Building suppliers aren’t popular with investors. Today, US housing market data revealed existing home prices fell by a record 9.5% in August. In Britain property sales are at their lowest for 50 years. Nevertheless, Tom Bulford says  Eleco (LON:ELCO) is a great contrarian play. The company has diverse profit stream from prison- and school-building programs, which should protect it from a recession.  With a P/E of over six and a yield of over 4%, Tom says this is a stock to watch.

John Ketteley is trying to get into prisons. He thinks there’s money in it. And what he told me made me think about a possible opportunity in the future.

OK, let me explain. Ketteley is not some arch villain on a crime spree. He is in fact the Executive Chairman and 13% shareholder of the building products group, Eleco (LON:ELCO). He reckons that the government’s increasing requirement to lock people up - which I somehow doubt will be reduced by the recession - will provide some work for his group.

The prison building programme, along with the planned construction of schools, nursing homes and ‘key worker accommodation’ is a natural target for the type of products in which Eleco specialises, products that make it easy to construct modular buildings using elements produced off-site. Principal amongst these are pre-cast concrete panels used for walls, rooms, barriers and sports stadium terracing produced by subsidiary Bell & Webster, which has just opened a new facility at Haveringham.

Work for the public sector should provide some defence against the slowdown of house building that affects 14% of Eleco’s turnover. Eleco has various subsidiaries including one called Gang-Nail systems that I seem to remember from my distant days as a building analyst used to be owned by Redland. The building products industry does not go in for fancy names and another Eleco subsidiary is called International Truss Systems - nothing surgical, just roof trusses supplied to the South African market.

The roof, as Ketteley pointed out, is the last part of the building to be completed. In other words it is the last part to be paid for, and Eleco has had a couple of ‘run-ins’ with its customers. But while the financial crisis is inevitably causing a few difficulties, Eleco is far better placed than most, partly because of its products, partly because it has read the cycle cleverly, but also because it has that one thing that we would all like right now - cash.

A recession-proof profit-stream

Aside from pre-cast concrete, roofing and cladding, timber frame and timber engineering systems, Eleco also owns companies involved in software for the building industry. There are different types of software. There is software used in architectural design, software used in cost estimating, software that maps and monitors the execution of a project, and software that essentially keeps a daily diary of the work on-site, something that can come in useful in the event of a dispute involving the client and contractors. Software contributes just over 10% of operating profits. But it should prove reasonably recession proof, especially as much of the turnover is outside the UK.

An interesting new service (that can be seen on the www.e-sign.com web-site) is made possible by visualisation software. This is used by building designers, as well as by Birmingham Council which used it to visualise the impact of shadows caused by new buildings. A new web-site, called Grand Designs, will be launched in October and this will enable the self-builder to design and visualise his own house.

Another interesting service allows you to download a photo of a room of your house and then edit in a choice of floors, thus allowing you to see what they would look like in your own home. This is already is use in Germany, where 80% of those that use the service go on to buy the flooring product.

So Eleco’s products appeal to modern designers and modern building techniques, and allow builders to meet the ever more stringent building regulations.

With a balance sheet like this, here’s one to watch

This is one of Eleco’s strengths, but perhaps the greatest at this point is the balance sheet. A former banker, Ketteley rescued Eleco in 1997 when it had a market capitalisation of £3m but borrowings of £7m. As he told me, ‘we don’t want to be in that position again.’

Today Eleco has a market cap of £46m and net cash of £6m as well as a £14m facility from Lloyds, arranged last year. This puts it in a great position to make acquisitions, but it also means that at a time when, for instance, the Olympics site is reviewing the credit worthiness of its suppliers, it can take business from others.

Broker Collins Stewart has raised its profit forecast for the year to June 2009 by £0.3m to and now forecasts earnings per share of 11.7p. The P/E ratio is little over six and the yield is over 4%.

Eleco is much better placed than most building products suppliers at this difficult stage of the cycle. That puts it on my list of shares that I’m not quite ready to buy yet… but which is certainly on my radar.

Source: The Attraction of Prisons