Interactive Investor

Edmond Jackson's Stockwatch: Is this cyclical trying to tell us something?

7th October 2014 11:35

Edmond Jackson from interactive investor

Has Management Consulting Group just signalled a drop in global corporate confidence with this shocker of a warning?

I've followed the company since it first listed in 1987 as Alexander Proudfoot and its volatile history makes it mainly useful as a leading indicator of wider corporate confidence. The group largely involves project work towards better productivity, so is sensitive to changes in outlook.

Consultancy is likely to get cut sooner in the face of a downturn than other areas of corporate investment, or employees. Partly for this reason the Proudfoot business declined in the 1990s amid recession, the name changing to Management Consulting Group in 2001 as it diversified. This continued for example with the 2007 acquisition of Kurt Salmon Inc., a consultancy specialising in global consumer goods, retail and US healthcare, and which merged in 2011 with a business that used to be Deloitte France's consulting division. All this enhances interest in the group as a litmus test of firms globally.

Management Consulting Group - financial summary
Consensus estimate
Year ended 1 Feb2009201020112012201320142015
Turnover (£m)276270303286257  
IFRS3 pre-tax proft (£m)6.314.323.214.714  
Normalised pre-tax profit (£m)22.716.923.319.415.416.319.6
Normalised earnings/share (p)5.43.13.73.12.122.3
Earnings/share growth rate (%)-35.3-43.421.5-17.7-32.6-3.415
Price/earnings multiple (x)    12.312.811.1
Cash flow per share (p)-6.72.15.40.50  
Capex per share (p)0.80.50.60.50.5  
Dividend per share (p)1.300.50.80.80.80.9
Yield (%)     3.23.33.4
Covered by earnings (x)4.207.343.62.42.7
Net tangible assets per share (p)-40-22.7-16.1-14.5-11.3  
Source: Company REFS.

Despite the end-July interims citing a healthy order book at Proudfoot, within two months the situation has changed to "very weak," making the group unlikely to meet profit forecasts (see table). What geographic areas are involved? The interim statement cited: "Alexander Proudfoot continues to operate very effectively in emerging market locations and in the first half of 2014 nearly 60% of total revenues related to work delivered outside North America and Western Europe (up from 50% in the first half of 2013)."

Dollar-denominated debt

Quite likely the rising US dollar is affecting developing countries' ability to service their dollar-denominated debt; a factor that caused New Year mayhem in stockmarkets and coincided with Proudfoot declaring a slow start to 2014.

Yet Europe and North America are implied too, considering a softening in the Kurt Salmon business and the group's revenue/profit breakdown. It doesn't disclose specific geographic revenues for each business, but we know Kurt Salmon is oriented to Europe and North America, and note 3 to the group interims cited Europe accounting for £64.6 million revenue versus £50.6 million for the Americas and £9.8 million "Rest of World" - although this was highest margin, contributing 23.6% of operating profit versus 46.9% from Europe and 29.5% Americas.

The latest update says regarding Kurt Salmon: "Order input and activity levels in France in the last two months were slightly weaker than expected, and the North American business has been affected by some project delays." The situation in France is understandable, but the US sounds uninspiring after quantitative easing (QE) was increased from $40 billion (£24.9 billion) a month to $85 billion from end-2012, scaled back this year.

Adopting a respectable face

Management is adopting a respectable face saying that while revenue and profit expectations are being reduced for 2014, encouraging order input and pipeline activity means "the medium-term outlook for the group remains positive." But the market isn't assured, marking the shares down 5p to 20p, a level not seen since early 2010.

The revelation connects with recent signs of weak global growth that have arrested stockmarkets. Any profit warnings have been excused as not reflecting the wider economy - e.g. UK supermarkets' price competition, Tate & Lyle and Next suffering from the weather. Perhaps it is wise to be cynical when different companies blame different weather.

This particular warning is significant for underlying confidence, with third-quarter US company results reporting soon. After a tough first quarter reflected the bad winter, the second quarter showed a strong rebound in revenues and profits - being a main driver of US equity prices during the summer. Much, however, depends on the profile of third-quarter results and, if Proudfoot is "the straw in the wind" like it usually is, then the outlook is mixed at best.

Be aware also of a positive sign how UK business investment is up; analysts at Citigroup estimate by 14.7% (like-for-like) in the second quarter of 2014, the fastest growth rate since 2007. Significantly this defines a more broad-based UK recovery than recent fears that it is too dependent on consumer spending linked to low-cost lending.

"Secular stagnation"

While this is reassuring for UK-oriented investors, mind how stockmarkets are liable to twitch on the global outlook - with the US setting any trend. It won't help if the balance of US third-quarter reporting turns mixed, just when the Federal Reserve's money printing programme is set to wind up. This would re-kindle controversy over how exceptional stimulus has mainly boosted asset values than provided a lasting effect to the real economy. It's a moment of truth for QE and markets will react badly if company reporting asserts "secular stagnation".

The situation also shows how stocks can get hit even when trading on apparently modest ratings. The price has just dropped 5p or 20% to about 20p despite an undemanding price/earnings multiple of about 12 times recently forecast earnings and a 3.3% prospective yield covered over twice by earnings - or so the consensus assumed. You can only dismiss this as another "special situation" warning on grounds the long-term track record of Proudfoot has involved nasty surprises, and the group's inherent volatility of fees doesn't marry well with the stockmarket.

It is 25.1% owned by BlueGem Capital Partners, a London-based private equity group which initially bought 17% in June 2010, so the future quite depends on what action they may take. I would not speculate on takeover prospects for a "people business", more likely BlueGem will have to buckle down and see this period through.

Only wider company reporting will prove how significant is this warning, but it's the first of several that perturbs me. So despite markets' rebounding after sharp falls last week, I would take care.

For more information see mcgplc.com.

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