Balfour Banks On Emerging Markets After Poor 2012
BMI View : Whilst there are some positive signs from the UK and US that their construction industries may be stabilising - more so for the US- , Balfour Beatty has suffered considerably due to the tight fiscal conditions in their primary markets in 2012 , which took a toll on large public spending . Revenue is down almost across all divisions and geographies. However, long-term prospects seem to be good thanks to a new focus on emerging markets and decisions to streamline US and UK operations and divest of low-growth sectors. Balfour's emerging market selection appears to be strong, where we forecast robust infrastructure industry growth rates. However risks increase in emerging markets, and the US and UK are yet to show signs that they will be the source of massive revenue growth, meaning we refrain from suggesting that Balfour's long-term outlook looks positive.
Tight monetary conditions in both the private and public sectors in their bedrock UK and US markets has resulted in Balfour Beatty posting a decline in profit in FY12. Their annual report - published in March 2013 - suggests that whilst they have begun to implement a robust strategy for short-term consolidation and long-term growth, they are still very exposed to the financial woes in the UK and US. The key to their long-term growth and escaping the effects of the economies in the US and UK is to target emerging, commodity exporting and infrastructure deficient markets. In 2012, Balfour's posted revenue was GBP10,869mn with a pre-tax profit of GBP310mn; this represents a 7% decline on FY11.
The UK construction division, which is Balfour Beatty's largest, has suffered which has seriously impacted the company as a whole, with revenue of GBP3,182mn in 2012 representing a 6% contraction on the previous year. Balfour cites that a reduction in the large, technical projects at which they excel and which also have higher profit margins is the reason behind this fall in revenue. The post-Olympics dearth of major projects is a prime example of how the market has changed since Balfour won such projects as London's Aquatics Centre. We estimate that the UK construction industry posted negative real growth of 9.3% year-on-year (y-o-y) in 2012 which supports Balfour's reasoning for a poor year. These tight market conditions have also resulted in numerous subcontracts defaulting leaving Balfour to absorb their costs, which has added to its financial strains. Over our forecast period we see the UK construction industry growing at just an average of 1% y-o-y up to 2022. The upside of this bleak forecast for Balfour is that infrastructure, where Balfour has a strong history, will garner government attention in an attempt to stimulate the economy (see BMI's No Change In Forecasts After Budget, 15 April 2013). Thus, we forecast that the sector will average 6.2% y-o-y real growth from 2013 to 2022 (compared to -0.7% for residential and non-residential construction), representing opportunity for Balfour to bolster its income.
|Orders Coming In From Rest of the World|
|Balfour Beatty Revenue and Order Book FY12|
In 2012, Balfour's UK project wins were diverse, although notable for their lack of large scale orders. A GBP321mn contract to upgrade the M25 and a share of a GBP288mn contract to work across ten Magnox sites for the Nuclear Decommissioning Authority, were two of Balfour's largest wins. The order book for Balfour in FY12 represents a 1% increase on FY11, and a 4% increase on H1 2012. Whilst this is an improving picture, in light of slow industry growth, we see another poor performing year for Balfour's UK operations in 2013.
In the US, thanks to a recent uptick in business, Balfour posted an increase of 8% in their revenue on FY11, amounting to GBP2,570mn in total. A stabilisation in the building market and some wins after the Transportation Bill was passed has provided a cushion for the rest of the construction sector. Prospects for economic infrastructure investments, increased use of the PPP model and continued success in green construction will also provide opportunities for Balfour to keep at bay the effects of broader US economic performance. That said, the US order book took a 17% hit in 2012 compared to 2011, which is by far the biggest reduction in orders of any region. We currently forecast that the US construction industry will grow at just 0.6% per annum up to 2022, which suggest Balfour's order book will unlikely pick up markedly in the coming years, considering competition will be much higher in light of the lack of major projects. Similar to the UK, Balfour's US projects wins reflect the broad coverage the company has across the construction sector. A US$362mn contract to build military houses was awarded to Balfour, as was a US$798mn project for the replacement of bridges in Texas as part of a joint-venture.
Internationally, Balfour has won major construction projects, but overall FY12 saw revenue of GBP1207mn, representing a 6% decline on FY11. In a joint venture with Gammon Construction in Hong Kong, they were awarded the HK$6.2bn (GBP507mn) development project at Hong Kong International Airport in March. Gammon also won the Shatin-Central line for the MTR Corporation, a deal worth. Both these projects are impressive in size and prestige, highlighting Balfour's strong position in the Asian market. Prospects for a stronger revenue performance in 2013 in its international markets are there, with a 3% rise in its order book, again suggestive of Balfour targeting emerging markets.
