Kier Init Aug 19

Building & Construction
For FCA purposes this is a Marketing Communication
Kier Group
6 August 2019 06:00 BST Company Update
BUY A question of self help and confidence

From Suspended
Having moved to 'under review' in June, we reinstate our target price at 150p and
Current Share Price 78p BUY recommendation. We do need to stress the binary nature and risk profile of
Target Price 150p Kier at present, which is ultimately dependent upon the success of management
Market Capitalisation £126m to reduce debt through disposals and restoration of cash backed profits. We argue
Shares In Issue 162m
that the underlying quality of services operations and ability to sell asset-backed
RIC/BLBG KIE.L/KIE LN
divisions makes restoration of fortunes the most likely outcome, but if not attained
Avg. Daily Volume (3M) 2,724,114
Broker Yes
then Kier could face major issues impacting cash flow, share price and potentially
its financial viability. The consequential huge differential in share price resulting
Current share price(s) timed at 4:30pm on 02/08/19
from these scenarios reflects the high risk/reward profile of Kier at present.
Share Price
1200 ● This document outlines what we see as the two scenarios for Kier from here, which
1000
in our view is binary; either net debt sees a further material increase, leading to a
800
600 reduction in industry and investor confidence and spiralling of issues, or management
400 stabilises the current situation and enacts strategic initiatives which reduce net debt
200
and restores confidence.
0
Aug-18 Nov-18 Feb-19 May-19 Aug-19
Kier Group ● It is worth highlighting with reference to the impact of confidence, that on Numis
Relative to UK Market
estimates some 65% of the £150m increase in average monthly net debt over 2019 to
Performance (%) 1M 3M 12M date is due to working capital outflow driven by supply chain squeeze.
Absolute -25 -79 -91 ● The full year trading update provided some comfort on two fronts. First, that average
Relative -24 -79 -91 net debt had ended at the lower end of management expectations, implying the working
Source: Datastream (relative to UK-DS Market index) capital squeeze had not worsened. Second, strategic initiatives to reduce the debt are
commencing and the "significant interest" in Kier Living suggests an ability to sell at a
good price and make inroads to the debt profile.
● We outline our view of what Kier would look like on a normalised basis post disposals,
and also how this will play out in terms of net debt reduction. Prudence is key given
Analysts
the outcomes, and we believe by 2022E Kier has the capacity to be refocused as a
Howard Seymour
Tel: +44 (0)20 7260 1260 market leading regional contractor and national infrastructure services provider with a
h.seymour@numis.com balance sheet which reflects this - albeit still with net debt on Numis analysis.
Chris Millington
Tel: +44 (0)20 7260 1325 ● Valuation is inevitably sensitivity-based and we focus only on our positive outcome,
c.millington@numis.com
but discounting prudent assumptions leads us to reintroduce our target price at 150p/
Christen Hjorth share. Attaining management target strategic initiatives would indicate a target price
Tel: +44 (0)20 7260 1213
c.hjorth@numis.com up toward 300p, but it is clearly too early to consider this.
Year to Revenue Op Profit EPS DPS Net Cash / PE Divi Yield

Jun (£m) (£m) PBT (£m) (p) (p) (Debt) (£m) (x) (%)
This research was prepared 2017A 4,264 145.6 126.1 103 67.50 (110.1) 0.8 86.5
and approved by
2018A 4,494 160.0 136.9 113 69.00 (186.3) 0.7 88.5
Numis Securities Limited 2019E 4,465 122.0 101.0 62.3 4.90 (167.3) 1.3 6.3
The London Stock Exchange Building 2020E 4,551 156.0 141.0 70.4 0.00 (85.3) 1.1 0.0
10 Paternoster Square
Source: Kier Group (historical) and Numis Securities Research (forecast)
London EC4M 7LT
+44 (0)20 7260 1000 | mail@numis.com
www.numis.com For FCA purposes this marketing communication has not been prepared in accordance
with legal requirements designed to promote the independence of investment research
and is not subject to any prohibition on dealing ahead of the dissemination of such
Registered No 02285918. Authorised and research. Important disclosures are on pages 29 to 30 relating to Numis Securities
Regulated by The Financial Conduct Limited, analyst certification, other requirements which restrict dealing ahead, relevant
Authority. A Member of the London investment banking relationships, potential conflicts of interest and additional
Stock Exchange
disclosures. See www.numis.com/x/regulatory.html for other disclosures.
Kier Group 6 August 2019
Financial Summary
Valuation Performance Metrics
Year to June 2017A 2018A 2019E 2020E Year to June 2017A 2018A 2019E 2020E
Valuation Ratios Growth Rates
P/E (co adj EPS, x) 0.8 0.7 1.3 1.1 Revenue Gth (%) 5 5 (1) 2
EV/Sales (x) 0.0 0.1 0.1 0.0 EPS Growth (co adj, %) 5 10 (45) 13
EV/EBITDA (co adj, x) 1.1 1.5 1.9 1.2 DPS Growth (%) 5 2 (93) (100)
EV/NOPAT (x) 1.6 2.0 2.7 1.6
Financials Ratios
Equity FCF Yield (%) 58.9 16.0 (197.0) 30.8
Operating Margin (%) 3.4 3.6 2.7 3.4
Dividend Yield (%) 86.5 88.5 6.3 0.0
Net Debt/EBITDA (x) 0.7 1.0 1.2 0.5
Price/Book (x) 0.15 0.13 0.12 0.13
Int cover (EBITA/int, x) 7.5 6.9 5.8 10.4
Source: Numis Securities Research
ROCE (EBITA/Cap Emp, %) 18.4 18.7 11.7 20.0
Financials Div Cover (x) 1.53 1.64 12.7
Year to June 2017A 2018A 2019E 2020E EqFCF / adj net inc (%) 45 11 nm 34
Profit & loss (£m)
Revenue 4,264 4,494 4,465 4,551
EBITDA (co adj) 165.3 179.7 145.0 180.0 EV Calculations
EBITA (co adj) 145.6 160.0 122.0 156.0 Year to June 2017A 2018A 2019E 2020E
Market Cap (fd) (£m) 77.5 77.5 103.0 126.4
Net Interest (19.5) (23.1) (21.0) (15.0)
less Net Cash/(Debt) (£m) (110.1) (186.3) (167.3) (85.3)
PBT (co adj) 126.1 136.9 101.0 141.0
Enterprise Value (£m) 187.6 263.8 270.4 211.8
Tax Rate (co adj %) 18.0 17.0 17.0 17.0
NOPAT (£m) 119.4 132.8 101.2 129.5
Net Income (co adj) 102.3 112.6 82.3 114.0
EPS (co adj) (p) 103 113 62.3 70.4
DPS (p) 67.50 69.00 4.90 0.00
Company-specific data
Year to June 2017A 2018A 2019E 2020E
Balance Sheet (£m)
Buildings EBIT 46.2 54.7 63.4 64.5
Acquired intangibles 802.8 862.2 835.0 820.0
Infrastructure EBIT 63.7 68.3 67.0 74.4
Fxd and non-aq int assets 274.8 317.7 304.0 285.0
Developments & Housing 65.4 72.1 51.6 56.9
Net working capital (287.1) (323.8) (95.1) (324.2)
EBIT
Capital Employed 790.5 856.1 1,044 780.8
Property EBIT 25.8 34.0 36.4 37.8
Net Cash/(Debt) (110.1) (186.3) (167.3) (85.3)
Central costs (29.7) (35.1) (59.9) (39.7)
Net Assets 621.1 787.4 883.3 884.5
Average monthly net debt/ 320.0 375.0 422.0 317.0
Shareholder Funds 511.0 601.1 862.1 955.4
(cash)
Cash Flow (£m)
Operating Profit 145.6 160.0 122.0 156.0 Share Price: 78p as of 02/08/19
Depn & non-acq amort 19.7 19.7 23.0 24.0
Chg in working capital (48.7) 26.6 (227.0) (10.0)
Other op cash flow 12.1 (99.9) (53.0) (66.0)
Operating cash flow 128.7 106.4 (135.0) 104.0
Capex (60.2) (63.3) (35.0) (35.0)
Tax paid (3.8) (9.9) (12.0) (15.0)
Net financing costs (19.1) (20.8) (21.0) (15.0)
Equity Free Cash Flow 45.6 12.4 (203.0) 39.0
Acquisitions & disposals 27.4 (5.7) 24.0 0.0
Equity dividends paid (47.9) (67.6) (50.0) 0.0
Financing & other 265.7 (173.6) 188.0 (17.0)
Chg in net cash / (debt) 290.8 (234.5) (41.0) 22.0
2 Registered No 02285918. Authorised and Regulated by The Financial Conduct Authority. A Member of the London Stock Exchange
Contents
Investment case ______________________________________________________ 4
Strategic focus – back to basics __________________________________________ 7
● Continuing activities and current trading ______________________________ 7
● Normalisation – the future shape of Kier _____________________________ 10
Net debt – the root of the issue __________________________________________ 12
● Debt reduction: Scope for disposals ________________________________ 16
● Debt reduction: operational cash flows ______________________________ 19
Valuation ___________________________________________________________ 24
● Risks ________________________________________________________ 27
Registered No 02285918. Authorised and Regulated by The Financial Conduct Authority. A Member of the London Stock Exchange 33
Investment case
Having moved to ‘Under Review’ with the two warnings in June, we re-initiate here with
a Buy rating and reduction in target price from 606p to 150p following on from the full
year trading update. However, we need to stress the binary nature and high risk profile
associated with the group at present. Kier is clearly in the eye of the storm, having seen
material profit estimate decreases and net debt increases over 2019. In our view,
confidence amongst both the industry supply chain and clients will be the defining factor
in this binary situation. There are two potential outcomes in our view:
● Confidence lurches down from here. This scenario would most likely be driven by
further net debt increase – most likely associated with falling profit expectations,
rising debt associated with previous management actions (e.g. cash provisioning on
problem contracts) or inability to make material disposals. This could further reduce
confidence and drive additional working capital outflows. To put this in context, in
this document we provide an overview of average monthly net debt movements over
2019 to date and the following chart summarises our conclusion; 2019E average
monthly net debt expectations have risen from £268m to £422m (as outlined with the
FY update), of which £100m/65% of the increase relates to working capital
movements on Numis estimates – which we regard as client and supply chain lack
of confidence in the group.
Figure 1: Average monthly net debt movements, 2019E

