Rather symptomatic of the market in the current state is the magnitude of punishments it is dishing out to even larger companies that give any cause for concern. The latest is Keller Group, who today reported that problems in the Asian Pacific would see that division turn a loss of c.£12-15m instead of a small profit: the market reaction was to mark their shares down 30% in early trading:
So, for the loss of around £20m (if it is a one-off), the value of the company has tumbled by over ten times that. Keller’s share price performance has mirrored that of many other firms this year: some modest increases until the past month where it has fallen pretty steadily. As late as August this was pushing for 1100p. Two months later and it today touched a five-year low. But it is fair to say there is a lot of fear in the markets at present.
A bit about the company. They describe themselves as a ‘geo-technical solutions specialist’. Their size is impressive, with operations all around the world. Between several divisions they specialise in piling, excavation, design and construction of ground solutions to allow further works to continue. Given that construction is on-going around the world, this doesn’t seem to be a bad business to be in.
That said, one of the pitfalls was shown up earlier this year by Carillion, who are no more. As contractors, they quoted priced too keenly, and had to take losses on some projects. Adding up some accounting discrepancies and large debts and it became a case where the banks were unwilling to fund them any more. So there is an understandable wariness about firms using these types of models.
Perhaps one of the worst times to release a warning was this morning. It reads:
Keller announces that, as a consequence of deteriorating ASEAN market conditions, notably in Malaysia, and the reassessment of project performance in ASEAN and Waterway as a result of recent changes of the management in those two business units, it is now expected that the APAC division will make a pre-tax loss of between £12m-£15m in the full year to 31 December 2018, in contrast to the previous expectation of a small profit.
It appears that the APAC division was something of a problem for Keller: the previous two years show similar losses. In fact, if the result here is as stated it would actually be an improvement on the previous year.
The warning signs off on a good note:
As a consequence the Group is undertaking a strategic review of the affected business units and will update the market in due course with the outcome of the review.
In all other respects, the Group’s trading results for the 2018 financial year remain in line with the Board’s expectations.
Keller’s recent performance has been good: they have booked several years of increasing turnover and more importantly, profits, leading to a very respectable Stockrank in the high nineties. They have a track record of paying dividends and these are well covered. Their projects tend to be large and complex, decreasing the potential competition.
There are plenty of expenses to be had in the business. Capital expenditures are unsurprisingly high due to the nature of works. On top of dividend payments this sees the company cash balances be fairly volatile, as cashflow doesn’t necessarily co-incide with the financial year.
One of the ways that the company has developed its worldwide footprint is the acquisition of smaller existing companies in other countries rather than to start afresh. The balance sheet shows £170m of intangibles, but there is a greater amount in property/plant/equipment. NTAV is positive here.
One worry is the debt pile. This has steadily increased over the years and there are two revolving credit facilities totalling $150m in the next year. However, there is still headroom (as the facility is $250m) and given overall the business appears to be in line with expectations there should not be a problem renewing, but with a net debt/EBITDA covenant of 3x, it would not take a massive downgrade in business for this to be failed.
One of the questions regarding the profit warning is, is it due to temporal or more fundamental factors? It seems obvious that Keller have put a lot of effort into the APAC region and have failed in the past few years. From the annual report:
There seems little explanation in the annual reports apart from a ‘very difficult pricing environment’. Perhaps because of the region, Keller might be at a disadvantage? If there is no improvement in that environment, it seems likely that the struggles will continue.
A strategic review gives the company a few options. One would be to withdraw from the APAC region altogether, or try to sift out the unprofitable segments, leaving only the profitable ones. However, this would not be a quick process and might see more losses while the position is exited.
It’s hard to know whether one would like to be part of this business. It is true that there are always projects won, and high-profile ones at that. Work is also very lucrative for those companies that can get it right. But it seems that these type of businesses have a bit of a soft underbelly: margins are not great (Keller’s operating margin has been averaging 5%) and unforeseen problems that crop up can cost the company massively, presumably because customers have signed a deal and expect to get what they paid for. For instance, the APAC division loss was mainly driven by two projects becoming adverse to the tune of £14m.
Given the size and scale of these projects, even a small problem that turns litigious can become quite a headache. I would be inclined to go 3/5; if the group can turn around Asia and improve the debt position they will be in a fairly decent position.