Questor share tip: Buy Interserve as profits and dividend jump

Interserve
637p+24p
Questor says BUY

INTERSERVE [LON:IRV] reported a strong increase in profitability and rewarded investors with a double digit increase in the dividend in first-half results yesterday. And there could be more to come from the FTSE 250 outsourcing and construction group as it revealed a jump in the order book.

The company makes about two thirds of its revenue and nearly all its profits from the support services business. Roughly the same proportion comes from the UK, although it does have a fast-growing overseas operation. The encouraging performance in the first half meant shares in Interserve increased by almost 4pc yesterday, which defied the wider markets, as the FTSE 100 slumped by 1.2pc on geopolitical fears.

The company bolstered its support services activities through the £250m purchase of Initial Facilities in March. This deal will expand caretaking activities, which were one of the main sources of growth during the first six months of the year.

Support services is mainly UK-based, but does include operations in the Middle East. The company started work on a contract for the upkeep of the BBC’s Broadcasting House and MediaCity in Salford. It won a £322m contract to maintain the Ministry Of Defence’s training facilities across the country. Future workload increased by 17.2pc from the same stage last year to £7.5bn at the end of June.

The UK operations delivered revenue growth of 35pc to £808m in the first half of the year and an acquisition in the Middle East operation meant revenue more than doubled there to £58.7m over the same period. The support services profit margin as a whole was steady at 4.2pc, and this meant support services operating profits increased by about a third to £37.1m.

This recovery in support services is helping to offset a tough time in the construction industry.

Interserve is involved in public sector projects such as building schools and hospitals and bridge maintenance. Construction contributes 45pc of the group’s revenue but the building arm is making very little in the way of profits.

In fact, the construction unit’s contribution to group profits fell in the first half of the year.

The main drag on results was increased competition in the Middle East, driving down the prices on contracts. So, while revenue increased by 10pc to £532m in construction as a whole, the operating profit fell 6.1pc to £12.3m.

The outlook may be tough in the construction sector, but there are some encouraging signs coming from the order book in the UK, which jumped by 40pc during the first six months to end the period at £1.4bn.

The group also has a building equipment hire business that is reporting rapidly rising profits on the back of strong demand in the Middle East and Asia. While still only a small part of the business by revenue, the profits in the first half of the year jumped by 65pc, to £14m.

Interserve shares have drifted recently, gaining just 2.5pc so far this year. This looks like a pause for breath after an extremely strong 2013 where shares gained more than 60pc; they have almost doubled during the past two years.

But profits keep on rising. This means the rating looks cheap with the shares trading on a price earnings ratio of 11 times, falling to 9.6 next year.

This is for a company with a construction business that is still in a cyclical trough. The shares trade on a prospective dividend yield of 3.6pc. That looks reasonable enough, especially given that the order book is hinting at a recovery in the construction sector. Buy.