This week has seen up to 70% wiped off the value of Carillion shares following a profit warning on Monday.
This is much more than a blip in its fortunes. The results issued on Monday raise legitimate questions about how the firm is going to recover and the impact of its financial problems on the supply chain.
Let us not underestimate the colossal size of Carillion. It employs around 48,000 people everywhere from Canada to the UK to the Middle East. The firm describes itself as having roots in construction, but its employees now do everything from providing school dinners to building roads.
The current financial picture is bleak, brought about by a complex set of influences.
Shares fell from £1.92 on Friday afternoon, diving to a low of 51p on Wednesday. At the time of going to press, the value of the shares was starting to show a small recovery, however the length of time a substantial recovery will take will be of more concern to shareholders.
On Monday the firm issued full year guidance, warning “overall performance is expected to be below management’s previous expectations” and said it had brought in KPMG to try and sort out the problems.
Monday’s profit warning also included the news that chief executive Richard Howson has stepped down and Carillion is quitting some Middle East countries and scaling back construction contracts.
The company is also undertaking a “comprehensive review” of the business, which will see it exit from construction PPP projects, exit from the Middle East markets of Qatar, Saudi Arabia and Egypt and look at future construction contracts on a “highly selective” basis, preferring those which are done via low risk procurement. It is also selling half of its economic interest in its Oman business, Carillion Alawi, for £12.8M.
The first half year figures show revenue similar to last year at around £2.5bn.
The fundamental problem is the balance sheet. On Monday Carillion also announced an £845M writedown. Of this £375M relates to the UK, mainly due to three PPP projects. In addition, £470M relates to overseas markets – the majority of which are exiting markets in the Middle East and Canada. One of the PPP projects is reported be the Aberdeen Western Peripheral Route (AWPT).
Low construction margins are well documented, so when projects become financially tight, that not only hits a specific contract, but it can impact the whole division.
In the Middle East, low oil prices mean governments have less revenue, and therefore less money to spend on infrastructure.
The problems are not entirely unexpected, but the city admits it missed warning signs, particularly around the issue of receivables – the amount of money a firm is owed. JP Morgan analyst Samuel Bland said: “We missed two key considerations. Firstly, we did not appreciate fully the warning sign of receivables increasing sharply in H2 2016. Secondly, we did not give adequate consideration to Carillion’s high receivable balances relative to revenue vs peers.” Carillion’s 2016 annual report, for example, showed that amounts owed by customers on construction contracts had risen from £386.8M in 2015 to £614.5M in 2016. However, Monday was the strongest demonstration yet of the difficulties the firm is up against.
Another red flag has been that Carillion has reportedly been subject to short selling. This is where shares are ‘borrowed’ by sellers, who sell them on the assumption that the share price will fall. They then buy back the shares at the lower price, returning them to the lender, but pocketing the difference between sale and buy back price.
Faced with a complex financial picture, what does this mean for the industry?
Specialist Engineering Contractors’ (SEC) Group chief executive Rudi Klein said there is “real concern” in the supply chain about these latest results.
“All of a sudden you see how frail the balance sheet of these companies are, what you do then is you fear for the commercial safety of the industry. The bulk of Carillion’s work is done by the supply chain,” he said.
Klein said the concern also raised wider issues around the industry, and said it would like to see cash retentions placed into trusts and also the introduction of specific bank accounts for projects. Cash retentions are when sub-contractors have payments held back, to ensure they return to remedy any defects on the job. But SEC claims that in reality the system is used to bolster the cashflow of the party deducting it and there can be long delays in the money being released.
So what can Carillion do?
Some financial experts have said that they are expecting a rights issue from Carillion, meaning it will issue more shares. However, if the share price falls further, then if more shares are issued, the value of the shares currently held could be reduced.
Lansdown Hargreaves analyst Nick Hyett explained: “The main problem that lay behind the share price fall on Monday and is still the problem, is that the balance sheet looks extremely stretched. That implies that a rights issue is around the corner.
“As the share falls, obviously that rights issue becomes more painful, because let’s say that they are going to need to raise £500M to £600M, which is the number that’s being bandied around. That would mean that at the current share price issuing almost twice as many new shares as there are currently shares in issue. This dilutes existing shareholdings substantially. The problem with that is it looks like it is going to carry on falling. So if you’re a current shareholder you’ll say ‘well this looks very unpleasant I might as well get out now’, which means the share price carries on going down.”
Another option is a takeover, but who would be a willing suitor? It seems unlikely rivals such as Balfour Beatty and Kier would want to take on this problem, particularly in the case of Balfour Beatty when it has worked so hard to improve its own financial position.
“A combination of low sterling and a low share price might tempt an international buyer, be they a trade buyer or financial buyer, but if it was a trade buyer it would have to be someone with a fairly robust balance sheet in an industry where margins are pretty low,” said Hyett.
But there’s no easy answer. JP Morgan’s Bland said: “We struggle to see an elegant way out for Carillion.”
He said any rights issue would need to bring in £532M, and added he isn’t convinced the firm is a “feasible target” for a potential buyer, given the scale of risk and liabilities.
Carillion looks determined to fight back, this morning it said it had appointed HSBC as joint financial adviser. It won’t just be its shareholders wishing it a speedy recovery.