470
420
Average monthly net debt
370
320
270
220
Opening (Nse Debt Macro: EBIT Dividend WC/confidence
2019E) reclassification impact suspension
We take the point made by management that debt facilities are materially above current
net debt levels at £920m. However, if we were to see industry confidence decline from
here, it could lead to further working capital outflows, weaker investor sentiment and a
lower share price, such that a situation where banks consider a debt/equity swap could
become the most tangible outcome.
● Management stabilises current net debt position and manages to enact the Strategic
Review, enabling both cash from disposals and also cash-backed earnings to
reduce average monthly net debt. We outline our assumptions behind this, outlining
both what we see as a central/prudent case and also the potential if the group saw a
full restoration of confidence in the business. On this analysis, net debt is materially
reduced and the company survives and rerates – but it does take to 2021/22E to
attain this. We note that the Full Year trading update pointed to average monthly net
debt of £422m, towards the bottom end of guidance from June, showing that at least
there has been some stabilisation since then.
The table below is explained later in the document, but based on timing and quantum of
actions, we get to the following average monthly net debt reduction from 2020 onwards,
and also total movements based on these assumptions and a ‘Bull case’.
Table 1: Kier Group average monthly normalised net debt progression

2020 2021 2022 Total – Normalised case Bull case
Opening monthly average net debt (422) (271) (126) (422) (422)
Disposals
Kier Living 50 50 100 120
Property:
Cash release 50 34 84 84
Disposals 30 45 75 100
Total disposals 130 129 0 259 304
Net income (normalised) 65 65 65 195 230

Pension costs (24) (19) (49) (92) (92)
WC (10) (20) (10) (40) 60
Early payment closure (10) (10) (20) (40) (40)
Total op cash flow 21 16 (14) 23 158
Closing monthly average net debt (271) (126) (140) (140) 40

ND:EBITDA 2.6x 1.2x 1.3x 1.3x -0.4x
Our view remains that, operationally, Kier activities are high quality market leaders, so
that balance sheet mismanagement can be corrected and the fortunes of the group
restored. That is not to say it is not a rocky ride in the short term, and we stress that this
document focusses on the capability to survive medium term and does not attempt to
focus on short-term issues – though a clear and essential assumption here is that net
debt does not worsen from the current position. On this basis, we outline below what we
see as the shape and normalised profile of Kier post enactment of the key tenets of the
Strategic Review outlined by the CEO in June (and expanded on later in this document):
Table 2: Kier normalised EBIT, continuing operations

Normalised EBIT
EBIT margin
Buildings:
Regional Building 3.0% 46
Middle East 1.0% 1
Total Buildings 2.9% 47
Infrastructure Services:
Construction 2.6% 11
Highways 4.0% 32
Utilities 4.0% 19
Total Infrastructure Services 62
Developments & Housing:

Housing Maintenance 1 2
Total Developments & Housing 2
Central costs (25)

Total normalised EBIT 86
In this scenario, discounted sum-of-the-parts implies a short-term target price of

150p/share and scope for the share price to move up to near 300p/share with full
attainment of management objectives. The risk/reward in our view reflects the binary
situation and the ball is very much in Kier management’s court to achieve this.
Strategic focus – back to basics

Having revised divisional structural with full year results in September 2018, we believe
this provides the starting point for any discussion of the future shape of the group. The
table below shows the key divisional components of revenue and EBIT using Numis
breakdowns:
Table 3: Kier divisional profile, 2018

Revenue EBIT EBIT margin
Buildings:
Regional Building 1,517 49.1 3.2%
Middle East 100 4.0 4.0%
Facilities Management 161 1.6 1.0%
Total Buildings 1,778 54.7 3.1%
Construction 420 12.7 3.0%
Highways 812 37.4 4.6%
Utilities 472 20.3 4.3%
Environmental Services 10 (2.0) -20.0%
Total Infrastructure Services 1,714 68.3 4.0%
Developments & Housing

Property development 218 34.0 15.5%
Kier Living 375 25.9 6.9%
Housing Maintenance 408 12.2 3.0%
Total Developments & Housing 1,002 72.1 7.2%
Central costs (35.1)

Total 4,494 160.0 3.6%
Source: Company & Numis Securities Research
Continuing activities and current trading

Activities and exposure With the result of the Strategic Review, CEO Andrew Davies outlined several key areas
of change at divisional level:
● Focus the company on Regional Building, Infrastructure, Utilities and Highways. In

addition, Kier Housing Maintenance and Middle East construction are to be retained.
● Simplify the group portfolio through sale or “substantially exiting” Kier Living,
Property, Facilities Management and Environmental Services.
We would suggest that the key tenets of the strategic direction are to focus on long-term
clients (high exposure to regulatory areas and frameworks with clients) to drive a low
risk model. Essentially, the exiting of the businesses above indicates a shift back to a
B2B strategy and move away from B2C exposure.
The table below updates the divisional profile above to show the shape of the group
post enactment of the strategic initiatives:
Table 4: Kier divisional profile pro forma post strategic review, 2018A
2018A
Strategic review Revenue EBIT EBIT margin
Buildings:
Regional Building Retain 1,517 49.1 3.2%
Middle East Retain 100 4.0 4.0%
Facilities Management Exit
Total Buildings 1,617 53.1 3.3%
Construction Retain 420 12.7 3.0%
Highways Retain 812 37.4 4.6%
Utilities Retain 472 20.3 4.3%
Environmental Services Exit
Total Infrastructure Services 1,704 70.3 4.1%
Developments & Housing

Property development Downsize/sale
Kier Living Exit
Housing Maintenance Retain 408 12.2 3.0%
Total Developments & Housing 408 12.2 3.0%
Central costs (35.1)

