Engineering firm Kier Group has hit trouble, but the core business looks sound, says Matthew Partridge.
The turmoil at Neil Woodford’s main UK fund has caused the share price of the companies in its portfolio to slip. The thinking is that as soon as the temporary restrictions on redemptions are lifted he will be hit by a wave of investors demanding their money back. Since Woodford won’t be able to sell the less liquid investments that are at the root of the current problems, he will be forced to dump his remaining listed companies, which will push their share price down even further.
One of his holdings that was already experiencing problems before the latest slide was the engineering firm Kier Group. The stock has fallen by over 85% over the past year. The trouble began when concern about the high level of debt that Kier had accumulated forced it to raise £264m by issuing new shares. This proved to be a spectacular flop, with around 40% of shares left unsubscribed, forcing brokers who had underwritten the deal to pick up the tab. Early this year things got even worse, with Kier’s management admitting that it had messed up its sums: debt was £50m higher than expected. Furthermore, its new boss, Andrew Davies, recently revealed that profits are going to be £40m below expectations
The gloom is overdone
This latest round of bad news means that some are comparing Kier to Carillion, the troubled outsourcing company that imploded in January 2018. The fact that Kier Group makes much of its money from public infrastructure projects, such as HS2 and Crossrail, as Carillion used to, has only reinforced the similarity in some people’s minds.
Kier clearly has some genuine problems, but to say that it is another Carillion is taking things too far. Even after the recent profit warning, Kier is still expected to make a profit – just a slightly smaller one. What’s more, the fall in the share price has been so dramatic that it looks like an absolute bargain. Indeed, it currently trades at five times this year’s earnings and twice projected 2020 profits. Even if it is forced to sell all its assets, shareholders should still come out ahead with the company trading at a discount of more than 60% to its net assets.
Overall, I think that the reduced valuation makes it a risk worth taking, so you should ignore the people who are talking about it imploding and instead go long on the company at the current price of 161p, with a stop-loss of 119p. Of course, we’re not blind to the fact that it could end up falling further, especially given the possibility of further problems coming to light, as well as the issues stemming from Neil Woodford being forced into a fire sale of his fund’s holdings. So while I’d normally suggest that you go long at £25 per 1p, giving you a downside of £1,050, I’ll recommend instead that you reduce this to half that amount: £12.50 per 1p. This means that the downside is only £525.
Trading techniques: dividend cuts are bearish
The lion’s share of equity returns stem from dividends. It’s no surprise then that when a company announces that it is going to suspend its dividend, the market generally reacts extremely negatively. A US study by researchers Laarni Bulan, Narayanan Subramanian and Lloyd Tanlu found that between 1962 and 2001, 80% of firms that cancelled their dividends saw their shares fall over the next three days, with an average decline of 6.7%, compared with the rest of the market.
Of course, contrarian investors might argue that this negative reaction presents opportunities for buying shares on the cheap, especially if the suspension is down to temporary factors. However, there is also evidence that the negative performance actually increases in the medium term. Indeed, Bulan, Subramanian and Tanlu also found that a year after the suspension, the average underperformance had widened to 13.9% Furthermore, the pattern was the same even if the underlying company had previously put in a strong financial performance. This implies that it might pay to sell such shares short, even if you’re not quick enough to exploit the initial fall in price.
It’s not just shares in firms that completely eliminated their dividends that perform badly. Even if you broaden the sample to include those companies that merely reduce the dividends, you get much the same result. An American study by the investment firm Ned Davis Research found that if you had put $100 into a basket of shares that had either cut or eliminated their dividends in 1972, it would be worth only $72 at the start of 2019 (a fall of 88% when you take inflation into account).
How my tips have fared
Over the past fortnight my tips have put in a mixed performance. Out of my seven open long positions, three have risen, two have fallen, and two have stayed exactly the same.
JD Sports increased from 618p to 621p, Hays increased from 150p to 153p, and Bellway climbed from 2,792p to 2,825p. Safestore remained at 643p and Superdry stayed at 480p.
However, John Laing Group fell from 387p to 380p, while Somero went from 367p to 290p. The losses on Somero mean that the overall profit from my long tips has fallen from £1,064 to £884.
My short tips, unfortunately, did even worse. While Weis Markets declined from $38.46 to $36.97, my three others went up. Pinterest rose from $25.50 to $27.94, Tesla rose from $190 to $213. Rightmove went from 559p to 585p – so it is lucky that I advocated covering your Rightmove short if it went above 580p.
Overall, if you had followed my advice you would have lost $1,008 on Rightmove. Zoom continues to rise, reaching $102, so it is fortunate that I recommended you wait until it falls below $68 before beginning to short it.
Stripping out the losses on Rightmove, the short positions are making a total profit of £835, which means that all my remaining open tips are making a combined profit of £1,719, just below the losses of £1,861 on the closed positions.
I’m going to recommend that you increase the price at which you would start shorting Zoom to $80, betting £50 per $1. In that case, I would cover it if it goes above $100, giving you a total downside of $£1,000. I’m also going to increase the stop loss on John Laing Group to 360p, since I tipped it over six months ago.