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Will the CIMIC Group Ltd share price go higher on its strong result?

CIMIC Group Ltd (ASX: CIM) provided a bright spot on our market this morning with the share price of the engineering and construction group jumping higher on the back of a solid first half profit result and bullish outlook even as the broader market slipped into the red with just about every sector losing ground.

The stock is up 2.4% to $39.27 in early trade as the S&P/ASX 200 (Index:^AXJO) (ASX:XJO) dropped 0.3% with most investors standing on the sideline ahead of next month’s reporting season. This just isn’t the time to be making big bets.

However, CIMIC gave investors reason to get excited after it reported a 28% uplift in revenue to $6.3 billion and a 22% increase in net profit to $323 million for the six months to 30 June 2017, and reiterated its full year net profit of between $640 million to $700 million. This would equate to a 10% to 21% improvement over the previous year.

The good result bodes well for CIMIC’s peers that are scheduled to post their results next month. This includes Downer EDI Limited (ASX: DOW), Monadelphous Group Limited (ASX: MND) and Worleyparsons Limited (ASX: WOR).

CIMIC delivered a great sales and profit result, but that’s probably not quite the thing that has gotten investors excited enough to push the stock to a near seven-year high this morning. Management also posted a sharp increase in earnings before interest, tax, depreciation and amortisation (EBITDA) cash conversion. This refers to how much cash the company received for every dollar of EBITDA that it is reporting.

For instance, if the company reported $10 in EBITDA and $10 in cash flow from operating activities, the conversion rate would be 100%.

CIMIC reported an EBITDA-to-cash conversion of 87% for the first half of FY17 compared to a mere 19% during the same period last year.

The cash conversion is one of the most important metrics to watch when it comes to listed engineering contractors and I would even rank its significance ahead of the top and bottom-line results. This is because of the accounting rules used by the sector, which allows them to recognise revenue from a project before getting paid.

What’s more, contractors can be hit with significant costs if projects do not go according to plan. Looking at the cash conversion over a reasonable period of time can often act as an early indicator of trouble that lies ahead.

Another thing that would please investors is the 25% increase to the group’s interim dividend of 60 cents a share, which reflects a reasonably conservative 60% payout ratio. CIMIC’s profits are skewed towards the second half, so the stock should generate a yield that’s a bit ahead of 3% – or around 4.3% if franking is included.

The outlook for CIMIC also appears strong with work in hand of $35.2 billon. This is equivalent to two years’ revenue for the group and is up $1.1 billion from the March quarter.

There are plenty of things to like about CIMIC’s result.

Pity about the price though as the stock is trading on an FY17 price-earnings of about 18 times. No doubt its FY18 P/E ratio will look better due to the expected growth in net profit, but I am loathed to pay much above 10 times for a listed contractor due to the lumpy nature of their earnings.

In fact the rule of thumb for engineering stocks is to buy on 8 and sell at 12. I might make exceptions if management has a long track record of delivering, but CIMIC doesn’t quite fit into this category, in my opinion.

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Motley Fool contributor Brendon Lau has no position in any stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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