Total 3,729 100.5 2.7%
We provide a brief outline below of what we see as the continuing businesses once the
strategic review has been implemented:
● Buildings:
● Regional Building. Kier is the largest regional builder in the UK, operating
through 67 regional offices across the UK. Average project size in the business
is c.£7-8m, and c.75% of volume is carried out through long-term frameworks. In
2018, 45% of revenue came from education, 30% from private sector and 10%
from health. The Broadmoor Hospital contract we discuss below is included in
this division. Major competitors would be Morgan Sindall, Balfour Beatty, BAM
and Galliford Try.
● Middle East. Provider of water, power, transport and major public buildings (eg
schools, hospitals), mostly in UAE. Competitors are mostly indigenous and
international contractors, but Kier mostly bids only on projects that have UK
export credit facilities.
● Infrastructure:
● Construction involves major projects. Kier has an ECI contract on HS2 as part of
a JV with Eiffage on lots C2 and C3, which is c.£1.4bn main works civils
packages. The group was a major provider on Crossrail and, at present, the
division’s largest single contract involves earthworks and site preparation at
Hinkley Point C in JV with BAM Nuttall. The group is in the process of completing
the Mersey Gateway project, involving landscaping and site clearance as
discussed below.
● Highways. Working on four smart motorway schemes (M6, M23, M20), Kier is
the largest provider of infrastructure service to Highways England, as outlined in
the table below. In addition, Kier provides highways services to Suffolk, Surry,
Lincolnshire, Northampton and Torbay Local Authorities, County Councils or
Borough Councils. There is a range of contract sizes in these areas from in
excess of £185m to smallest at c£10m and average is c£65m. In terms of split in

Highways, we would argue that Local highways would be just over 50% of the
total Highways revenue so there is not a major skew between National and
Local. Other major players are Amey, Balfour Beatty and Costain.
Table 5: Kier Highways England contracts

Contract
Client Area Contract value (£m pa) Status
Highways England Area 3: Hampshire, Dorset, ASC/maintenance 110 Extended to 2021
Wiltshire, Berkshire, Bucks
and Oxfordshire
Highways England Areas 6&8: Essex, East Maintenance 15 2019
Anglia. Cambs, Beds &
Herts
Highways England Area 7: East Midlands Design 50 2021
Highways England Area 9: West Midlands ASC/maintenance 140 Extended to 2022
Highways England Area 13: Cumbria and ASD/maintenance 10 2032
north Lancashire
Transport for London LoHAC - South London 50
Source: Company data
● Working across the water, electricity, gas and telecommunications sectors, the
majority of work is delivered through framework contracts and long-term
alliances. The business materially increased its exposure in this area with the
acquisition of McNicholas in 2017 and is the third largest player in the sector,
competitors including Balfour Beatty, Costain, Amey and Morrison Utility
Services (part of M Group, owned by PE house PAI Partners).
● Developments & Housing. The table above assumes Property is fully exited, as we
believe the need to generate cash is more important than retention of the business
and we see Kier refocussing exclusively into a service business. This leaves
Housing Maintenance, which provides planned and response maintenance repairs
nationwide, delivering services to c.350,000 houses per annum. Mears and MITIE
would be the largest public competitors in this space.
Recent trading and outlook We focus here on trading from the start of 2019 in the continuing businesses:
● January: Management pointed to trading in line with expectations, and with new
contract wins in both Infrastructure Services and Buildings divisions. The combined
orderbook was over £10bn, with 100% visibility of FY 2019 forecast revenue. FPK
programme was ‘progressing well’.
● March. While maintaining underlying FY 2019 expectations, management pointed to

a £25m non-cash provision at Broadmoor Hospital, which we see as eliminating any
expected future cash recoveries from the project, but agreed with the client to “reach
agreement with respect to the Group’s entitlement to the additional costs associated
with the project’s delay”.
● June. Volume pressures in Highways, Utilities and Housing Maintenance, coupled

with lower revenue growth in Regional Building, led to a £250m reduction in revenue
and £25m reduction in EBIT expectations in these areas. Management pointed out
that Regional Building would still show revenue growth and that orderbook in this
area was showing double-digit growth. On FPK, FY 2019 costs were increased by
£15m, in part due to acceleration of the programme following CEO Andrew Davies’
appointment.
● July. Buildings and Infrastructure divisions “remained resilient”, but period end delay
to a small number of property and land-led transaction completions gave rise to a
£100m revenue reduction vs. expectations, which at a group gross margin of 10%,
led to a £10m EBIT reduction for 2019E and 2020E. Divisionally, we estimate 1/3rd
of downgrade was in Residential and 2/3rd in Property.
Normalisation – the future shape of Kier

Against a difficult market backdrop across all areas, we do not believe that revenue
growth will be the major factor for Kier, as it seems likely that margin and cash
normalisation will be key to both management credibility and also attainment of cash-
backed profits. The following table provides a simple approach to normalisation using
what we regard as industry margins. It should be noted that these may be lower than
Kier’s historic margins, but in our view, the recent chequered history of the group means
that using an industry return makes more sense as a yardstick. This also takes account
of current market conditions in our view.
Table 6: Kier normalised EBIT, continuing operations

Normalised
EBIT margin EBIT
Buildings:
Regional Building 3.0% 46
Middle East 1.0% 1
Total Buildings 2.9% 47
Construction 2.6% 11
Highways 4.0% 32
Utilities 4.0% 19
Total Infrastructure Services 62
Developments & Housing:

Housing Maintenance 1 2
Total Developments & Housing 2
Central costs (25)

Total 86
● Construction. Aggregating the Construction businesses (i.e. Regional Building,

Middle East and Construction from Infrastructure Services) implies a normalised
EBIT of £57m, which equates to a 2.8% EBIT margin on £2bn of revenue. We
believe that Kier’s Regional Building business should operate at a premium to other
regionals due to its scale. Traditionally in the industry regional construction tends to
operate at higher gross but lower EBIT margins than civil engineering due to higher
administrative costs associated with having a nationwide spread of activities.
● Services. We contend that EBIT margins in Kier’s services operations – Highways

and Utilities – should be c.4-5%. Again, these are not dissimilar to the margins
attained by peers. We also include Housing Maintenance in this category, but would
argue for a lower EBIT margin given that the market is currently being impacted by
ongoing austerity at Local Authority level and that resources have been diverted post
Grenfell. Overall, Housing Maintenance dilutes the total Services EBIT margin to
c.3% on revenue of £1.7bn.
10
● Central costs. The ‘Future Proofing Kier’ programme started by previous

management has been accelerated by CEO Andrew Davies, with the expectation
that it will deliver annual sustainable cost savings of c.£55m from FY 2021, at a cost
of £56m (split 50/50 2019/2020). Our assumption above is that central costs of the
group will reflect some of these savings and we assume a figure of £25m (down
from £35m in 2018). We would argue that the lion’s share of FPK will fall into central
costs and that ability to reduce central costs could be a key component of the CEO’s
plan to drive forward the profitability of the company.
This gives rise to a normalised EBIT from the continuing operations based on Numis
analysis of £86m. Putting this in context, the chart below shows EBIT from the activities
that comprise these components. We have used previous divisional categories as we
see these as more meaningful than the new divisional split, as they separate out
construction and support services as distinct businesses, and this also enables historic
perspective.
Figure 2: Kier Construction and Service financials, 2014-18 and normalised (pre
central costs)
160.0 8.0%
140.0 7.0%
120.0 6.0%
EBIT margin (%)

100.0 5.0%
EBIT (£m)
80.0 4.0%
60.0 3.0%
40.0 2.0%
20.0 1.0%
0.0 0.0%
2014 2015 2016 2017 2018 Normalised
Construction EBIT Services EBIT

Construction EBIT margin Services EBIT margin
Group EBIT margin post CC
Conclusion We conclude that the strategic repositioning put forward by CEO Andrew Davies looks
to be the best response to Kier’s difficulties and will refocus the company back into
areas where it has market leading capabilities. The attainment of this involves a ‘back to
basics’ approach, so that while there are some questions at present about the macro
outlook, our normalised approach outlined above is focussed on attainment of industry
standard margins rather than an assumption of top-line growth. We use this as the base
for net debt reduction, which we see as the key challenge for Kier, as we outline below.
11
Net debt – the root of the issue

