Disappointing demand in Civil Engineering (CE) markets causes us to reduce earnings estimates. Despite this, FY17 is expected to show good progress overall although the reduction in net debt from the half year will now be less than previously anticipated. Good underlying performances from three business units are being partly obscured by CE. Resolving this is likely to benefit group valuation in our view.
Civil Engineering demand has not picked up as anticipated in H2; while western Europe is slightly better, central and eastern Europe remain very subdued. This is understood to reflect low project activity rather than any loss of market share, but a shortfall in specification projects in particular affects business unit profitability and will reduce working capital inflow. Low & Bonar’s other business units have fared better; we expect all three to report higher H2 EBIT y-o-y, with Building & Industrial and Interiors & Transportation achieving solid mid-teens margins despite upward pressure on polymer-based input costs. Regionally North America and China appear to be the stronger territories served with some variability in Europe.
The previously announced disposal of agro-textiles operations is proceeding and we have factored in completion by the year end. In FY17, we expect the CE business unit to generate £100m+ revenue and now break even (before central costs). As such, it sits below stated group margin targets of 10%+ and a review of the business position is a natural step to take, in our view. Our reduced estimates (group EBIT 9% lower in FY17 followed by c 7% and c 5% reductions in the two subsequent years) are after a small net incremental transition benefit compared to our pre-update numbers and include some CE margin recovery, to c 4% by FY19. Our year end FY17 net debt projection is now c £130m, versus c £118m previously.
The downward reaction to Low & Bonar’s trading update means that the ytd share price gain is now c 7%, slightly ahead of the FTSE All-Share Index. On revised estimates, this takes the current year P/E to 10.9x with a prospective dividend yield of 4.6%. Growth in both earnings and dividends is anticipated beyond FY17 so there are clear valuation attractions. The company operates in a number of different markets globally so uniform progress across all business units is unlikely. However, fixing the underperformer could meaningfully boost earnings and valuation metrics.