Carillion plc slumps 35% on profit warning

Reporting its first-half results on Monday was support services company Carillion(LSE: CLLN). The company's share price moved as much as 35% lower after it announced three pieces of hugely significant news.

First, its performance in the half has been below expectations, and it is now expected to miss forecasts for the full year. Second, its dividend has been suspended for the current year as it seeks to improve its balance sheet strength. Third, its CEO has resigned and a search has begun for his replacement.

Difficult outlook

Clearly, three items of such magnitude are bound to cause investor sentiment to weaken to some extent. However, the scale of Carillion's stock price fall is vast, and could easily worsen over the short run as the market reacts to a different outlook for the business.

Part of the reason for the profit warning is the phasing of Public Private Partnerships (PPP) equity disposals, which have been delayed. The company has also experienced a deterioration of cash flows on a number of construction contracts. This has prompted a review of all of the company's contracts, with a provision of £845m being recorded as a result.

In turn, average net borrowing is now expected to be £695m, which is higher than forecast and up on last year's figure of £587m. This is a key reason for the company having suspended its dividend. It is seeking to save cash, with the lack of shareholder payout this year expected to save it around £80m. Alongside a comprehensive review of the business, this could leave it in a stronger position for the long term.

Growth potential

As well as disappointment in its update, Carillion also announced that it has made progress on its strategic objectives. For example, it has begun its cost reduction strategy and disposed of 50% of its interests in Oman. It has also delivered strong work-winning performance, with £2.6bn of new work secured in the first half of the current year.

Therefore, in the long run its performance could improve as there appears to be a strong underlying business on offer to investors. In the short run though, there could be further share price falls as a new CEO may seek to shift the company's focus and strategy. This could lead to further declines in investor sentiment in the short run, while an extension to the suspension of the company's dividend cannot be ruled out.

Therefore, buying Carillion now appears to be a risky move. However, it could also prove to be a profitable one if the business is able to turn its performance around. Given the action it has already taken, its management team seems to be taking a ruthless approach to improving the outlook for the company. Having now fallen by 50% since the start of the year, it could have significant upside potential in the long run.

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Peter Stephens owns shares of Carillion. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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