JPMorgan upgrades Carillion, Kier is top pick, Interserve 'attractive'

Taking a look at the UK construction services sector, JP Morgan Cazenove upgraded Carillon to 'overweight' and said Kier Group remained its top pick for quality.

The investment bank said it remained on the sidelines for sector-mates Balfour Beatty and Interserve, which both were kept on 'neutral' ratings, though Interserve's lowly 5.3 p/e ratio valuation is quite attractive for investors with a higher tolerance to risk. It was given a target price of 260p.

Compared to construction companies, their services providers have seen
relatively modest margin pressure in recent years, with Cazenove calculating gross margins have fallen by 300-400 basis points.

Infrastructure construction has also been experiencing a short-term lull in activity, which analysts attributed to political uncertainty and upheaval delaying contract awards in both the UK and US.

"Against this backdrop, we tend to prefer services-orientated business, and also prefer lower value regional construction work to infrastructure in the short term."

Carillon was upgraded from its previous 'neutral' rating due to "several areas" of upside versus the bear case, particularly a forecast of gradual deleveraging.

"We are also not convinced that Carillion over-earns vs peers, or that any valuation adjustment should be made for reverse factoring."

Kier remained analysts' "pick for quality" in the sector due to an appreciation of the movement towards services, and highways in particular.

In addition, the current share price is calculated to imply around a 9% free cash flow yield on the core Construction & Services business.

Kier's target price was set at 1,639p, with Carillion's at 292p, lifted from 231p.

For Balfour, while a nod was given to management strategy that is expected to be successful "to an extent", analysts believed the current share price reflects the execution risk and margin pressure faced.