Carillion shake-up raises big questions

As a rebuilding exercise, it's a colossal job, and Carillion remains one of the most shorted stocks in town. The construction basket case has just firmed up another clearout and settled on a team it thinks is up to the job, but is it enough to repair the investment case?

Carillion announced Monday it has sent a number of key execs packing. Richard Howson – replaced as CEO by Keith Cochrane, but brought back as chief operating officer - finally gets his marching orders. Finance director Zafar Khan is replaced by Emma Mercer from the UK construction business, and Andy Jones from the Canada unit is COO.

Adam Green and Nigel Taylor, who run Carillion's construction and services divisions respectively, leave on 30 September, while group strategy director Shaun Carter is out by the end of the year. Lee Watson is parachuted in from consultancy EY, which has already kicked off a strategic review, to head the transformation.

Many had been screaming for change, essential for a credible re-capitalisation and turnaround. However, broker UBS questions the logic behind these appointments. "The timing [ahead of first-half results on 29 September] is somewhat odd," says analyst Gregor Kuglitsch.

Carillion's share price crashed by three-quarters following a widely anticipated profits warning in July, announcing that full-year revenue would be lower than previous guidance due to "difficult markets". There would be £845 million of project writedowns and profits would miss forecasts. The dividend was axed, net debt continues to rise and it's exiting a number of territories.

Pessimistic hedge funds that had taken bets against the company rejoiced. However, we're told the firm is still winning contracts – it's won two Hestia contracts, which will see it soft facilities management for the Defence Infrastructure Organisation for five years, and a pair of HS2 deals since the warning.

Worth around £1.5 billion in total between the joint venture partners, Liberum's Joe Brent says they "provide more evidence that the government generally remains supportive", with more positive contract news expected over the summer.

But none of this is good enough to stop the share price sink as much as 7.5% Monday to a low of 40.54p, a fraction above the all-time low 40.15p struck three weeks ago. Clearly, investors remain sceptical.

It's the construction business that's taken much of the blame for Carillion's demise, so management changes at the support services division will raise questions. It was initially suggested a review by KPMG found no issues here. It would be a big worry if that were not the case.

"We believe that the value to equity holders now mainly depends on whether the support services business also has problems or not," explained Kuglitsch.

His base case assumes margins in support services decline to 6% from 6.7% in 2016, and construction margin excluding Middle East at 2% with Middle East at 3%. This explains the price target of 47p. But there is still significant risk here, and investors are waiting and watching.

Should UBS's downside case become a reality – services margin of 5% and lower construction margin – there would be no value for equity holders versus the £200 million market cap. A painful rights issue, takeover or bankruptcy all remain possible.

"The outcome for shareholders from a restructuring and recapitalisation exercise is highly uncertain," says the UBS man. We'll know more in 18 days' time.

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.