Shares in contractor Kier Group (LON:KIE) took a hammering today as the group announced a £25m hit to profit this year and also a strategic review. The share price decline was gentle at first but picked up in momentum as fear dominated. It is yet to be seen whether this drop goes any further:
The woes of many firms in the contracting industry are well-publicised and we don’t need to stray very far to see more profit warnings. There have been huge failures lately such as Carillion and even firms such as Galliford Try, Van Elle and to a lesser extent Keller have been affected. Some similar factors seem to be at play in all of them: big, complex contracts, the costs of which are agreed up front and things going wrong see large losses being incurred because of the expensive nature of the obligation.
Arguably, the market must have seen this coming. The share price for Kier Group was ove 500p in the middle of March, yet just over two months later the company has slipped to only a third of the price, with shareholders incurring hefty paper losses. There has been a recent shakeup at the top of the company with a new CEO and finance director, and a strategic review commenced in April. Perhaps like Royal Mail, this could be the case of a new leader getting all the bad news out of the way.
The warning arrives in an RNS which updates us on trading and the strategic update. We get to the point:
As highlighted in Kier’s FY2019 interim results, the Group continues to experience volume pressures within its Highways, Utilities and Housing Maintenance businesses. In addition, whilst continuing to perform well with double digit growth in its orderbook during FY2019, the Buildings business’ revenue growth for FY2019 will be lower than previously forecast.
Double-digit growth is good, but with the wafer-thin margins here may not translate into much.
Losses are quantified:
As a result, Kier now expects that FY2019 revenue will be broadly in line with the Group’s reported revenue for the 2018 financial year and currently expects that the Group’s underlying operating profit for FY2019 will be c. £25 million lower than previous expectations and that the Group is likely to report a net debt position as at 30 June 2019, which would have an adverse impact on its FY2019 average month-end net debt position.
The debt question is interesting, as in December the company raised £264m in a rights issue (in which the banks were the main losers, with only 38% of new shares taken up).
It also appears there will be more pain in the exceptional costs column and for some time as well:
The net costs associated with the FPK programme for FY2019 are now expected to be c. £15 million higher than previously forecast. In part, this reflects an acceleration of the programme following the appointment of Andrew Davies as Chief Executive. These net costs are in addition to the £25 million reduction in operating profit identified above. Kier will provide a further update on the FPK programme when it announces the conclusions of the strategic review.
Kier have a massive footprint across the UK, operating in the infrastructure as well as housing sectors. The last year was a bumper year for them, delivering great profits although there are plenty of adjustments to be had to the figures. The previous year saw businesses being closed and the current year saw an impairment charge against existing contracts similar to the type promised by the profit warning today.
Even at the higher prices the valuations had seemed cheap as the headline numbers are large, but as was the case with Carillion there is a lot going on in the accounts. Turnover has increased massively over the years here, but the company has been acquisitive so this can be understood.
As we can see from the segmental analysis, it is not really the case that one division is struggling but they are more exposed to both construction and services as opposed to property and residential developments. The geographical split also shows that virtually all their business comes from the UK, with a small slither from the Middle East.
The pension schemes here are interesting and quite costly, with Kier on the hook for some heavy payments in the future. However, the deficit here has been cleared and the fund is now in surplus, where it was a £120m liability in 2015.
Debt is less of a worry because of the recapitalisation recently. The last results showed borrowings of £500m, so debt is not totally eliminated, and it could be the case that the cash position also weakens as the end year prediction is net debt. Given the lack of success of the last rights issue and the declining share price it seems that this option is off the table for the near future if more money is needed.
There is a rather large intangibles balance on the balance sheet, giving rise to a negative tangible book value. Much of this is attributed to the services division, and its contract rights.
One comfort factor for investors was the dividend. This cost the company £66m in the last year and the projections are already for a savage cut to 15.7p a share on Stockopedia. Even at this level this equates to a near 10% yield and hence is a good candidate to be cut further.
Economies of scale often is cited as a benefit but for some of these contractors it is often a risk, as big projects going wrong often cost a significant amount of money. From Carillion it is certainly possible to see things unwind very quickly.
The market seems to be giving very little credence to Kier’s earnings. On a multiples basis, it would appear to be pricing it in for further trouble ahead as the market cap stands at £280m. One of the problems appear to be there will be many adjustments required to the figures, and this years troubles will add at least £40m to this. On top of pension, interest and dividend costs this is a test for the cashflow.
The bull case is that the rights issue recently means this is not another Carillion, and although net debt is a concern it is not the case where it is an immediate danger. If the company can rediscover its touch the share price is a bargain, with plenty of upside to the price. I don’t believe an increase will be immediate but paying down debt further will reinforce confidence.
The bear case is that the company is exposed to the UK and the macroeconomic winds are not that great. Additionally the company appears to be a favourite of shorters, so it very well could be some further problems will emerge in the strategic review. At a reduced level of profit there may be no room to make decent inroads into the debt.
Whilst I don’t think this is a complete basketcase I do believe a recovery here, if any, will be slow. 2/5.