What to do with Carillion (CLLN)? On one hand, the bombed-out construction firm is touted as a takeover target, and the sale of its Canadian and UK Healthcare businesses is already underway. On the other, it has a mountain of debt and the chief executive admits any recovery could be five years in the making.
Investing in companies that have handed out profit warnings like confetti and clearly been mismanaged, requires a strong stomach. Fixing broken businesses takes skill, especially when the low-hanging fruit like ditching the dividend and job cuts have been picked.
However, the temptation is always to believe that the worst is over, and to fear missing out on the inevitable rally when it comes. Timing here is everything, and we’ve all been caught by the dead-cat bounce. Trick is to learn and accept the risks of this strategy.
Bottom-fishing with Carillion might have been a hugely profitable trade for some, but getting this one right required big cahunas and a huge dollop of luck. Buy the low at 40p and sell amid subsequent bid speculation at 67p – easy!
Few, if any, will have made it work quite that well. But what should investors still holding Carillion shares do? The price has dropped back to just below 48p, but seems in no hurry to revisit 40p.
However, Chris Moore, an analyst at Investec Securities, believes it will eventually, so has just cut his price target by 10p from 50p previously. Mind, that assumes a big fundraising at a 20% discount to the current share price. Without it, the valuation is just 30p.
Earnings per share estimates for both 2017 and 2018 are scaled down by 12% and 16% respectively, following recent first-half results and problems spreading to the support services division, explains Moore.
“At a minimum, Carillion needs to execute on its £300 million disposal plan and raise around £450 million of equity to repair the balance sheet, in our view,” he says. “However, this will be challenging given the current market cap of c.£215 million, and the risk of further write-downs, with gross receivables and payables c.40% above the sector average”.
Add the new £200 million provision against the support services operation to the £845 million against construction, announced in July, and Moore reckons gross receivables reach £1.2 billion. Payables are around £2 billion.
“This suggests a risk of further provisions, in our view.”
And then there’s debt. Average net debt will likely reach £1 billion in the second half given it was £694 million in the first six months and full-year guidance is for £825-£850 million.
Disposals would reduce average net debt/EBITDA (cash profit) for 2018 from 4.5 to 3.9 times, according to Investec. Get a £450 million equity issue away and that comes down to 1.4 times, within Carillion’s 1-1.5 times target.
On the broker’s estimates for 2017, Carillion trades on 10 times adjusted enterprise value/cash profit, a 14% premium to the sector. “Risk outweighs reward, in our view,” concludes Moore.
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.