisk 9% per annum over the past five years.

Financial viability

As for financial viability, Carillion’s debt to equity ratio is fairly moderate at 55.6%, and interest cover is sufficient at 14.8 (when operating profit includes profit from jointly controlled entities). Both of these figures offer comfort that the company is not overstretched and that the return on equity figure is not artificially high.

The industries in which Carillion operates are likely to enjoy a substantial amount of demand in the long run. Sure, this demand may experience peaks and troughs, but there will always be a requirement for new and improved infrastructure, commercial buildings and industrial buildings.

Facilities management and property services fall into the same category, although demand for such services may prove to be steadier than that of construction.

However, although the services which Carillion offers are specialist, they are not unique. Price and service levels are the most likely battle grounds for competition, with Carillion having a successful track record of delivering its services and enjoying the reputation which this brings. In addition, the company is able to service large clients and deliver large-scale projects, facts which should not be overlooked.

Overall, Carillion has at least some form of economic moat, although it should not be viewed as particularly large – especially if austerity and cost cutting continue to feature in the medium to long run.

The verdict

In terms of value, with shares currently trading at £2.68 the price to earnings ratio is 8.4, and the price to book ratio is just 1.19. Both of these ratios indicate that shares are very cheap.