Why Stock Investors Should Look Past Falling Revenue

THE WEEK: Morningstar's columnist Rodney Hobson says he looks for revenue, profits and dividends, but the they are not all created equal

Rodney Hobson 24 August, 2018 | 12:40AM

Balfour Beatty saw the error of this path and turned itself round before it was too late

As a cautious investor I naturally prefer companies that increase revenue, profits and dividends year by year. It’s worth remembering, though, that revenue is the least important of the three.

Project manager Carillion (CLLN) spectacularly proved that chasing uneconomic contracts leads to disaster; rival Balfour Beatty (BBY) saw the error of this path and turned itself round before it was too late, living to become a respectable and improving member of my portfolio.

In contrast, WH Smith (SMWH) has long sacrificed unprofitable revenue and concentrated on locations that pay, a tactic that has made it another welcome addition to my holdings.

This week’s update from infrastructure specialist Costain (COST) followed a similar theme. Revenue fell by more than 10% in the first half of 2018 as two major construction contracts came to an end, causing hasty investors to sell at the market opening. However, closer inspection revealed that operating and pre-tax profits were substantially higher, thanks to improved profit margins. So the interim dividend was raised by 8%.

The second half has started well and the claim that full year results will be in line with expectations looks a little conservative. The order book is level with this stage last year but is of higher quality and reflects strong repeat business with good visibility of earnings that will comfortably cover an increased final dividend.

The shares have moved erratically over the past 12 months to stand almost unchanged just below 450p. Three times they have balked at 490p but they seem to have a solid floor at 420p. I believe the upside potential outweighs the downside risk. Even if the shares continue to move sideways there is that growing dividend to consider. Costain has demonstrated that it is possible to handle government contracts without letting greed overwhelm common sense.

Even the government sometimes wakes up to the fact that outsourcing tends to produce a less efficient service at a higher price.

Serco (SRP) shares were above 600p five years ago and even as recently as the start of last year they stood at 150p. They are now just below 100p and looking overpriced. Capita (CPI) has brought in a turnaround specialist after getting away a rights issue that involved shareholders throwing good money after bad. Its shares are worth a quarter of what they traded at 12 months ago and any investment is an act of faith in new finance director Patrick Butcher.

G4S (GFS) has the nerve to “welcome” being stripped of the contact to run Birmingham prison any further into the ground. The miracle is that its shares have lost only a quarter of their value in the past 12 months. It garnered quite enough adverse publicity over its role in the London Olympics. How many more highly publicised failures can it survive?

Tea and Dividends

Just occasionally I like to spice this column up with something racy, and food producer Camellia (CAM) fits the bill. First half profits came in ahead of expectations, as benign weather and favourable markets boosted returns from tea, avocados and macadamia nuts. The interim dividend is raised from 37p to 40p.

However, the shares are down by about a third over the past six months because one good harvest can easily be followed by drought and frost. In any case, if everyone has a good harvest then there is a glut and prices fall, leaving farmers to work harder for less reward.

The second half is traditionally more important for Camellia so the board is rightly cautious for the full year outcome. There could be plenty of upside for the shares if the year continues to pan out well. Just remember this is a risky punt. The weather is notoriously fickly.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

Securities Mentioned in Article

Security NamePriceChange (%)Morningstar
Rating
Balfour Beatty PLC273.90 GBX-0.87-
Camellia PLC10,625.00 GBX-0.23-
Capita PLC125.75 GBX-0.36-
Costain Group PLC389.00 GBX-0.26-
G4S PLC184.45 GBX-0.83
Serco Group PLC94.70 GBX1.83-
WH Smith PLC2,054.00 GBX0.10-

About Author

Rodney Hobson

Rodney Hobson  is a columnist for Morningstar.co.uk and author of several investing books, including The Dividend Investor and How to Build a Share Portfolio.