Carillion crash delights short sellers

Pessimistic hedge fund managers celebrated Monday morning after construction mid-cap Carillion, one of the most shorted stock around with around 30% of its shares out on loan, announced the profits warning they had all been waiting for. It's cost the CEO his job and shareholders their income.

For shareholders, though, today's grim trading statement was painful reading, reflected in an initial 40% plunge in the share price to a 14-year low at just under 114p.

Carillion warned that revenue for the full year would be below previous guidance - at between £4.8 billion and £5 billion, rather than over £5 billion previously. It blamed the shortfall on "difficult markets and exits from certain territories".

First-half operating profit will also be lower than expectations as phasing of Public Private Partnerships (PPP) equity disposals would slip into the second half.

A review by finance director Zafar Khan found cashflows had deteriorated on a number of construction contracts. As a result, Carillion will write down £845 million of projects. That's around four years' worth of operating profit, according to broker UBS.

UK contracts account for £375 million of that - mainly three PPP projects - with the remaining £470 million in overseas markets including exits from the Middle East and Canada.

In future, Carillion will only choose construction work on a "highly selective basis and via lower-risk procurement routes". This "will clearly be negative for cash", warns broker Liberum.

In a further blow to shareholders, Carillion has axed dividend payments for 2017, saving the firm £80 million. That's no surprise. We've previously warned of Carillion's large - and growing - pension deficit and the risk to the dividend. There's no guarantee the payout will resume next year, either.

Such a fiasco has also cost chief executive Richard Howson his job. Keith Cochrane, the firm's senior independent non-executive director and ex-CEO at Weir, takes the reins until a permanent successor has been identified.

Rights issue alert

Well, they're not the first in the sector to warn, and data from EY suggests they won't be the last. According to the business consultancy's quarterly analysis of UK profit warnings, support services companies are by far the most prolific, topping the tables for the last seven quarters (to Q1 2017) - 95 in total.

Serial offenders include Balfour Beatty, Mitie, Capita and Serco. All bar the latter appear to have stemmed the tide and are looking upwards once again. However, this is a massive task for Carillion.

While UBS says it's "hard to see what can fix the balance sheet," Liberum doubts whether Carillion actually has sufficient funds to restructure.

"We have long argued that Carillion is running excessive risk with total net debt including pension of £1.4 billion," explains the broker. "While [a] dividend cut and asset sales are the first step, we struggle to see how they will be sufficient in reducing net debt."

Disposals of £125 million over the next 12 months will help, including the sale of half its interest in its Oman business for £12.8 million, and a restructure of the business should save some more money. However, Liberum thinks Carillion will need much more, raising the prospect of a painful rights issue.

Analyst Joe Brent slashes earnings per share (EPS) forecasts for 2017 by over a quarter, to 25.6p, and pencils in no dividend before 2019.

We'll get more detail on the planned restructuring at interim results in September.

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise.The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.