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Smart Investor: a stock for the Buffetts, not the Grahams
This is a stock that'll separate followers of Benjamin Graham from Warren Buffett devotees, says Smart Investor.
FTSE 250-listed WS Atkins (ATKW.L) isn't a household name. However, it is the UK’s largest engineering consultancy firm and the 14th-largest global design company in the world. Its clients include Transport for London, Airbus, BP (BP.L) and Rolls-Royce (RR.L), and it employs more than 17,000 people worldwide.
Its history dates back to 1938, when the company specialised in civil and structural engineering design. Since then, it has grown its range of services to include specialist services in planning, engineering sciences, architecture and project management. With a market capitalisation of £663 million, it is the 254th-biggest listed company in the UK and, notably, was the official engineering design services provider for the 2012 Olympic Games.
The past five years have been steady for WS Atkins, with the company’s net profit ranging from a low of £68.6 million in 2008 to a high of £106.8 million in 2012 (profits from discontinued operations have been excluded). Interestingly, the average return on equity (ROE) figure for the period is a negative number due to the company having ‘negative net assets’ between 2008 and 2010 – in other words, liabilities were greater than assets.
However, the fact that average ROE is negative should not be viewed as a weakness in terms of the company’s performance. Its price-to-book ratio is likely to be high (as will be discussed later on) but purely from a performance perspective the ROE is impressive, hitting 89.5% last year.
The shares currently yield an attractive 4.6% with a very comfortable payout ratio of 28.6%. It could be argued that the company should be paying out a higher proportion of profits as dividends but, equally, dividends have increased at an annualised rate of 5% over the past five years, which is understandable given the difficult economic circumstances.
As for financial soundness, financial gearing of 92.7% is high, but it is comfortably serviced, with the company having interest cover of 72. So, although debt levels are high relative to the company’s net asset base, this is due to a small amount of net assets rather than a large amount of debt, with the high interest cover ratio showing that the company is very capable of paying the interest due on its borrowings.
In terms of an economic moat, the company's business is to plan, design and deliver large-scale infrastructure projects. This is an area in which there will always be demand for a high-quality service that offers good value for money.
In addition, its client list includes public and private companies, which means it is not wholly dependent upon one or the other for its revenue. The mix of public/private can be broken down as follows: 32% private, 13% regulated and 55% local and national government.
Weathering the storm
The past five years show that even when trading conditions are challenging, WS Atkins is able to remain in profit. Therefore its economic moat, although not vast, appears to be of a sufficient size to offer reassurance to investors.
With shares currently priced at £6.62, WS Atkins currently trades on a price-to-earnings (P/E) ratio of just 6.2. However, because of its very low net asset value it also has a price-to-book (P/B) ratio of 5.8. Therefore, it could be argued that, based on its P/E, the shares are extremely cheap or, based on its P/B, shares are fairly expensive.
On 9 November 2011 I wrote an article that compared the investment styles of Benjamin Graham and Warren Buffet. Both are value investors who focus on many of the same aspects of companies such as profit track record, return on equity and price level. However, the two differ in their view of the price to book ratio, with Warren Buffett preferring a high P/B ratio (when ROE is also high) and Benjamin Graham favouring a low P/B, even if ROE is high.
The reasons for this are detailed in the previous article but, with a very low P/E, a high P/B and a high ROE, this is one for the Buffetts and not the Grahams.
In other words, if you can live with buying the rights to future profits rather than a pile of assets, this is a company for you.
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