Chronology of net debt increase We believe, in keeping with the commentary above, that a good starting point is to
outline recent net debt movements and events.
Table 7: Average and period end net debt expectations, 2018-19E

Average Period end Key driver
FY 2018 375 186
2019E
AGM update (November 360 159 Focus on cash generation
2018)
Rights issue (December 268 (24) £250m rights issue
2018)
Update (March 2019) 318 (2) JV debt reclassification
Interim results 318 (2) Assumption of WC reversal
Profit warning (June 2019) 370 56 £40m EBIT reduction
Strategic review 453 195 Working capital outflow due to industry confidence,
conclusions dividend suspended
Full year trading update 422 167 Working capital outflow shows slight improvement
While we have outlined period end net debt in the table above, our commentary below
focusses on average monthly net debt, as we see this as the key debt criterion:
● Full year 2018 showed average monthly net debt of £375m. With FY results, Kier
announced targeting average monthly net debt of £250m and year end net cash
position by year end 2021, which followed on from the announcement of the FPK
programme in July 2018. Numis estimates for 2019E at the time of FY 2018 results
were average monthly net debt of £360m.
● November 2018 AGM update suggested a small reduction in H1 average net debt
(£390m vs. £410m in 2018) and the disposal of KHSA for c.£24m. Numis average
and period end net debt profiles for 2019E remained as before.
● Rights issue. The rights issue in December for £250m (net of expenses) was a major
surprise. Management justified the key reasons for the raise as:
● Reduced lender appetite for lending plus client focus on balance sheets. Greater
balance sheet focus from clients and banks has been a recurring theme post
Carillion’s demise and the rights issue suggested that “a number of
lenders...indicated an intention to reduce their exposure to construction”.
● Shortened supply chain payment terms, which have become an increased area
of focus across the industry.
● The rights issue document outlined a net debt figure of £624m at end October,
which clearly provided something of a shock when compared with the £186m
period end figure for end June 2018 and comments with the AGM statement in
November that H1 average monthly net debt would be £390m (with daily net
debt some £90m higher).
Adjusting for the rights, Numis estimates for average monthly net debt reduced to
£268m at end December 2019.
● January H1 trading update. Post rights issue, management pointed to H1 period end
net debt of £130m (vs. £239m) and H1 average monthly net debt of £370m, down
from £410m in 2019, though clearly the rights impact on average net debt would
have been insignificant happening towards the end of December.
12
● March debt update. Reclassification of some development assets held for resale
added £50m to the period end net debt and H1 average net debt was adjusted up
from £370m to £430m. Numis adjusted average monthly net debt up by this
quantum to £318m for the full year 2019E.
● Interim results. While H1 period end net debt was down to £180.5m (from £238.5m),
average net debt of £430m was some £80m above previous year level of £350m. A
notable feature was the £220m working capital outflow that occurred in H1:
● £26m net WIP due to delay in residential site completions.
● £97m outflow due to reduction in trade payables, taking payable days from 48 to
42 days.
● £97m outflow due to net increase in receivable days moving from 56 to 65 days
as payments reduced in advance of costs.
We retained our average monthly net debt of £318m at this time, arguing that the WIP
delay would be reversed and £194m receivables/payables outflow would adjust back to
NSe WC outflow £70m expectation for the full year.
● June warnings. Two issues in June impacted the net debt profile of the group:
● 3rd June. We have outlined in the previous section that volume pressures led to a
£250m/£25m revenue/EBIT reduction at the start of June – the table below
illustrating that, given the unexpected revenue shortfall, EBIT decline matched
gross profit decline of £25m for the current year (annualised impact of £40m in
2020) and on NSe this drove a £40m working capital outflow. As a result, NSe
increased 2019E average monthly net debt to £370m (WC plus EBIT impact)
and period end net debt to £56m.
Table 8: Financial impact of June profit warning

Revenue Gross margin Gross profit WC % sales WC outflow
Building 120 8% 10 19% 25
Highways/utilities 100 12% 12 12% 12
Housing maintenance 30 10% 3 10% 3
Total 250 10% 25 15% 40
● 17th June. Management pointed that the “recent external commentary” had led to
working capital outflow, taking average monthly net debt to a range of £420-
450m. This included the news that two trade credit insurance companies had
refused to write new cover (but retained existing cover) for Kier subcontractors.
Management engaged with the industry, though clearly they technically have no
direct exposure, resulting in two new insurers writing cover for Kier
subcontractors. However, it is also worth putting this in context; trade credit
insurance will not be needed where project bank accounts are used as this
means funds are ringfenced. As a result, approx. one-third of work done with
Highways England falls under this category, and as much of the work carried out
by Regional Building is in framework then the use of PBA’s here also tends to be
high. Management also announced the suspension of dividend payments for
FY2019 and FY 2020. As a result of this announcement, Numis raised 2019E
average monthly net debt expectations to £453m, and period end net debt to
£195m.
● 1st August. FY trading update confirmed that average month-end net debt was
£422m and that year end net debt was £167m, a relatively positive outturn in our
view. Payment days (in terms of HMG payment practices reports) in H2 stood at
13
41 days (vs. 57 days in H1 2019) and we believe receivables have improved

from H1.
Putting this in context, the flow chart below outlines what we regard as the key areas in
net debt movement based on our average monthly estimates since the start of the year;
namely, that post rights NSe was that Kier average monthly net debt would be £268m
for 2019E, and this has ended up at £422m:
Figure 3: Average monthly net debt movements, 2019E

470
420
Average monthly net debt
370
320
270
220
Opening (Nse Debt Macro: EBIT Dividend WC/confidence
2019E) reclassification impact suspension
We believe it interesting for the scope of this discussion to categorise the movement in
net debt into three categories:
● Management issues/actions. The reclassification of JV debt can only be regarded as

an error on the part of management and added to net debt – which unhelpfully came
at a time of heightened industry and investor concern with Kier. The suspension of
dividend payments with the Strategic Review provides some small alleviation of net
debt (having limited impact on average net debt), which we also classified as
management action.
● Macro impact. We believe the profit warning at start of June should be regarded
more as a response to weaker macro conditions than management actions, though
of course the distinction is also difficult, as it in part reflects management
expectations. However, the fact that Costain warned on similar issues toward the
end of June in our view is some vindication that this was a wider industry issue
rather than a Kier-specific one.
● Confidence. The largest increase in average monthly net debt expectations relates
to the shift in Working Capital (WC), which has added some £100m to Numis
expectations for average monthly net debt in the chart above. This reflects:
● Payable days moved from 48 days to 42 days for the group between June 2018-
December 2018. We see this as part of a wider shift in the industry to ease
supply chain pressures, with Central and Local Government in particular
expecting contractors to shift payments toward 30 days over a period of time. In
our view, the shift in payables was in keeping with industry peers, so that a
reduction in trade payables and subsequent working capital outflow was to be
expected.
14
● Receivable days moved from 56 days in June 2018 to 65 days at December

2018. The shift in receivables arose from a reduction in payments in advance of
costs and, in our view, is the key area where confidence in the group has been
felt. News that two of the major credit insurers would not insure Kier
subcontractors to work for the group on new projects, for example, has been
manifest in subcontractors demanding cash upfront from Kier to work for the
company, which effectively comes through as a receivables outflow. More food
for thought that something addressed here, but we wonder if the rights issue
surprise in December in fact drove a reduction in confidence rather than its
stated aim of alleviating issues.
Table 9: Kier balance sheet working capital, 2018 and H1 Table 10: Kier cash flow working capital movement, 2018-H1
2019 2019
2018A H1 2019 H1 2018 H2 2018 FY 2018 H1 2019
Raw materials 17.5 0.0 (Increase)/decrease in inventories 7.2 26.2 33.4 (35.7)
Construction contracts in progress/assets 105.9 456.5 (Increase)/decrease in receivables 39.9 (69.3) (29.4) (15.6)
Land & WIP 214.4 286.5 Increase in contract assets (50.1)
Other 237.2 0.0 (Decrease)/increase in payables (94.8) 127.3 32.5 (48.9)
Total inventories 575.0 743.0 Decrease in contract liabilities (68.1)
Decrease in provisions (8.6) (1.3) (9.9) (1.8)
Trade receivables 198.9 466.5 Total (56.3) 82.9 26.6 (220.2)
Construction contract retentions 92.9 0.0
Prepayments and accrued income 256.1 0.0
Other 104.3 0.0
Trade & other receivables 652.2 466.5
Trade payables (ex Supply chain finance) (435.7) (978.8)

