Over the past five years, security services firm G4S (LSE: GFS) has been rocked by a series of scandals. However, it now looks as if the group is beginning to regain the trust of customers and employees alike, but does this mean you should buy the shares?
Time to buy?
Since 2012, G4S has struggled. After reporting a small profit in 2012, it plunged to a £365m net loss in 2013. Profits recovered in 2014, before slumping again in 2015 by 95%.
After reporting net income of £198m for 2016 and £236m for 2017, City analysts are expecting the group to earn £293m for 2018. According to figures released by the firm today, for the first six months of 2018, it looks like G4S is well on the way to meeting the City’s growth projection.
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Profit before interest, tax and amortisation from its continuing businesses (after stripping out parts of the business earmarked for closure or lossmaking contracts) rose 5.9% to £235m. Revenue from continuing businesses ticked up 6.2% to £3.7bn. EPS rose 8% to 8.3p from 7.7p. Management is targeting medium-term annual EPS growth of between 4% to 6%.
I believe these numbers demonstrate that G4S is back on track. Earnings are growing, and the company’s bid pipeline is expanding. The pipeline totalled £7bn in annual contracts at the end of June.
Nonetheless, what concerns me is the group’s razor-thin operating profit margin of just 6.4%. Management is trying to improve margins with a £100m efficiency savings target by 2020, which is badly needed. On top of this, the firm has £1.6bn of net debt. Looking at the business’s cash flow figures, last year it was able to pay off £260m of debt on top of paying a 9.7p per share dividend (a yield of 3.4%), so it is heading in the right direction. That said, at 14 times forward earnings, shares in G4S look overpriced to me after taking into account the high level of debt and tight profit margins.
Buy the best
I like to invest in companies with fat profit margins and cash-rich balance sheets to protect against uncertainty. Neil Woodford’s favourite homebuilder Taylor Wimpey (LSE: TW) is an excellent example.
With an operating profit margin of 20% and just under £500m of net cash on the balance sheet, Taylor is one of the market’s most profitable companies, and its cash balance gives it protection against a housing market downturn.
The company has also earned itself a reputation as a dividend champion. For 2018, analysts have pencilled in a dividend of 15.4p per share, giving a yield of 8.8%. Next year, as the profits continue to roll in, Taylor is projected to distribute 17.7p per share, a 10.1% dividend yield.
And on top of this market-beating payout, the shares also trade at a highly attractive forward P/E of 8.1.
What’s not to like? Well, Taylor’s fortunes are dependent on the state of the UK housing market. Recently, cracks have been starting to show in the market, particularly in London, one of the group’s primary markets. Still, I believe a full-blown property crash is unlikely just yet. Banks remain happy to underwrite mortgages and the government’s help to buy scheme does not end until 2021. These tailwinds should support Taylor’s growth for the foreseeable future. That’s why I believe the homebuilder is a better buy than G4S.
