Shares in Eddie Stobart (LON:ESL) were suspended today as the company issued one of the worst profit warnings an investor may face: the dreaded accounting regularities excuse. The CEO has left, the effect on profits is not known but is almost certainly significant, and the dividend looks set to go.
The trading suspension simply crystallises the share price at present:
When the share is re-admitted to trading I would envisage the damage to be quite harsh depending on what is said. Any good-will generated by the board is likely to be gone despite the top man walking the plank, and the issues could mean these shares are suspended a long time.
Like a few other firms with accounting regularities there is often not much warning beforehand. Stobart was a well-regarded firm, founded by a spin-off of the logistics arm of Stobart Group (which is also listed, but a separate company, but holds a minority stake in ESL). The shares were re-listed in 2017 but overall have been a poor investment for investors, not including today.
The logistics side of the business is large, and revenues have increased rapidly since the demerger. It specialises in rail freight and road freight, with distinctive branding. The business was performing well on paper, with a captive market and steady margins – but as of today’s warning, we can’t be sure if this is trustworthy.
Comes in an RNS which details the bad news. The CEO steps down, or is rather pushed, notably no thanks are due. The killer line is as such:
As part of the Group’s review carried out in conjunction with the Group’s auditors in relation to the interim results, the Board is applying a more prudent approach to revenue recognition, re-assessing the recoverability of certain receivables, as well as considering the appropriateness of certain provisions. While revenue expectations for the first half are broadly in line with previous guidance, the full impact of these items on Adjusted EBIT is unclear, but it is likely to be significantly lower than anticipated at the time of the Half Year Trading Update on 9 July 2019. As a result, the Board also intends to review the Group’s current dividend policy.
This potentially hits the balance sheet in several places, and it is certain that any write-downs will be affecting the results hard.
Pending clarification of the impact of these items, the Group has applied to suspend trading of the Company’s ordinary shares on AIM, which will be effective from 7.30 a.m. today. The Group previously announced that the Company would release its interim results for the six months to 31 May 2019 on 29 August 2019. However, the ongoing review will result in a delay to the publication of the Group’s interim results, and it is now anticipated that the Group will release its interim results in early September.
The last bit does not sound too bad: the delays are anticipated to be around a week. Other accounting mishaps have required longer, for example Goals Soccer Centres or Patisserie Valerie. However, the bad news is that these things are rarely harmless things and the longevity of the whole operation is at risk.
It may be prudent to dive into some of the parts of the business that the profit warning describes. Revenues have been increasing very quickly over the years. In 2014, turnover was £346m, in 2018 this had gone to £843m. More impressively, a recent brokers note (available on Research Tree) projected this to beat the £1bn mark this year.
One of the surprises is that despite turnover increasing heavily, cash did not follow:
Over the last 5 years the accounts receivable balance has increased steadily, to be sure not a warning sign on its own in an expanding company, but it does seem from todays announcement that some of this may not be recoverable. Writing these off would have an impact on profit, so we can see why it may not be done as bonuses were contingent on earnings.
Provisions are a more tricky aspect. The annual report suggests these may be used for items such as legal disputes, but also onerous leases and contracts and restructuring costs. A revision would certainly be in a downward direction, in that the provision would be increased to more accurately reflect potential future outgoings.
It is also worth looking at the financial status of the company. ESL has a net debt position, which to an extent leaves it at the mercy of lenders, who may not be as favourable to the company if the revised results leads to covenant breaches. The group have been acquisitive in the past year, and a good deal of intangible assets sit on their balance sheet. Net tangible asset value is positive to the tune of £97m, but this may change with adjustments.
Net debt stands at some £160m as of the last annual report. Almost £30m of this is on a revolving facility (of which there is still £55m headroom) and £124m in loans. Total finance expense was £6m, so in theory this does not seem an excessive debt burden, but there are sufficient unknowns in the revisions. A large net cash balance would give some confidence to ride these problems out, but without that we can’t be sure.
Accounting ‘misjudgements’ are pretty serious stuff, and investors have every right to be quite angry with management here, who are picking up handsome salaries for their troubles. Throwing straight dice is the least we should expect, and as with most errors I would think the motivations are to keep the charade going. Certain company structures do not help either, with lots of pressure on different people.
Even before today, this was a cheap share to purchase, and one of the biggest draws was the yield at over 5%. But this seems in doubt now. A further draw might come when the shares re-open trade as the slated book value of shares is 62p, although quite what the assets are worth going forward is up for discussion.
Brexit also potentially has a large impact, but Eddie Stobart are a large part of the logistics system with some well-established operations. Business is not going to disappear overnight.
Depending on the issues though, it could well be that private investors take the biggest hit. Coupled with a share price fall, potentially a huge rights issue could be required to sort the mess out. 1/5.