WYG On the Brink? Profit Warning and Missed Covenants Sends Shares Crashing

By | 13th February 2019

Management consultancy WYG (LON:WYG) today issued up one of the worst profit warnings this year, forecasting both lower targets and imminent missed covenants. And if this wasn’t bad enough, this was released during office hours at 2.30pm. The share price reaction was volatile, with the price dipping to 14p at one point. By the close it had recovered a little:

A market cap of just £13.2m indicates a massively bombed out business, although to be fair the decline has been on the cards for a while. WYG a couple of years ago enjoyed a share price of over 130p, but several subsequent profit warnings have seen the share price drop sharply, from which it has never really recovered. Today, however, marks a new low.

WYG is not a company familiar to many. They operate in the professional services field, operating a consultancy service across construction projects worldwide providing things such as supervision and project management. Thoughts of this bring up bad memories of Carillion, and there are some worrying similarities, such as extremely thin margins and project over-runs.

However, WYG would argue they are on a much smaller scale and as such do not touch the massive projects that can become real headaches, and have roughly a tenth of the turnover, have a truly global footprint, and also operate a modest debt level.

The Warning

Todays warning was poorly timed, at 2.30pm. There was no real reason why any of this could not have been written before business opened. In the trading update today, we see:

The Board expects revenue for the current year ending 31 March 2019 to be similar to the prior year and that revenue and net debt will be broadly in line with current market expectations. However, for the reasons explained below, we now expect a higher proportion of Group revenues to be generated from our International Development business. As a result, we now anticipate a second half operating profit performance which is below that achieved in the first half, implying an operating profit for the year as a whole which is materially below current market expectations.

In not so many words, the UK outlook is worse (without mentioning Brexit) and although order books are good for countries such as Turkey and Africa, it must follow that for operating profits to be worse, margins must be thinner. This is not really a surprise, as Keller struggled to make headway in territories far from home and this was the cause of a similar profit margin.

The worse part for investors was a warning about covenants:

As a result, we expect that we will not meet either of the net debt to EBITDA or interest cover covenants within our facility agreements for 31 March 2019 and we have opened discussions with our lending bank with a view to securing a deferral or waiver of the relevant covenant tests. We already have a number of clearly defined actions underway in order to materially reduce our net debt position. Subject to the timing of some larger trading receipts within our International Development business, we expect year end net debt to be in line with previous market expectations at around £10.0m.

The statement does not go on to share what these ‘clearly defined actions’ are.

The Business

As mentioned before, this isn’t a business to really excite investors, although it has to be said that doesn’t mean that they cannot become a good investment. TClarke (LON:CTO) is an example of a contractor who are managing to make great headway in terms of their share price. Business performance over the past couple of years really sums up the story:

A lot of work, for not much money, and although turnover has increased in a linear form, profits have not, and the previously mentioned profit warnings have really dragged it down. The debt position has also remarkably reversed from a heavy cash position to a net debt position, which of today is potentially distressed. The decrease in cash has also weakened the balance sheet, with only a very small net tangible asset value.

Stockopedia doesn’t think much of this share, and it is rated 45. WYG has paid a dividend since 2014 but in the last 3 years, it has in part had to borrow in order to finance this. It seems crazy to keep on paying this with the covenant troubles.

The troubles seemed to start a couple of years ago with delays to some projects causing profit forecasts to be slashed, only to be slashed even further with the addition of more contract delays and losses moving into 2018. The most recent broker update on Research Tree was bullish (but all of them are), including the following quote:

In our view, the rating is attractive on all key metrics – P/E 9.8x, EV/EBITDA 7.8x, yield 4.1%. Whilst market uncertainties remain, we take confidence from the strength of the order book and look forward to improving cash generation over coming periods, a clear management priority.

The big problem of the debt was not that easy to forsee. The latest report shows that the group have a £35m revolving credit facility with HSBC, so they are well inside that, and there was no mention of any covenants.

Comment

Notwithstanding the time of release, it goes without saying this is very bad news for holders. The most immediate question is will the banks relax or renegotiate the covenant? Coupled with the profit warning today, if net debt/EBITDA is not met now, it seems very unlikely it will do in the next year.

One obvious solution might be to reduce the debt, but that seems difficult, as cashflow would have been negative had loans not been taken out. A huge amount of money seems to be tied up in work in progress, which is not uncommon in this type of business, and releasing it may take some time.

My gut feeling is that they will manage to secure some sort of deal with the banks. The level of debt is not desperately bad, although they have gotten themselves into a sticky situation.

Going forward, there is little that generates much confidence. It is all very well reading about some of the fabulous projects they have carried out, but if there is little margins in it then from an investor view there will always be the risk of warnings such as this.

It may be that the company needs a huge overhaul, to concentrate in key territories, as geographically it is spread very thinly. But the omens I think are not good. The market cap is so low that someone may think of a takeover, but if WYG disappeared it would be no great disaster as the core competencies (the workers) would be picked up by competitors. 2/5.

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