Investors’ Chronicle: Keller Group, Travis Perkins, HSBC

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BUY: Keller Group (KLR)

The construction company is benefiting from a strong US economy as its price rises filter through to profits, writes Arthur Sants.

The issue last year for construction companies was protecting profitability. Rising prices of commodities squeezed margins forcing them to pass on costs. Now that commodities prices are dropping, costs are falling and margins are expanding, the opposite side of this coin is a lot better for Keller’s business.

In North America, the engineering business saw its revenue drop by 3.9 per cent, yet its operating profit still doubled to £65mn. A combination of prices rises, improved operational performance and the falling price of steel expanded the operating margin by four percentage points year on year to 7.5 per cent.

The US business saw volumes drop because of a slowdown in the residential housing market, but as a region it is far more profitable than Europe. Higher European energy prices and a weaker economic outlook meant margins were just 1.2 per cent and the order book slipped back from £389mn to £306mn.

Investors will be relieved that Europe makes up just 23 per cent of total revenue, while 60 per cent comes from the US and the rest from Asia and the Middle East. The high-margin US order book grew 8 per cent which should be the main growth driver this year. The Asian order book dropped 10 per cent but management is hoping to pick up some more work on Saudi Arabia’s Neom city project in the coming year.

Broker Peel Hunt is forecasting earnings per share to rise to 128p in 2024, giving a cheap-looking price/earnings ratio of 6.5 and a free cash flow yield of 10 per cent. Growth may slow but the exposure to the high-margin US economy is appealing, especially at this price.

SELL: Travis Perkins (TPK)

Falling volumes and a bleak macro outlook make the group’s current valuation look overdone, writes Jennifer Johnson.

Turbulence in the UK’s construction sector has had a material impact on earnings at builders’ merchant Travis Perkins. Weakness in both the new-build housing and repairs, maintenance and improvements markets led to a 31 per cent decline in the group’s adjusted operating profit in the first half. 

Markets had clearly anticipated a move like this, as the shares rose 3 per cent on the morning that the company reported its results. It is likely that investors were relieved that management did not further downgrade full-year guidance following an initial reduction in mid-June. 

Higher rates are expected to constrain demand in housebuilding for the remainder of the year — which makes the 9 per cent share price rally the company saw in July look rather hasty. Management is predicting a low single-digit drop in revenue and mid single-digit decline in sales volumes across 2023. 

“With volume weaker and price inflation likely to fall, we would not be surprised to hear of some more cost-cutting measures,” wrote Peel Hunt analysts ahead of the group’s half-year results. Travis Perkins’ operating margin fell by 160 basis points in the six months to the end of June due to the impact of lower volumes in its largely fixed cost base.

Elsewhere, the company’s Toolstation business — which caters to self-builders and individual tradespeople — recorded revenue growth of 9 per cent. But more importantly, its operating profit fell 25 per cent year on year.

With the issues plaguing the business unlikely to reach an easy or timely conclusion, Travis Perkins’ full-year price/earnings multiple of nearly 13 times looks steep.

HOLD: HSBC (HSBA)

A return to quarterly dividends, record interest income and a $2bn share buyback improve the mood music for HSBC, writes Julian Hofmann.

HSBC completed the trifecta of unexpected capital returns among the big high street banks with a surprise $2bn (£1.55bn) share buyback announced in its half-year results, on top of an earlier scheme dating from the first quarter.

Like all banks, HSBC benefited in the half from a widening net interest margin of 1.72, up 0.5 percentage points, as interest rates in all its core geographic areas rose. The performance meant that management could upgrade its forecast for interest income for the year to $35bn, a modest upgrade on its previous guidance.

The bank, which is less vulnerable to domestic regulatory pressures when compared with its rivals, has enjoyed a relative stock market honeymoon over the past few quarters, whereas many institutions have given back most of the share price gains that were based on higher interest rate assumptions. A return to a quarterly paid dividend, a key demand of HSBC’s Hong Kong retail investor base, has also helped to support the shares.

The performance of wealth management was another highlight for the bank. Net interest income was the key to the division’s overall performance, with net income up by 60 per cent to $16bn as cash balances in all areas generated higher returns. However, it wasn’t all plain sailing.

The ever-present threat of China’s dysfunctional property market made itself felt in the results. Of the $913mn set aside for expected credit losses in the second quarter, $300mn of this was linked to commercial real estate in mainland China. In total, HSBC has made expected impairment allowances of $1.3bn. This was not limited to China and the UK business also a booked a $300mn charge related to potential commercial banking bad debts.

Digging deeper into the results showed the problems that China, either directly or through the Hong Kong channel, is posing for lenders with exposure to commercial property investments. Out of a representative sample of $14bn of property loans to mainland China, over $9bn are now rated either satisfactory or less, with $3.5bn considered to be outright impaired. How the situation develops is dependent on macroeconomic factors, but it seems certain that HSBC will be booking losses in this loan book for some time to come — although so far this stayed within the City’s forecasts.

The net effect of the positive results is to temporarily damp down the longstanding dispute between the board and its largest shareholder, Chinese insurance group Ping An, over the potential carve out of its European and Asian operations.

UBS forecasts a price/earnings ratio of 6.7 for the year, rising to 7.7 for 2024. That represents a premium to the sector, currently, which does not yet suggest value.