Supply chain finance (184.8) (200.5)
Construction contract balances/contract liabilities (406.8) (125.3)
Other (523.7) 0.0
Trade & other receivables (1551.0) (1304.6)
Working capital total (323.8) (95.1)

Source: Company data Source: Company data
Outcome now becomes binary The issue of confidence is, in our view, binary. We would agree with management’s
view at the time of the strategic review that committed debt facilities are materially
above current net debt and stand at £950m as outlined below. This would indicate that,
as stated by management, “the Group’s liquidity headroom is able to absorb the
volatility” of recent events:
● Bank debt of £670m does not mature until June 2022, and as covenants are set
on period end net debt, then there is not an issue on potential breach; on current
NSe, 2019E period end net debt will be 1.65x and interest cover of 6.3x.
● Majority of private placement debt (USPP plus Schuldschein) matures between

2021-24.
Table 11: Kier Group banking facilities

(£m) Maturity Terms
USPP 183 2019-24
RCF 670 2022 ND:EBITDA >3x; Interest cover >4x
Schuldschein Loan notes 69 2019-23 ND:EBITDA >3x; Interest cover >4x
Overdraft 27 On demand
Total facilities 950
15
However, this has not stopped both industry and financial companies raising concerns
on Kier, which has led to working capital outflows – which we see as a crisis of
confidence and an effective ‘run’ on the company. The binary nature of the outcome is,
in our view:
● Positive outcome: Management enabling greater confidence in the business through

debt reduction could lead to a sharp improvement in confidence with consequential
WC improvement, mostly as receivable pressures abate.
16
● Negative outcome: Concerns lead to ongoing WC outflow and spiralling debt, so that
availability of bank facilities take a back seat to crisis of confidence – potentially
ultimately leading to banks having to take greater stakes in the company as equities
price in the lack of confidence to the point where market capitalisation becomes
immaterial. This was the case on Carillion’s demise, for example, though we stress
that we see no parallels between the two companies for reasons we outline
throughout this document.
The scope to materially reduce the debt is therefore crucial, and comes down to two
areas, in our view:
Debt reduction: Scope for disposals

There are three potential areas where whole or partial asset sale can take place:
1. Kier Living Comprising Kier’s private and partnership housing operations, the table below shows
the split between the two. Private housing is mostly in the East of England,
Cambridgeshire and down to outer London with ASP of £234k last year, while Kier
Partnership provides mixed tenure housing, mostly through JVs with Cross Keys, Home
England and Together Housing Group.
Table 12: Kier Living financial metrics, 2014-18

2014 2015 2016 2017 2018
Private (Kier land)
Units 601 706 750 748 749
ASP (£ '000) 213 201 221 232 234
Revenue 128 142 166 174 175
Mixed Tenure
Units 980 1,424 1,424 1,452 1,293
ASP (£ '000) 107 81 131 139 154
Revenue 105 115 187 202 199
Total Revenue 233 257 353 376 374
EBIT
Private 3.9 6.4 14.3 16.1 17.5
Mixed Tenure 3.8 4.8 6.0 6.7 8.4
Total EBIT 7.7 11.2 20.3 22.8 25.9
EBIT margin:
Private 3.1% 4.5% 8.6% 9.3% 11.1%
Mixed Tenure 3.6% 4.2% 3.2% 3.3% 4.2%
Total EBIT margin 3.3% 4.4% 5.7% 6.1% 6.9%

The strategic review outlined the following key metrics in the context of potential sale:
● On commencement of sales process, Kier “has received significant interest” in Kier

Living, as highlighted in the full year trading update. We understand this equates to
c30 in total.
17
● At end June, tangible net asset value of Kier Living assets were £180m, but of this
£60m of assets held on balance sheet would not be included in potential sale, as
these are strategic land and assets, with no immediate intention of development. As
such, net assets for sale comprise £120m of TNAV. The carrying value of £60m
strategic land will be reviewed with FY 2019 results, from which we would infer a
likely writedown in the asset value; we would expect that this would be a non-cash
item and potentially pave the way to disposal of this asset. Management has
suggested that excluding the strategic land should reduce the timing and complexity
of the sales process.
● JVs would be included in the sales process, including their share of JV net debt. On
questioning, management suggested that £110m of off balance sheet debt was
associated with Living JVs, so would be removed on disposal.
● Of the total Supply Chain early payment facility, some £35m is attached to Kier
Living, so disposal would also release use of supply chain financing. With some
£50m of working capital in the business on NSe, disposal of the business would also
unlock this and benefit working capital.
The value of the business is clearly dependent upon ROCE, given that P/TNAV/ROCE
is the staple valuation tool in the housing sector.
Figure 4: Kier Living average ROCE, 2014-18 Figure 5: Housebuilders P/NTAV vs. ROTCE, 2019E
20.0% y = 2.7719x + 0.6322
2.1
R² = 0.6661
18.0% PSN
16.0% 1.9
14.0% 1.7 CSP

ann 2019 P/NTAV
Average ROCE
TW
12.0% BKG
BDEV
1.5
10.0%
BVS
8.0% 1.3
6.0% RDW
1.1 BWY
4.0% GFRD
MCS CRST
0.9
2.0%
0.0% 0.7
2014 2015 2016 2017 2018 5% 10% 15% 20% 25% 30% 35% 40% 45% 50% 55% 60%
Total ROCE Private Mixed tenure ann 2019 ROTCE
Source: Company & Numis Securities Research Source: Numis Securities Research
While Kier may be perceived by some as a forced seller, we believe that the scope to
integrate private housing into a larger business and also attain a major mixed tenure
business will provide competitive tension to the sales process, so do not see a firesale
as necessary. We have outlined above that the full year trading update pointed to
“significant interest” in the business, which should provide sensible pricing tension. In
our view, therefore, we believe that, based on the chart above, a P/NTAV of between
0.85x-1.15x would imply a sales figure of £100-138m and believe it prudent to assume
sales proceeds at the bottom end of this range at £100m.
2. Kier Property Kier Property operates mostly as a local developer on small (c.£50m) sites in JV with
local and central Government plus regulated industries across the UK, with regional
offices in London, Birmingham, Edinburgh, Leeds, Manchester, Newcastle and
Nottingham. The following charts give an overview of asset base and key financial
metrics.
18
Figure 6: Kier Property asset base breakdown, 2018 Figure 7: Kier Property financial metrics, 2014-18
140 30.0%
Student
Accom, 16%
120 25.0%
Mixed use,
100
30% 20.0%
ROCE (%)
80
£m
15.0%
60
10.0%
Retail/leisur 40
e, 20%
20 5.0%
0 0.0%
2014 2015 2016 2017 2018
Total average capital employed
Industrial , Offices, 22% EBIT+JV PAT

12%
ROCE
Source: Company data Source: Company & Numis Securities Research
Key points from the strategic review with reference to Kier Property were:
● Due to “the investment requirements of the Property business (being) incompatible

with the Group’s capital requirements”, the business will accelerate capital invested
reduction, “which may lead to a sale”.
● Capital allocated to Kier Property will reduce to £100m in FY 2020 as a minimum.

