HS2 is not the disaster in waiting it is reported to be. If it goes ahead, opportunities lurk for investors

HS2 may turn out to be one of the most expensive white elephants never built, but let’s say it goes ahead. What companies will benefit? There is another question, is this project really the bad idea it is purported to be?

Article updated: 7 March 2019 9:00am Author: Michael Baxter

It is difficult to find people outside of the government or employees in the companies selected to work on HS2 who support the project. I would like to stick my neck out and give it a qualified yes.

Critics argue that the money would be better spent on something else — that government resources are strapped, why throw a reported £56 billion at a project no one wants?

Well, let me tell you, that is a false argument. The UK government can go out and borrow over a ten-year period for just 1.27 per cent. This is not a project that the tax payer will necessarily foot the bill for without a corresponding benefit. If HS2 boosts the UK economy by more than the cost of the project, plus the modest interest, then it is worth considering. If it boosts the UK economy by more than three times the cost plus interest, then the extra tax revenue that will result will pay for it.

Providing the macro economic benefit adds up, there is absolutely no reason why this has to be the only major infrastructure project.

Lousy infrastructure

And let’s face it, the word that describes infrastructure in the UK rhymes with frappe.

The UK suffers from awful productivity. Yet, for determining the strength of an economy, productivity is the most important metric. There is surely no mystery as to why. You only need to take the car for a saunter on the M25 to get the answer — I have driven along that dreadful road hundreds of times, yet I can count on the fingers of one hand how many times I have avoided a traffic jam.

The rail network is almost as bad — waiting for a train, the one announcement you keep hearing is “we are sorry for the delay.” Then, when you get on the train, you are lucky to get a seat, and if you do, a decent internet connection is as elusive as a mobile phone signal — a rare thing indeed.

We need more. More, more and more. We can’t have a bigger M25, it is eight lanes (that’s both sides combined) for most of the way as it is. We could build another eight lanes on stilts above it, we could have another eight lanes below it, underground — as Elon Musk wants to do in California. Neither idea strikes me as realistic. Or we can build a super fast railway.

Don’t get me wrong — we need more than just HS2 — and yes we need more transport links cutting across the country. A railway station in my home town would be nice too.

But the UK is in desperate need of more infrastructure and the nimby brigade have just got to accept this. The potential economic benefits of spending on infrastructure are enormous. The interest on money borrowed to fund such building would be relatively small.

Investors

As for companies: one firm that was awarded an HS2 contract was Carillion — whoops, having just come out in defence of the government, I guess the award to that now defunct company shows that incompetence is alive and well in government circles.

Balfour Beatty

One of the largest companies to pick up an HS2 contract is Balfour Beatty — market cap of around £2 billion, shares flattish over the last year and over the last five years. The company sold off a lot of assets last year. Under its newish boss, Leo Quinn, it has been paying down debt, solved a lot of the issues with old contracts, and has been picking up new business.

Projections for the year ahead are encouraging, then again, this may be reflected in a share price that does not have a trivial P/E ratio of around 12.

There are two caveats, but then they apply to all companies in this space — the ghost of Carillion serves as a reminder of how uncertain this business is. Banks, in part, spooked by the Carillion demise have not been so happy to lend in this area.

Costain

Another potential winner from HS2, assuming it goes ahead, is Costain. Last year, revenue fell, but thanks to improving profit margins, profits were up. Shares are down by around a fifth in the last year, but up by around a half over the last five years. Market cap is around half a billion, P/E is roughly 12.

There is an aspect of this company I like, it’s technology oriented. It focuses on so called smart infrastructure, a big chunk of staff work in either consultancy or technology roles. To a large extent, it seems to be doing the kind of things infrastructure companies should be doing in the midst of the fourth industrial revolution.

Kier Group

Kier Group — shares down by 40 per cent over the last year and less than a third of the level five years ago, has been a favourite of Neil Woodford.

Last year the company announced a rights issue — not exactly confidence building.

Last December its CEO, Haydn Mursell said: “There has been a recent change in sentiment from the credit markets towards the UK construction sector, with various lenders indicating that they will be reducing their exposure to the sector. This has led to lower confidence among other stakeholders and an increased focus on balance sheet strength. The Rights Issue is intended to address these issues.”

It is not hard to find reasons not to buy Kier, but maybe that makes it a buying opportunity, the P/E is around six.

To repeat, this is a tough market. Ten years ago, back in 2009, pundits were praising Kier with its strong cash position. The Telegraph’s Questor column had it as a buy. Well, the current share price is lower than the level in 2009 — and that illustrates the problem with this sector.


These views are those of the author alone and do not necessarily reflect the view of The Share Centre, its officers and employees

Michael Baxter portrait photo
Michael Baxter

Economics Commentator

Michael is an economics, investment and technology writer, known for his entertaining style. He has previously been a full-time investor, founder of a technology company which was floated on the NASDAQ, and a director of a PR company specialising in IT.

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