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Costain (67% Profit in 14 months)

The UK construction industry has taken several blows in the recent past – once Brexit uncertainties were beginning to lift, it has to deal with a pandemic. Costain Group plc is a UK-focused technology-based construction company serving the transportation and natural resources segments. It has an illustrious history of UK construction and serves primarily large customers.

2019 was a sub-normal year for the company owing to contract delays, cancellations, adverse arbitration judgments and other one-off factors. Previous to that, it generated pre-tax profits of around GBP 40m. Operating cash flows were adversely affected recently due to prompt payments to suppliers required by UK regulations.

Other cash flow squeezes by customers requiring greater financial strength from their contractors - partly as a result of recent failures of other large contracting firms (e.g. Carillion) – has prompted the company to propose a rights issue of GBP 100m, which is fully underwritten by bankers and investors but due for shareholder approval.

The auditors have expressed concern on the going concern assumption pending the shareholder approval. Although the company operated with net cash of GBP 65m as at December 31st 2019, cash flow projections leave it insufficient headroom on quarterly covenants with lenders.

This uncertainty has driven the share price to apparently absurdly low levels of 35p – valuing the equity at a mere GBP 37m. This is less than the net current asset value of GBP of 40.5m – a proxy for liquidation value, and under 2x average past earnings. Insiders have been scooping up the shares as recently as March 16th at 40p per share.

Covid-19 has curtailed London activities comprising 30% of revenues. Until then, it has undrawn bank facilities of GBP 71m to lean on.

We can’t handicap the odds of the shareholder approval of the rights issue; or the terms at which they’ll be set. Legacy shareholders are almost certain to be diluted significantly near the current market price –but the standby underwriting of the rights issue is a source of comfort.

At current market prices below liquidation value, entering shareholders seem to have little to lose and much to gain with Costain.

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