This compares with average capital invested and end December 2018 of £184m.
● Off balance sheet debt associated with JVs in Property are some 68%/£238m of
total £349m off balance sheet debt, with the remainder involved in Kier Living.
Management has indicated that the off balance sheet debt should expect to reduce
in line asset reduction and we would also expect committed investment to decline
alongside this.
Table 13: Kier Joint Venture financials, 2018

(£m) FY June 2018 H1 December 2018
Investment on Balance sheet 226 238
Kier committed investment 27 6
Partners Investment 104 108

Partners committed Investment 14 3
Debt drawn (281) (349)

Debt committed (133) (137)
GDV 1,181 1,265
LTV 35% 38%
Average equity 68% 68%

19
We believe that the ability to see Kier Property as a saleable entity is much harder than
Kier Living, as it is a collection of individual JVs rather than a corporate business.
However, the high ROCE and low risk nature of the business means it is an attractive
prospect. In the context of debt reduction, management is clearly indicating that to end
FY 2020 there should be at least an £84m inflow resulting from average capital. We
expect that remaining assets are likely to also be sold down, and if we assume a
prudent 25% discount to asset value, this would imply c.£75m of disposal proceeds, so
the total proceeds from exiting Kier Property could ultimately be c.£160m. We discuss
timing of this below.
3. Sale of FM, Energy We do not expect either business to generate disposals proceeds of magnitude for Kier.
We have outlined above that FM is c.£160m of revenue, but on Numis estimates in the
current year is likely to break even at best and therefore sales proceeds likely to be
negligible. Environmental is effectively one contract, and at interims Kier management
indicated being in ‘advanced stages’ of early termination. We have outlined above that
the contract is in loss at EBIT level of c.£2m, but with central support costs, etc, the
impact of Kier Group is nearer £8m and so, while we do not see any proceeds of
disposal, we do believe that the scope to generate cash-backed profits would increase
with the exiting of this. At time of interims management announced a £26m non-
underlying non-cash provision relating to the likely termination of the waste collection
contract Overall, we believe the sale of these businesses increases the capability to
produce cash-backed profits and also enables management to take a more focussed
approach.
Debt reduction: operational cash flows

We believe it most prudent to use our normalisation analysis above in terms of scope for
cash-backed profit to reduce net debt – but treat WC separately in this discussion
below. On the basis of our analysis above, pre WC movements we argue that
continuing businesses within Kier should be able to generate EBIT of c.£86m post
central costs. Post tax, this would imply net income of £70m per annum. However,
additionally, we need to consider:
● Additional cash costs of pension schemes. The table shows that cash contributions
of £24-25m should be expected out to 2020, but in 2021 there will be a major shift
up to £65m, though in the case of the Kier, May Gurney and Mouchel schemes,
some £26m of the total is guaranteed by surety. Clearly, this may be an area where
management may aim to achieve a cash payment deferral of additional cash
payments with trustees, which could add a dimension to net debt reduction. The
pension triennial valuation commenced in March 2019.
Table 14: Additional cash payments to pension schemes, 2019-23

2019 2020 2021 2022 2023 Last triennial review Revised deficit plan
Kier Group 12.2 12.4 29.2 16.5 6.9 31/03/2016 Jul-17
May Gurney 1.8 2 11.8 0 0 31/03/2017 Jun-18
Mouchel 8.6 9.2 22.5 15.7 17.1 31/03/2016 Sep-17
McNicholas 1.2 1.2 1.2 1 0 31/03/2017 Jun-18
Total additional cash contributions 23.8 24.8 64.7 33.2 24
● Major issues in UK construction projects. Bears point to the fact that Kier has not
seen the profit explosions that have beset others in the industry, and to this we
would make three points:
20
● Small project scale reduces risks. The nature of Kier’s UK business – small
repeat contracts mostly in framework – has meant that Kier has avoided major
project blow-ups that others have seen. The chart below from the 2018 Report &
Accounts provides an interesting illustration, highlighting that, according to
management, only some 3% of total projects are involved in “higher-risk, single-
stage, non-framework projects”. It will be interesting to see new CEO Andrew
Davies’ take on this approach, but we regard a ‘back to basics’ and low risk
approach, as we have discussed above, is the best way to reduce the risk profile
of the business.
Figure 8: Kier Construction risk profile, 2018
10% of projects 81% of projects 9% of projects
Risk Averse Risk Neutral Risk Tolerant
● Major projects where Kier has had contract settlement issues were alluded to in
the rights issue document as Broadmoor Hospital and Mersey Gateway. In both
cases, the issue is recovery of construction costs already borne by Kier.
Broadmoor saw a £25m non-cash provision in the March trading statement,
effectively wiping out any expectation of cash recovery. Phase I of the project
has been handed over, and Phase II is commencing now and less than 10% of
value involves basic groundworks rather than construction. At interims,
management suggested that “Work continues on the remaining landscaping and
site clearing at the Mersey Gateway project, with the claims recovery process
continuing”.
● Kier has not been immune to construction issues. It has seen over £100m of
cash outflows relating to the closure of the Caribbean and Hong Kong
operations, with cash closure costs of £83m and £26m, respectively, over 2016-
17. The company has been affected by lax management and contract issues and
this, in part, is reflected in the higher net debt the group has seen over the last
four years.
We believe that the Kier business model in Construction should imply it is not prone to
the same risks as major project contractors and do not model project issues into our
sensitivity. Clearly, however, FY results in September will include the £25m non-cash
exceptional at Broadmoor we highlight above.
21
● Working capital recovery. We believe this is the most difficult call, as it is part of the
binary scenarios we have outlined above. If management can demonstrate that net
debt is reducing and there are no operational issues within the company, we believe
it possible that WC could see an inflow as receivable days moved back to a more
normal pattern. However, the mirror image is also possible – if management is not
able to make disposals to a level whereby net debt reduces and/or profits take a
further hit due to either over-optimistic management expectations or a worsened
macro situation, then we could easily expect another ‘run’ on Kier’s WC, which
would reduce the scope for cash-backed profits. We believe it prudent here to
assume:
● Maintenance of status quo on receivables at 65 days, assuming management

transacts its strategic plans, and supply chain therefore does not react any
further.
● We take the conservative view that all contracts move to 30 days payment. This
is in keeping with analysis we have done for the whole contracting sector
(“Working capital: work in progress”, May 2019), which we point out is a very
dramatic view of likely industry trends, but something we believe merits inclusion
into a conservative model. Given the starting point and outflow to date, on the
analysis we have outlined previously, we would expect WC outflow on payables
to be c.£40m from here, but that the impact of this will take place over a number
of years, as this is industry standardisation of terms, rather than a Kier-specific
issue.
● While clearly Kier’s Regional Building model implies that supply chain finance
can a very useful tool given the high incidence of very small subcontractors, this
needs to be considered against the backdrop of investor scepticism and
reluctance from Central Government to use this in the wake of abuse of the
mechanism by Carillion. We therefore believe it prudent to assume that the Lier
Early Payment Scheme (KEPS) is removed over a period of time, or at the very
least scaled down to a much smaller offering. Assuming sale of Residential
would remove the use of facility by c.25%, then exiting the process would imply
c.£40m of net debt moving back on to the balance sheet, but that this would take
place over a period of time and be wound down rather than immediately closed.
At the time of the rights issue and subsequently, Kier management has indicated that
average daily net debt is c.£90m higher than average monthly net debt. This is the most
pronounced divergence in daily vs. monthly in the sector – others would point to a c.£5-
10m differential, and Morgan Sindall is the only company that provides average daily net
cash on a consistent basis. We have previously outlined that the early payment facility
at Kier is the key reason why daily and monthly net debt are so different, and therefore,
in our view, exiting this facility removes this as an issue and we would continue to look
at Kier on a monthly basis, as we do for most of its peers and not look to adjust for the
daily net debt position.
Overall, therefore, our assumptions as set out below on WC, imply a continuation of
industry trends, rather than a further lurch down in confidence in Kier. If the latter were
the case, spiralling WC and net debt would increase the risk of a debt-equity solution for
the group.
Based on our analysis above, the table below outlines Numis sensitivity analysis of
average monthly net debt out to 2022. This is based on the discussion of key drivers
above, and we would stress that we have taken the lowest assumptions in each case,
as we believe that prudence is clearly the major factor at this time. This is our ‘Total -
Normalised case’ column below:
22
Table 15: Kier Group average monthly normalised net debt progression
2020 2021 2022 Total - Normalised case Bull case
Opening average monthly net debt (422) (271) (126) (422) (422)
Disposals
Kier Living 50 50 100 120
Property:
Cash release 50 34 84 84
Disposals 30 45 75 100
Total disposals 130 129 0 259 304
Net income (normalised) 65 65 65 195 230

