Flowgroup (LSE: FLOW) is down 37% today at the time of writing: its latest trading update, which was released today, did not go down well with investors. This is unlikely to be an opportunity to buy is shares on the cheap, however — and here’s why.
What’s Going On?
The UK group, which develops and sells alternative energy products, announced today “a substantial reduction in the expected number of boiler installations in 2015“.
“The European Court of Justice ruled on 4 June that the UK’s reduced 5% rate of VAT on energy-saving products is in breach of EU laws,” it said, adding that it is accelerating “its cost reduction programme for the Flow boiler to offset these costs, with VAT now expected to be applied on these products at the usual 20% rate“.
That’s a terrible blow for shareholders, whose holdings — after a terrific +170% performance in 2014 — had already been hammered in 2015 before today’s news.
Blame The Government
“While the UK Government has yet to clarify the ongoing position, (…) the company has decided to take the prudent step to focus the Flow Products business on its cost reduction programme, (…) ensuring that customers remain unaffected by any potential increase in VAT and maintaining the long term viability of the ‘Boiler that pays for itself’ model.“
However, a substantial reduction in boiler installations will determine a plunge in revenues, with the inevitable results that financial targets won’t be met.
What’s Next?
The reduced VAT rate “was a UK government initiative to encourage energy efficiency and to meet energy reduction targets under the UK’s Green Deal” and applied to micro-generation products such as the Flow boiler, Flowgroup said, but it’s unclear whether the government remains committed to providing incentives to encourage the adoption of similar products.
So far the government “has said that it will study the judgement carefully and consider the next steps,” yet the problem is that Flowgroup now has to forgo its ambitious plans, which until yesterday suggested it would be “net cash flow generative by Q4 2015 and profitable by Q1 2016“.
Tony Stiff, chief executive, said that the group now has “to wait to see how the government will interpret this and how they will react,” also noting that the long-term expectation of a “successful roll out of our technology remains unchanged,” but it is clear “that launching during a time when consumers might have to pay over £500 more for the Flow boiler and see installation costs rise by 15% would be inconsistent with our initial roll out plans.“
Financials
Before today, Flowgroup had already lost 44% of value in 2015, and recent results reinforced the view that too much risk surrounds its business model. Its equity is now worth £77m.
Its operating loss in 2014 stood at £10m (2013: £7.7m), “reflecting infrastructure and resource costs to support business growth and commercialisation,” the group said on 4 June. Meanwhile, its cash position, as at 31 December 2014, was £8.4m (31 December 2013: £17.4m).
It’s likely that Flowgroup will need more equity to keep going and that’s one of the reasons why investor are selling off today. Another reason is that at 15.4p a share, where it currently trades, Flowgroup still looks expensive based on its net worth.