One winner of this downturn has been outsourcing. Governments and companies have been busy off-loading non-core operations in order to reduce costs. The only problem is finding the right company to buy, as most outsourcers trade on stretched valuations.
Not so Carillion, Britain's largest support business (50% of sales), providing long-term repair and maintenance services for property, roads, railways, and many other types of essential infrastructure. It serves a host of government organisations (including the Ministry of Defence and the NHS) and blue-chip clients, such as BT, Virgin Media, Philips, Siemens and Unilever.
All told, the order book is worth a gigantic £17bn, representing more than three and a half years' turnover, with about 80% of that derived from public, or similarly regulated, industries.
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Yet Carillion isn't just an outsourcing story. It also constructs buildings and infrastructure, such as schools, sewage works, hospitals and prisons. This it does either directly (35% of sales), or as part of a consortium typically under one of the Public Finance Initiatives (PFI, 15% of sales). Despite the poor economic backdrop, this division is holding up well. Last Friday, Carillion announced it had bagged a £370m deal to build 26 new schools in Wolverhampton as part of Britain's £55bn Building Schools for the Future' initiative.
Carillion (LSE: CLLN), rated a BUY by Oriel Securities
Furthermore, the firm's Middle Eastern unit is performing strongly. Sales grew from £464m in 2008 to £600m in 2009. It also delivered an operating margin of 6%, which compares favourably to most Western markets. This demand has been driven primarily from Abu Dhabi and Oman and offsets some contraction in Dubai it now accounts for only 20% of the region's revenue. The firm's balance sheet is being bolstered by investor interest in its PFI projects two equity stakes were sold before Christmas for £86.9m. PFI schemes are attractive to fixed-income funds because they generate decent long-term returns when compared to 20-year gilts, which offer skinny 4.4% yields.
The City is forecasting 2009 turnover and underlying earnings per share (EPS) of £4.7bn and 37.6p. That puts the shares on an average price/earnings (p/e) ratio of eight. The firm also offers a healthy 4.7% dividend yield and zero net debt. However, I value the outsourcing unit at £1.1bn, the construction division at £500m, and the PFI portfolio at £100m. Taken together, after deducting the £176m pension deficit and £100m of central costs, that creates a fair value of about 360p per share.
But it's not all good news. Britain is likely to remain challenging as clients squeeze more savings from their partners, especially after the next election. Then there's the Dubai exposure and the usual risks inherent in this industry. These include poorly priced contracts, non-performance, fines, customer bankruptcies and foreign-exchange fluctuations. But I'm not put off. With an excellent franchise and a Himalayan-sized order book, Carillion is a buy. Preliminary results are due out on 3 March.
Recommendation: BUY at 302p
Paul Hill also writes a weekly share-tipping newsletter, Precision Guided Investments
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