News from Carillion(LSE: CLLN) today isn't good. The support services provider and construction contractor has delivered a third profit warning and reckons it would be on course to breach its banking covenants if the banks hadn't agreed to delay the tests. The shares were down more than 50% in early trading but have bounced back a little since - ouch!
Materially lower than market expectations
Is that it? They say profit warnings come in threes, so it's onwards and upwards all the way on flight Carillion, right? Well, I'm not piling in. Today's update adds further detail about the depth and breadth of the firm's problems, and it's not pretty.
The company operates in a difficult sector characterised by thin margins and complex, often bespoke contracts of work. Construction contractors and firms offering support services often mess up when tendering for contracts and the consequences can be dramatic. There's frequently little room for error, and in the case of Carillion, a gargantuan weight of debt threatens the continuing existence of the company.
Since July, Carillion says it has been focused on "reducing costs, collecting cash, executing its disposals programme and implementing its new operating mode" aimed at reducing the debt burden, but it will take too long. The directors reckon profits for the year to 31 December will be "materially lower than current market expectations," leading to a breach of banking covenants on 31 December 2017. Luckily the firm's principal lenders have agreed to defer the test date for its financial covenants from 31 December 2017 to 30 April 2018, by which time delayed revenue could come in.
Delays and slippages
The directors put today's profit warning down to delays of PPP disposals, slippage in the commencement date of a significant project in the Middle East and lower-than-expected margin improvements across a small number of UK Support Services contracts. Net borrowing during 2017 will now likely come in between £875m and 925m and the directors are in discussions with stakeholders "regarding a broad range of options to further reduce net debt and repair and strengthen the Group's balance sheet." The directors plan to announce the final form of recapitalisation during the first quarter of 2018.
So that's it. As a business, Carillion has failed. We want to see companies building up their assets and returning cash to shareholders, not using up cash and seeking more capital to survive. But in all fairness, the market is tough and many similar firms have trodden this path before Carillion. However, although it often provides services that enhance our lives, I don't think the business model forms a strong basis for investing.
Many aim to buy stocks when they are beaten down and on paper this one looks like a potential candidate for recovery. A new chief executive, Andrew Davies, is due to start on 2 April and that should coincide with the firm's refinancing. In theory, new management energy and a stronger financial base could propel operations forward and the stock up. Yet it will still be active in a challenging sector, so I'd rather take my chances by investing elsewhere.
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I reckon Carillion remains a dangerous proposition for investors and we should be selective about investments to help protect the downside risk in a portfolio.
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Kevin Godbold has no position in any of the shares mentioned. 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.