Whilst Balfour's construction services have posted smaller revenue in FY12, their professional and support services sectors have posted 1% and 3% revenue increases respectively. This is indicative of the company's desire to provide end-to-end services to increase profitability. Notable is the fact that it is the rest of the world, rather than the bedrock countries, which have driven the growth in professional services, posting a 9% increase in revenue and accounting for 35% of the whole division. This highlights the potential for Balfour to use its breadth of expertise across the infrastructure sector to capitalise on the demand for complex infrastructure projects in geographies where those expertises are hard to find. Additionally, more professional services business is likely to stands them in good stead to benefit from emerging markets more broadly across the company.
|Financial Data||FY 2011(GBPmn)||FY 2012(GBPmn)||Percentage Change|
|Source: Balfour Beatty Annual Report and Accounts 2012|
|Group Revenue (including share of joint ventures)||11035||10896||-1.26%|
|Group Operating Profit||168||-23||-113%|
|Profit Before Tax||246||75||-69%|
|Profit for Year||186||44||-76%|
Economic conditions across the board are to remain tough though, particularly in the residential and non-residential construction sectors. Balfour's streamlining and consolidation plans therefore are an encouraging sign. Efficiency savings of GBP80mn are being targeted by 2015, centred on consolidating their offices into regional delivery units, both in the US and UK. Additionally, a change in their operational strategy will see them develop their ability to provide end-to-end services on projects and their capacity for work throughout the lifecycle of infrastructure assets. Considering capacity to operate and maintain infrastructure is less well developed in a number of their target markets, being able to offer these services will likely enhance Balfour's prospects.
However, these measures seem to have failed to convince investors of Balfour's short to medium-term prospects. Looking at the share price over the last year, we see that Balfour has underperformed in comparison to the FTSE 100. Backing up this bearish outlook is their price-to-earnings ratio which stands at 38.8, compared to an industry average of 16.1, which considering the poor performance of the company and its short-term prospects in its major markets suggests that it is currently overvalued. Considering the scale of Balfour's profit contraction in 2012 and that efficiency savings will only go so far in mitigating the loss, we see another poor year for Balfour in 2013.
|Balfour Suffers At The Hands Of Market Constraints|
|Balfour Beatty And FTSE 100 Stock Prices|
The steep drop in share prices seen in November 2012 came from the announcement that Balfour will divest its European rail business, which has traditionally been one of its key sectors. The company cites a curtailment of investment as a reason for this move , particularly in Italy and Spain where the construction industr ies as a whole will only grow by 2.7% and 1.3% res pectively on average up to 2022. T he loss of a historically profitable part of Balfour's business is a key development and will weigh on profit in the short to medium-term . Other reasons for the divestment of the rail business included that Balfour credits its broad sector coverage for its ability to weather the poor construction industry climate over the past years, a diversification strategy which the European rail business was contrary to. Balfour viewed having so much capital tied up in one sector in one geographical area a risk considering its outlook.
In light of their poor performance in their established markets, Balfour's 2012 report is heavily focussed on plans to expand in five key geographies, with the aim of putting themselves in a strong position to capitalise on future construction demand. Australia and Canada are to be targeted as resource driven , capital investing continues. Positive signs include Australia's infrastructure spending reaching sustainable levels and Canada's functionin g Public-Private Partnership (PPP) market. According to our forecasts, Balfour will do well from this move as average real growth rate in the infrastructure sector will be 4.9% in Australia and 3.9% in Canada.
Brazil and India are the major emerging markets Balfour will target. India's massive scale urbanisation, already over-capacity infrastructure and ambitious government spending plans are all attractive opportunities for Balfour; we forecast India's infrastructure sector to grow in real terms at 6.7% per annum up to 2022. Brazil will play host to two major sporting events, the 2014 World Cup and 2016 Olympic Games, which will add to the opportunities to develop infrastructure around Brazil's burgeoning mining and agriculture sectors. We forecast 5.6% growth in real terms for the infrastructure sector in Brazil annually up to 2022. South Africa is another growth market that Balfour will target, keen to take advantage of the country's mining sector and general need for an upgrade of its existing infrastructure network. We are forecasting real growth of 4.8% y-o-y in South Africa's infrastructure market.
Whilst Balfour's target geographies can expect strong growth in the coming decade, risks are higher than in their core markets. Particularly in the emerging markets, the PPPs which Balfour is accustomed to winning are much less established and subsequently are higher in risk. Additionally, many of the target economies' ambitious growth rates are dependent on funding from commodity exports. This exposes them to price fluctuations, like those we have seen in light of China's slowdown. Should commodity prices drop, we would expect that spending on infrastructure will drop also. That said, our forecasted growth trends broadly support Balfour's strategy of focusing on growth markets, whilst streamlining its struggling bedrock country operations.