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Buy Safestore (SAFE) at 162.5p THE BUSINESS Kier Group is a construction, development and service company which specialises in building and civil engineering, support services, private house building and property development. The company, founded in the 1920s by Danish engineer Olaf Kier, is currently divided into the five divisions of Construction, Support Services, Homes, Property and Infrastructure Investment, with the cash generative operations, such as construction, funding the cash intensive operations such as housebuilding. The Construction division, which is by far the largest, providing around two-thirds of the group’s revenues, is comprised of two businesses, Kier Regional and Kier Construction. Kier Regional encompasses ten regional contracting businesses, an affordable housing business and major building projects. Kier Construction contains the group's infrastructure and overseas operations with civil engineering infrastructure, rail and several mining operations. The Support Services division comprises four businesses. Kier Building Maintenance, as the name suggests, provides maintenance services mainly to local authority clients and housing associations, as well as Street Services, including refuse collection, street cleaning and grounds maintenance, principally to local authorities. Kier Managed Services provides facilities management services to public and private sector clients. Kier Building Services Engineers comprises of specialist mechanical and electrical design, installation and maintenance business; and Kier Plant hires plant to Kier Group companies as well as external clients. The Homes division, Kier Residential consists of five companies located throughout the UK. Allison Homes operates throughout Lincolnshire and north Cambridgeshire; Bellwinch Homes has sites in the south and south-east; Kier Homes, operates across central Scotland; Kier Homes Northern (formerly Hugh Bourn Homes) is located in north Lincolnshire; and finally Twigden Homes has activities in East Anglia and Bedfordshire. Kier’s property development activities cover commercial, offices, industrial, retail and mixed-use sector. It operates through its wholly owned subsidiary Kier Ventures and Kier Developments, a 50% joint venture with the Bank of Scotland. Finally, Kier Project Investment manages Kier's interests in serviced assets sourced under the Private Finance Initiative (PFI) and as Public Private Partnerships (PPP). KPI is responsible for these projects by acting as promoter and developer and then as equity investor and operator. Its portfolio currently includes 12 projects in which it has invested, or has commitments to invest, a total of £18.5 million. MANAGEMENT Non-Executive Chairman, Phil White was appointed to the board of transport giant National Express Group in January 1996 and became its CEO in 1997. He is a chartered accountant and has extensive experience of both listed and private companies. Additionally, he is currently president of the Confederation of Passenger Transport. Finance Director, Deena Mattar, joined Kier in 1998 from KPMG where she developed an in-depth knowledge of construction. She held the role of finance director of the group’s major projects, mining and international projects arm until July 2001 and was appointed Group Finance Director in November 2001. She is also chairman of Kier Project Investment. CURRENT TRADING Kier recently released a strong set of results for the six month period to 31st December 2007, which showed record revenues and profits. This was despite the difficult market conditions experienced in the Homes business. Over the period group revenues were up by 18.1% to £1.2 billion, pre-tax profits rose by 23.3% to £44.6 million and earnings adjusted for amortisation rose by 19.1% to 90.3p. Cash flow was strong over the period with £26.7 million generated from operating activities. At the end of the period the company had net cash of £135.9 million. An interim dividend of 18p, covered 5 times by earnings, was announced. The Construction division performed well over the period, posting a 21% increase in revenues to £816.1 million and a decent 51% increase in operating profits to £14.3 million. The order book at 31 December 2007 was £1,616 million supported by a healthy pipeline of orders which the company said are close to being awarded. The Support Services division also performed well with revenues rising by 25.6% to £179.3 million and operating profits by 41.2% to £7.2 million. The Building Maintenance division performed particularly well seeing revenues grow by 35.7% to £134.3 million on the back of a number of significant contract wins with local authorities including Hull, Harlow, Harrow and Liverpool. Kier Residential sold 827 homes in the six month period, just up on the 819 homes sold in the same period in 2006, of which 15% were affordable housing units, compared with 21% last year. Revenue in the period of £143.2 million was down by 65 but excluded land sales compared with the £8.3 million of land sales included in the prior period. Average sales prices fell marginally from £175,200 to £173,200 reflecting a higher proportion of lower value Kier Homes Northern sales in the period. Despite the weak markets the Property division saw revenues rise by 34% to £58.3 million although operating profits were lower by 18.5% at £7.5 million. Going forward the company recognises that the commercial property market remains tough but has said that the carrying values of the developments in its portfolio continue to be substantiated and will provide good revenue streams. Finally, the Infrastructure Investment division made a significant sale in February 2008, that of its 50% investment in Hairmyres District General Hospital in East Kilbride, Scotland. This made the company proceeds of £13.8 million and when combined with a refinancing gain deferred from August 2004 gave a total profit of £16.2 million, which will be recognised in the second half of the year. Incidentally this is a return of around 5 times the original investment. Following the year end the company signed a massive £400 million deal with Stoke on Trent City Council to carry out repairs and maintenance on the city’s 20,000 council-owned houses through a newly formed joint venture company, Kier Stoke, OPPORTUNITIES & RISKS Shares in Kier have almost halved in value since April last year, the main reason that we can see is the negative sentiment and concerns over the performance of the property sector. Despite the credit crunch having an effect on the Homes and Properties businesses the company has said that the Construction and Support Services businesses have never been busier, order books are strong and the company is firmly on track for growth in the current year, market setbacks aside. The company’s exposure to the housing market is perhaps one of the biggest risks if faces. With recent reports suggesting that the level of new mortgages being granted at their lowest in years the Homes and Property businesses could have tough times ahead. In its interim report Kier said that its housing order books were around 20% lower than they were a year ago, reflecting a dip in visitor levels during November and December. Visitor numbers did however rise in January but the order books in February were 20% lower compared to the same time last year. The company is planning to open a number of new sites in the second half of the financial year which will increase the average by five sites over the first half. Completions to 1st February combined with the order book for the current year secure over 75% of projected unit sales for the year. On the other hand the company has said that is has seen little evidence of the credit crunch affecting the Construction and Support Services businesses. In fact the growth prospects in these divisions remain good. The construction division continues to operate in strong markets and at the end of December 2007 had strong order books, 10% ahead of last year at £1,616 million, benefiting from both private and public sector spend particularly in the education, prison and affordable housing sectors. Also, a greater proportion of the company’s work is being generated through framework agreements, two-stage bids and negotiation which create better quality, lower risk order books. The Support Services division has also seen strong growth in its order books which at the end of December stood at £1,674 million, 8.6% ahead of last year. This is before including the £400 million Stoke Council deal which commenced operation on 4th February 2008. The Government continues to be committed to the affordable and regeneration sector with a target to build 70,000 new social houses per annum compared with the current total of 25,000 each year, providing further opportunities for the group. VALUATION For the full year to 30th June 2008, driven by continuing strong growth from the Construction and Support Services division, consensus forecasts expect Kier to post revenues of £2,371 million, pre-tax profits of £89.45 million and earnings of 174.3p. The steady growth is expected to continue in 2009 with revenues rising to £2,443, pre-tax profits to £94.16 million and earnings to 183.4p. If we strip out the 368p of cash that the company had in the bank at the end of December then Kier trades on a derisory 2008 multiple of 5.5 times earnings. With its 5 separate divisions the house broker analyses Kier on a sum of the parts basis, less an adjustment for overall group costs. This values the Support Services and Construction divisions on higher multiples, 14 and 11 respectively, due to their strong order books, and the Homes and Property divisions on lower multiples, 6 and 7 respectively, due to the uncertainty over the housing market. On this basis, and adding average cash over the year, the PFI equity, less the pension deficit of £24.8 million, Kier is valued at 2007p per share, implying 54% from the current price. However, we think that this valuation is conservative. The multiples used are not very demanding considering that if any part of the business were to be bought out to would be at premium to this valuation. Whichever method is used Kier looks undervalued and the shares are a BUY.Key Data EPIC: KIE *The value of investments can go down as well as up. Investing in equities can lose you part or all of your capital. Smaller company shares can be relatively illiquid and thus hard to trade. And that makes such investments more of a high risk than larger company shares. Small Cap Shares is owned by t1ps.com Ltd which is authorised and regulated by the FSA and can be contacted at 5-11 Worship Street, London EC2A 2BH or on 020 7562 3370. 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