With the shares down around 70% since Carillion’s (LSE: CLLN) July train-crash trading statement, is now is the time to invest? I don’t think so because the weaknesses I identified in my last article about the firm two years ago are still true today. Let me explain.
Getting picky about construction work
One snippet stood out to me in the update. The support services provider and construction contractor said that from now onwards it would “only be undertaking future construction work on a highly selective basis and via lower-risk procurement routes.”
That looks like a good tactic because the construction business has always been fraught with uncertainties and big risks. So why hasn’t the firm been more careful in the past about what it took on? The usual way that companies commit to big contracts is via a tendering process, which involves upfront estimation of the labour and materials costs required to execute a contract of work. Get it wrong – which contracting firms often do – and the consequences can be dramatic.
Turning Carillion’s statement on its head suggests that the firm has hitherto been less selective about its construction contracts and that the procurement routes have been higher risk. Maybe that’s led to the company’s decision to exit from construction public-private partnership (PPP) projects and from construction markets in Qatar, Saudi Arabia and Egypt.
Cash flow down, debt up
Trading has been below the directors’ expectations, which they put down to deterioration in cash flows on construction contracts and a working capital outflow arising because of a higher-than-normal number of construction contracts completing without replacement contracts starting. The worrying outcome is that average net borrowing for the first half of the year has blown up to £695m from £586.5m at the end of 2016.
These figures for debt are huge compared to the £15m the company generated in operating cash flow last year, which explains why the directors are focusing on the problem. They plan disposals to exit non-core markets, which could raise around £125m over the next 12 months. Hopes also seem pinned on bearing down on costs and getting heavy on recovering receivables. But again, you’ve got to ask, why weren’t they keeping on top of those fundamentals anyway? The company’s shareholders will take up some of the slack because the 2017 dividend is toast, and that’ll save the firm around £80m.
Sick for some time
I thought two years ago that Carillion wouldn’t make a decent investment when I last looked at and wrote about the company. The firm has earned the dubious accolade of being the most shorted firm on the London stock exchange now and for some time.
Back in July 2015, I saw in Carillion a firm operating in the difficult support services and construction sector with low margins, struggling to make any progress on earnings growth. The share price had drifted sideways for years. I argued back then that its activities had a large element of inherent cyclicality and that “if the firm isn’t flying now when the economic sun is shining, when will it?”
Even as a recovery candidate I’m still not interested in Carillion because there are many better firms with better businesses listed on the London Stock Exchange.