Pension costs (24) (19) (49) (92) (92)
WC (10) (20) (10) (40) 60
Early payment closure (10) (10) (20) (40) (40)
Total op cash flow 21 16 (14) 23 158
Closing average monthly net debt (271) (126) (140) (140) 40

ND:EBITDA 2.6x 1.2x 1.3x 1.3x (0.4)x
● Management has suggested that the sale process on Kier Living could take
around 6 months, so should happen in the current year. The £100m proceeds
are discussed above.
● We would expect that, in 2020, the most likely driver of cash from Kier Property
will be cash release from reduced capital employed and assume over the next
two years that the business will be sold outright.
● In terms of net income as a cash inflow, we use assumed normalised figures, as

outlined earlier in this document.
● Pension costs are averaged across Kier financial years, so the largest
component of increase would take place in the year to June 2022E.
● We believe that Government pressure to reduce payment days will also lead to
pressure on the Early Payment process and assume here it is closed down. In
both cases, however, we do not see a dramatic shift in payment terms, rather a
progressive move. As we have outlined above, however, this argument is
predicated on the fact that there is no further lurch down in confidence in Kier
from the supply chain.
On this basis, we argue here that, in 2020E, we could see Kier’s average monthly net
debt move down from the £422m opening level on NSe to c.£270m, and in the following
year this could reduce to c.£125m. This would suggest net debt:EBITDA on normalised
numbers moving down to 2.6x in 2020E and 1.2x from 2021E. Our analysis implies that,
in 2022E, we see an increase in net debt due to the higher pension payments, but
outline above that this could be subject to discussion between management and
trustees. We would make the following points with regard to the progression of net debt
reduction:
● While net debt:EBITDA of 2.6x would still be high in comparison to the industry, the
reduced level of net debt would be seen as a major factor in reducing concern about
Kier, which we believe is the key at this point. We would also point out that
covenants are set on period end and not average debt, which we would expect to be
considerably lower than the average figure.
23
● We do not put much store in period end net debt in the construction industry, given
that it is effectively a one-day figure, but we do believe that Kier moving back to
period end net cash is a factor that would demonstrate progress from the current
situation. Based on the figures above, if Kier were to transact the sale of Kier Living
at c.£100m and we saw the operating cash flows we outline above, this would
translate into Kier ending 2020E with period end net cash of c.£40m vs. current net
debt assumption of £85m and be an important milestone in rebuilding confidence
within the group.
We believe it prudent to assume the most conservative expectations of debt reduction

drivers at present, but there is upside potential in terms of possible debt reduction,
which in the table above we outline as our ‘Bull case’:
● If Kier Living and Property were sold at book value, this would add £55m (£20m
+ £25m respectively) to disposal proceeds vs. the table above.
● We outlined above that lack of confidence from the supply chain has led to a
£97m outflow in receivables. Clearly, if this situation reversed, we believe it likely
that this situation could reverse, albeit likely to take some time to achieve.
● Our normalised figure only assumes £20m benefits from the FPK programme, as
we believe management needs to provide more detail on where the major
benefits will be attained. Management has guided to “sustainable cost savings of
c.£55m from FY 2021” in the update on 17th June, and clearly if these are
tangible and net savings, this could add £35m to our cash flow figure, though the
benefit of this is mostly expected toward the back end of the period analysed.
If all of these were attained, this would add £187m to cash inflow and effectively leave
Kier in a zero net debt position by end 2022E. Given the uncertain outlook, we believe
taking the most conservative approach as our central case is sensible, but do allude to
ramifications if debt were reduced by this quantum in the valuation section of this
document.
Conclusion: material debt In conclusion, our analysis suggests that Kier will not get into an average net cash
reduction is attainable position, even with disposal and cash flow benefits by 2022E on our normalised
analysis. However, there are meaningful actions that can materially reduce the debt
profile. This is crucial, as we see supply chain confidence as the key risk to the
company from here, irrespective of the bank facilities that the company has. Actions to
stabilise outflows and reduce net debt should therefore be key aspects of strategy and
we do not believe that Kier has the luxury of time in this regard.
24
Valuation
Ahead of outlining our approach, the table below illustrates short-term valuation metrics
for our Building and Facility Services universe:
Table 16: Building & Facility Services annualised fundamental valuations, 2018-
202E
P/E Yield
2018A 2019E 2020E 2018A 2019E 2020E
Balfour Beatty* 7.5 8.5 7.7 2.4 2.9 3.6
Costain 4.1 5.4 4.7 10.0 7.6 8.6
Keller 8.2 7.2 6.9 5.5 5.8 6.0
Kier* 1.0 1.2 1.0 47.4 3.1 0.0
Morgan Sindall* 7.3 7.3 6.5 4.8 5.1 5.5
Nexus* 6.5 8.5 6.1 5.4 4.0 5.7
Renew* 10.5 9.6 9.0 2.7 3.0 3.3
Average 6.4 6.8 6.0 11.2 4.5 4.7

* Numis acts as broker to this company
The sector has been out of favour for some time, but 2019 to date has seen further
underperformance, which we would put down to two factors:
● Macro. The recent Construction PMI survey showed a sharp fall-off in confidence
and a key aspect of this, and other commentary in the sector, has been that private
sector malaise plus central government uncertainty is shifting infrastructure projects
to the right, while commercial sector activity is also suffering. The news on review of
HS2 being under review, for example, is a good illustration of this.
● Micro. In the first half of 2019, we have not only seen Interserve move into
administration, due mostly to construction overruns on Energy for Waste projects
and the issues at Kier we outline here, but the shock profit warning at Costain in
June – generally regarded as a company that had escaped the unpredictability of
construction profitability – was a major blow to investor perception of the industry.
The table above illustrates that, as a result of this, 2020E P/Es of 5-9x and yields of 3-
8% are a feature of the industry. Clearly, we put little store in Kier’s short-term valuation
metrics as a fair reflection of value.
We have traditionally used a sum-of-the-parts approach to Kier due to the differential

valuation techniques required for asset-intensive vs. service-based companies.
However, clearly our thesis here is that the refocus of the group back into services will
create a much simpler business and this should also be the case with reference to
valuation. The approach we have taken is outlined below:
● Assign a range of P/E values to the normalised approach to the company as set out
above. As we split out net debt as a key variable, this effectively equates to NOPAT.
On normalised EBIT of c.£86m and tax charge of 18%, this implies net income of
£70m. Hence putting this on 10x we would get a figure of £704m; discounting this
out to 2022E would imply a NPV of £548m at 8% discount rate.
25
Table 17: Discounted Normalised Services value, 2022E

4.0x 6.0x 8.0x 10.0x
Value (£m) at P/E 282 422 563 704
8.0% 219 329 438 548
10.0% 205 308 410 513
12.5% 189 283 377 471
● Adjust valuation to take account of enterprise adjustments:
● Average monthly net debt. We have outlined in this document that we believe
period end net debt has little relevance to the investment community and
increasingly the industry supply chain. Our assumption above is that by end
2022E average monthly net debt could be c.£140m
● Discounted pension liability. IAS19 Pension deficit has little bearing on the
underlying state of the pension situation and, in our view, using this as an
enterprise adjustment would understate the actual underlying situation – for
example, at end December 2018 the net IAS19 pension liability was £(13.7)m.
We therefore believe the best indicator of true cost is to look at expected
additional cash flow payments and apply a discount rate that best reflects WACC
to provide present value. As we have outlined above, the total cost of agreed
additional pension cots contributions is some £146.5m to end 2022E. While the
actual cash cost of servicing the pension deficit is included in our net debt
calculation, so it could be argued this is double counting; we believe Kier’s
pension deficit needs to be included in some form and see DCF of cash
contributions as the most sensible– and conservative – way to put a value on
this.
● We expect that the normalised figure we outline here will take several years to
achieve and therefore we also weighted our enterprise adjustments by the same
discount rate sensitivity based on 2022E attainment.
Table 18: Discounted enterprise adjustments, 2022E

