Buy Galliford Try at 46.5p
argues Benjamin Cooper of Small Company Selector
Galliford Try (GFRD) was formed from the merger of construction companies Galliford and Try Group in September 2000. The merger was a result of the rampant consolidation in the sector at the time. The company is divided into two divisions: construction and housebuilding. Construction generates most of the sales, but problems since the merger have made it loss making. The housebuilding division, on the other hand, benefits from significantly higher margins and at present it generates the bulk of the profits. The company's results for 2003 suggested that management had finally gained a handle on the problems in the construction division, and that a return to profitability was imminent.
Just as Galliford revealed it was turning the corner, ROK Property Solutions made, what Arbuthnot Securities described as, an "opportunistic" bid for Galliford at 51p per share. Galliford's board rejected the offer out of hand, but ROK was not dissuaded by this initial rebuff, and returned with a 54p per share bid a month later. This too was rejected as, according to Galliford, it still "significantly undervalued the group." The second rejection sent ROK packing, and complaining about the lack of access to conduct due diligence.
News of the initial bid caused Galliford's shares to jump as high as 45.5p, but the withdrawal of ROK sent the shares tumbling back to the 41.5p level. Galliford has continued to concentrate on its business, and in November the company announced two 3 to 4 year deals with the NHS worth approximately £92m, and recently announced a £58m Private Finance Initiative deal with Bedfordshire County Council to upgrade and maintain two schools in the region over the next 30 years. The progress in the underlying businesses has helped lift the shares back to the their current level of 46.5p.
In a recent research note, Arbuthnot described Galliford's results for the year to 30th June 2003 as a "watershed" for the group. The year was a disappointing one for the company in terms of earnings growth, but it was also one of progress. The company's management moved to turn around the troubled construction division, and their actions have removed an estimated £4m from the division's running costs. This helped cut the losses to £400,000 last year, and makes Galliford confident the division will return to profitability this year.
The housing operations continued to perform well and hold up the rest of the business. Like most housebuilders, Galliford Try is not pushing volume at the expense of margins and the group produced a 7% rise in operating profits and a higher average selling price. Overall, the results were in line with expectations, with pre-tax profits down slightly to £17.6m from sales of £640m. Earnings per share rose from 5.6p to 5.7p, and the dividend was maintained at 1.5p.
This year Arbuthnot is expecting the remedial action taken by Galliford's management to bare fruit. The broker has pencilled in sales of £641m for this year, and pre-tax profits of £20m. Earnings per share are expected to rise by 8.8% to 6.2p, and a 0.1p rise in the dividend to 1.6p is forecast. For 2005, profits are expected to hit £22.5m, with earnings per share up another 11.3% to 6.9p and the dividend up another 0.1p to 1.7p. This places the shares, which are trading at 46.5p, on prospective price/earnings ratios of 7.5 times for the current year and 6.7 times for 2005. The prospective net yields are 3.4% and 3.7%, respectively. This rating would appear sensible for a basic housebuilder, but we do not believe the valuation contains any consideration for the contracting arm of the company. Contractors normally at around 10 to 12 times earnings, so we believe the shares could have some upside on a simple revaluation. The shares are also supported by an estimated 2004 year-end NAV per share of 32.4p.
Galliford Try appears to have turned its construction division around. After a year of consolidation, the company appears set to push forward. The housebuilding division should continue to perform, but it is the contract wins and PFI deals that should help push earnings forward over the next few years, and could lift the rating of the shares in the market.
On the flipside, Galliford is now in play. ROK's failed attempt at an "opportunistic" takeover attempt has highlighted the attractiveness of the business, either as a unit, or broken up. Both Arbuthnot and KBC Peel Hunt has said that an offer in excess of 60p per share would be needed before Galliford's board would consider an approach, and it is possible such a bid could materialise. ROK, for one, still maintains a 2.7% holding in Galliford.
Galliford has been through a tough time with its construction division, but it now appears to have turned the corner. The company offers solid, but unspectacular earnings growth at a very modest rating. The shares also offer an attractive yield and are supported by a rising net asset value. On this basis alone the shares would be a long-term buy. But with the potential for corporate action thrown into the mix, Galliford could be a little more exciting than might first appear. Buy
Market Cap: £102.97m
Benjamin Cooper edits Small Company Selector, a newsletter which monitors the trading activity of small company investment trusts to provide a shortlist of potential investments each month. Ben then uses the shortlist to select the best one. The remainder of the newsletter is dedicated to keeping subscribers up-to-date with previous recommendations. Since inception in April 1997, the average gain on all of its recommendations is 63.03%*, compared to an average gain on the FTSE Small Cap (excluding investment trusts) Index over the same period, of 10.03%*. For more details click
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