Published : 5 years ago, on 09/12/2019

• Business models of tier one contractors have been questioned and share prices of quoted contractors such as Kier, Costain and Balfour Beatty have suffered
• Investors looking to profit from UK infrastructure plays should consider contractors which are relatively undervalued and separated from overall project risk such as Renew and Van Elle

 Whichever of the main political parties wins the General Election, the UK is set for a state-sponsored infrastructure boost as a result of the Labour and Conservative manifesto promises alongside already committed significant railway investment. Given that the business models of tier one contractors, such as Kier, Costain and Balfour Beatty, have already been questioned and their share price has suffered, investors seeking to profit from UK infrastructure plays should consider contractors, which are relatively undervalued and separated from overall project risk, such as Renew Holdings plc and Van Elle Holdings plc.

These are the conclusions of a new research report by the leading adviser and broker to ambitious growth companies, finnCap Group plc. The report highlights the three key drivers of significant public infrastructure spending, which look set to continue in the coming years, and should make the sector an attractive investment opportunity.

The first driver is that both the Conservatives and Labour have promised a significant increase in infrastructure spend. The Conservatives (currently favourite to win) have promised a £20bn p.a. increase to £67bn. Indeed, whilst the party has set itself a proposed fiscal rule of investment in long-term projects, such as road and railways not exceeding 3% GDP, that is still a considerable step up relative to the long-run average of c1.8% and 2018/19’s figure of 2.2%. The Conservatives’ manifesto highlights Northern Powerhouse Rail, the Midlands Rail Hub, upgrading flood defences and a £28.8bn investment in roads, as priorities for the additional £100bn.

Labour’s investment will be made through its National Transformation Fund; £250bn will be invested through its ‘Green Transformation Fund’ over the next 10 years in energy, transport and other networks, alongside another £150bn to be invested over 5 years through its ‘Social Transformation Fund’, which is to be used to “replace, upgrade and expand… schools, hospitals, care homes and council houses”. This promises to more than double net capital spending to £102 billion, making the UK’s capital spending amongst the highest in the world.

The second driver of the infrastructure boost in the coming years is Network Rail’s “Control Period 6” (CP6) – the ambitious strategic business plan outlining all rail projects, works and improvements to be delivered between 2019 and 2024, which promises a 25% increase in renewal and maintenance spend in rail. Crucially, CP6 also commits Network Rail to make it easier for external providers to compete and carry out work on the railway directly. The growing rail network needs to be maintained and supported, and the forecast expenditure of £53bn will provide significant growth opportunities for suppliers and partners.

The third and final driver is that even though a review of HS2 is due to be published after the election, the headline recommendation from a leaked version of the report was for the Government to push on with the project, including the full Y-shaped line from London to Manchester and Leeds and the estimated £88bn (and rising) that it is projected to cost.

For investors seeking to capitalise on this favourable infrastructure spending backdrop, the report highlights that whilst the business models, finances and share prices of a number of tier one contractors such as Kier, Costain and Balfour Beatty have come under strain, contractors which appear more relatively undervalued and are separated from overall project risk, which frees them to focus on core specialisms, delivering directly and getting involved with the specific types of projects they fully understand the risks of, present interesting medium term opportunities.

Two companies, which share these characteristics, in particular were highlighted by the research: Renew Holdings plc (RNWH) a provider of repair and maintenance services for UK infrastructure and which the report found to be “perfectly positioned to see the benefit of increased renewal and maintenance spend in rail”; and Van Elle Holdings plc (VANL), the specialist piling contractor to UK house-building and road and rail infrastructure segments, which the report concluded could expect benefit from both “higher rail spend and the competition being lured off onto HS2”.

Guy Hewett, Research Director (Support Services) at finnCap, commented: “The prospect of an infrastructure boost in the UK post the election, makes the sector one for investors to focus on over the coming year. Given that the larger tier one contractors have recently suffered from a range of operational and reputational issues, related to their involvement in a number of significant projects, we focused on seeking out companies that are separated from overall project risk and are free to focus on core specialisms. Very often they provide discrete services critical to projects so the value-add is high but company valuations have been hit alongside their larger cousins. It is worth investors seeking infrastructure plays taking a closer look at such underappreciated but attractive companies.”