(£m)
Average monthly net debt (140)
Pension additional contributions (147)
Total enterprise adjustments (287)
Enterprise adjustments % discount rate: 8.0% (223)
10.0% (209)
12.5% (192)
The table below outlines the conclusions of the two parts of the valuation, in terms of
potential value per share at current diluted total number of shares. The implication is
that valuing normalised NOPAT at 4x suggests a negative value on the shares at any of
the discount rates chosen. At the other extreme, valuing the business at 10x and
assuming the WACC moves back to a discount rate in line with sector average of c.8%
puts a valuation of 200p on the shares.
Table 19: Share price sensitivity, services valuation vs. enterprise adjustments,
current value
P/E/Discount rate 4.0x 6.0x 8.0x 10.0x
8.0% -2p 65p 133p 200p
10.0% -2p 61p 124p 188p
12.5% -2p 56p 114p 172p
26
In practice, we believe that, if management can achieve the normalisation of the group
we outline in this document, the shaded area is probably the most likely outcome on our
conservative net debt reduction target. It is clearly hard to be too exact on this, but if we
take an average of the shaded area above, we would get a figure of 150p/share. If we
assume this is our revised target price, we would make the following points:
● Prior to putting Kier under review, Numis target price on Kier was 606p, as outlined
in our post-rights document (Redressing the balance, December 2019). The key
differences are:
● Normalising Construction and Services EBIT plus central costs and tax in this
approach assumes £70m of net income, and compares with the £103m
previously annualised 2019E net income we used in our previous SOTP. This
lower figure reflects the profit warning in 2019E and a need to assume prudence
given the more uncertain industry and Kier-specific backdrop.
● We assigned a valuation of asset-intensive businesses (Housing, Property, PFI

equity) of 1.14x on net assets of £370m. We assume a value of £259m attained
on these assets in our analysis here, with proceeds used to reduce net debt.
● Enterprise adjustment at the time were some £416m, comprising post rights net
debt of £270m, pension deficit of £111m and JV recourse debt of £35m. Our
revised enterprise adjustments are some £287m – average monthly net debt of
£140m (£422m starting point pre assumed disposals) and pension deficit of
£147m based on cash payments out to 2022E. As we assume JV net debt goes
with disposal of asset-intensive businesses, there should be no JV recourse net
debt adjustment required.
Our revised target price implies 92% upside to the current share price, which of course
also reflects the risk/reward position of Kier at the present time. However, we have also
outlined above that we believe our net debt reduction assumptions are prudent, but
could look to be conservative on the basis that confidence in the group is rekindled
through enactment of the Strategic Review. It is clearly too early to assume this is the
case, but food for thought is that re-running the model assuming zero net debt by 2022E
and all other assumptions as before would imply the following matrix:
Table 20: Share price sensitivity to P/E and discount rate assuming zero net debt
by 2022E – bull case
Discount rate/P/E 4.0x 6.0x 8.0x 10.0x
8.0% 84p 152p 219p 287p
10.0% 79p 142p 205p 269p
12.5% 72p 130p 189p 247p
On the same basis as above, the ability to increase target price up to 230p/share (as the
average of the top and bottom share price in the shaded area) would be sensible if
management can get to zero average net debt by 2022E, but a price approaching 300p
would be achievable on this basis.
27
Risks
● Operationally, Kier has a mix of end user clients focussed into the Central and Local
Government and private sector. While we believe that many of Kier’s operations
have low exposure to the most vulnerable areas of the build economy to current
macro conditions, there are clear risks relating to wider GDP concerns due to the
current malaise relating to Brexit and international issues.
● We have outlined in this document that a major feature of the working capital outflow
issues we have seen at Kier year to date have related to lack of confidence from the
supply chain in the business. This illustrates the fragile nature of the construction
environment at present. We believe, as we outline in this document, that Kier is now
at a crossroads – any further reduction in confidence could lead to further supply
chain tightening, so what while net debt facilities remain materially above debt
expectations, banks may start to consider debt/equity solutions to the debt issue.
However, stabilising and then reducing the net debt situation would have the
opposite effect and lead to a re-rating. This document assumes the latter rather than
the former, but we would stress that attaining a meaningful decline in net debt will
still take some time and that the confidence issue in Kier will be very prone to
management actions.
● Our SOTP is based on peer analysis and normalised forecasts, and clearly if we did
see any detrimental move in either, this could impact the target price we have
outlined here. Moreover, it is early days for new management and we believe
actions to date and the strategic initiatives are encouraging, but Kier is in a
precarious situation at present and management needs to be aware that the
company needs decisive and speedy action to shift the group back to a situation
where comparison with peers is meaningful.
28
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Unless otherwise clearly specified in this document, the author(s) of this document Buy 1600
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200
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Building & Construction

For FCA purposes this is a Marketing Communication

BUY A question of self help and confidence

Year to Revenue Op Profit EPS DPS Net Cash / PE Divi Yield

Financials Div Cover (x) 1.53 1.64 12.7

Strategic focus – back to basics __________________________________________ 7

● Continuing activities and current trading ______________________________ 7

● Normalisation – the future shape of Kier _____________________________ 10

Net debt – the root of the issue __________________________________________ 12

● Debt reduction: Scope for disposals ________________________________ 16

● Debt reduction: operational cash flows ______________________________ 19

Figure 1: Average monthly net debt movements, 2019E

Source: Numis Securities Research

Table 1: Kier Group average monthly normalised net debt progression

Net income (normalised) 65 65 65 195 230

Closing monthly average net debt (271) (126) (140) (140) 40

Table 2: Kier normalised EBIT, continuing operations

Developments & Housing:

Central costs (25)

In this scenario, discounted sum-of-the-parts implies a short-term target price of

Strategic focus – back to basics

Table 3: Kier divisional profile, 2018

Developments & Housing

Central costs (35.1)

Continuing activities and current trading

● Focus the company on Regional Building, Infrastructure, Utilities and Highways. In

Developments & Housing

Central costs (35.1)

excess of £185m to smallest at c£10m and average is c£65m. In terms of split in

Table 5: Kier Highways England contracts

● March. While maintaining underlying FY 2019 expectations, management pointed to

● June. Volume pressures in Highways, Utilities and Housing Maintenance, coupled

Normalisation – the future shape of Kier

Table 6: Kier normalised EBIT, continuing operations

Developments & Housing:

Central costs (25)

● Construction. Aggregating the Construction businesses (i.e. Regional Building,

● Services. We contend that EBIT margins in Kier’s services operations – Highways

● Central costs. The ‘Future Proofing Kier’ programme started by previous

EBIT margin (%)

Construction EBIT Services EBIT

Source: Company & Numis Securities Research

Net debt – the root of the issue

Table 7: Average and period end net debt expectations, 2018-19E

● £26m net WIP due to delay in residential site completions.

Table 8: Financial impact of June profit warning

41 days (vs. 57 days in H1 2019) and we believe receivables have improved

Figure 3: Average monthly net debt movements, 2019E

Source: Numis Securities Research

● Management issues/actions. The reclassification of JV debt can only be regarded as

● Receivable days moved from 56 days in June 2018 to 65 days at December

Trade payables (ex Supply chain finance) (435.7) (978.8)

Working capital total (323.8) (95.1)

● Majority of private placement debt (USPP plus Schuldschein) matures between

Table 11: Kier Group banking facilities

● Positive outcome: Management enabling greater confidence in the business through

Debt reduction: Scope for disposals

Table 12: Kier Living financial metrics, 2014-18

Total Revenue 233 257 353 376 374

Total EBIT 7.7 11.2 20.3 22.8 25.9

Total EBIT margin 3.3% 4.4% 5.7% 6.1% 6.9%

● On commencement of sales process, Kier “has received significant interest” in Kier

14.0% 1.7 CSP