Making Sense of Carillion Interim Results

On Friday, Carillion has finally come clean (sort of) and reported an expected write-down of £1.2bn.

But, how should investors interpret this? Before the results were released, there was a rumour circulating around the company about a takeover from a Middle-Eastern suitor. Well, since the share price responded negatively we should take this with a grain of salt because even if a bid (i.e. £400m for Carillion) they will be responsible for Carillion’s debt and pension deficits.

 

INTERIM RESULTS

Before we begin, here’s the link to Carillion’s interim results.

 

Underlying Profits

Ignoring exceptional items, underlying profit is reduced by 27% to £82m and underlying pre-tax profit is down by 41% to £50m. That’s due to “the lower contribution to profit from PPP equity disposals and the impact of not recognising a margin on some £400m of revenue on contracts impacted by the exceptional contract provision.

If one looks at PPP, the underlying profits fell from £19.7m to £6.3m., while construction services (incl. Middle-East) dropped from £32.4m to £17.2m.

Exceptional write-downs

The contracts review saw Carillion wrote off £1.2bn. It is true these are non-cash charges. Although it speaks volume of the previous management wasting money on meaningless acquisitions. Also, it confirms what the market have long expected, that their construction contracts are priced too high. In my previous post, I pointed out their construction receivables rose from £190m to £614m, while revenue has been in terminal decline. That is why the market wrote off £1.4bn of Carillion’s market value!

Borrowings

The average net debt is £694m, but full-year average net borrowing is expected to be between £825m and £850m. Ignoring the cash balance, then I expect total borrowing comes to £1.24bn by year-end, up from £1bn in 2016.

I estimate normalised operating profits to be around £120m-£130m. Given the rise in total borrowings, then net interest costs could rise to £55m-£60m. This constraint the company from paying off their loans. 

 

Committed bank facilities

The Group has some £1.5bn of available funding. The debt due in 2018 comes to £83m, but they require a further £140m of term sheet loans meaning this short-term loans brings total maturity to £223m.

In 2019, loans maturity will rise to £281m.

Therefore, over £500m is due in one and a half years. However, a total of £835m of borrowings are due by 2020.

 

 

Foreign Exchange

Thanks to the weakness of Sterling it helped their Canadian and Middle-Eastern operations revenue by £91m, an amount which exceeds their underlying profits! However, they didn’t disclose any adversity that weak sterling may have on their UK operations.

 

Strategic reviews

Some positive news.

The company promised to bring in £300m proceeds from asset disposals by 2018. Also, they target £75m in cost-savings. The cost-savings should be ignored because this relates to a reduction in expenses from the sale of assets.

There is also a discussion for the possible sale of their Canadian operations and UK healthcare services. Expected sales amount unknown. Carillion’s Canadian operations bring in £389m in sales and have £289m in non-current assets.  

 

Revised full-year outlook

Expect a further £100m in restructuring costs for the next six months.

 

Now, let’s peak at their financial statements and compare the change from their previous interim results and for the year-end 2016.

Financial Statements

Profit and Loss

Apart from the £1.2bn write down and 30% decline in normalised profits there is nothing important appearing in their P&L account.

One wonders if this “kitchen-sinking” is done and dusted, so by 2018, Carillion can carry on as a normal company.

But, this is far from simple.

 

Balance Sheet

The weird thing is total assets saw a deduction of £760m to £3,660m, instead of £1.2bn. At same total liabilities rose by £360m in six months or £1bn from the same period last year.

What does this mean?

Management is technically right in saying the £1.2bn is a non-cash charge, but by re-evaluating their contracts and asset valuation, it has resulted in £360m in further liabilities.

It’s possible they are funding their loss-making contracts with more debt issuances.

More than debt

We already established net borrowings were rising to £850m. What we haven’t established is Carillion stretching their goodwill from their own suppliers. Despite, the likelihood of a drop in year-end revenue I expect trade payables to reach £2.25bn because their interims saw an increase of £250m to £2bn. The problem is the increasing divergences between receivables and payables.

A year ago, payables were 1.3 times higher than receivables.

Now things have changed because trade receivables saw a £500m reduction to £1.1bn, and by year-end, this could go below £1bn.

Six months later, trade payables would EXCEED receivables by £1bn. Normally, payables exceed receivables by £300m-£400m, given the nature of its business. Now that mould has broken, there is a strong risk of Carillion needing £500m to satisfy their suppliers’ needs.

Meanwhile, provisions saw a big increased from £8.3m to £292m. I realised it would increase expenses by £283m!

Adding this together, Carillion is on the hook for £2.3bn-£2.5bn.

 

Cash Flow Statement

First, we see a big deterioration in operating cash flow from negative £69m to negative £290m. Given that 2016’s cash profit was only £73m, then 2017 net cash flow will turn into a net cash loss of £100m.

Unsurprisingly, it resulted in a cash inflow of £220m from financing.

 

Conclusion

Looking ahead, I don’t see suitors lining up to buy Carillion because even if they buy at 50 pence or £220m. The suitor would need to address the £2.3bn liability elephant in the room. Unless the buyer has over £4bn-£5bn in cash reserves, then an acquisition is best avoided.

For me, Carillion has five problems that require immediate attention:

First, Carillion’s £835m of debt is due by 2020. To deal with this, management is targeting £300m in proceeds and £75m in cost savings. There is ongoing discussing to sell their Canadian operations and UK Healthcare division.

Potentially, would this be enough? We don’t know.

 

Second, their £700m pension deficits are stinking the balance sheet. For example, we recently saw Interserve got served with a share price collapse to £1.10 from £7, despite pension deficit registering under £100m. I’m not asking for much, but a reduction of pension deficit to £300m is progress.

Third, Carillion needs stability on their liabilities. We know Carillion net borrowings will grow to £850m by year-end. But if they could stabilize borrowings it would help a lot.

Fourth, Suppliers’ problems. After writing off £500m from trade receivables. There has been no mentioned from Carillion about growing trade payables, as it grew by £250m to £2bn. My forecast by year-end could rise to £2.25bn or doubled that of receivables. A year ago, payables were 1.3 times greater than receivables.

Fifth, addressing the biggest elephant in the room is “Rights issue”.

How much will Carillion raise if a bidder fails to turn up?

Here is my assessment.

By 2020, £835m of debt is maturing, £350m for pension deficit reduction, there is a provision of £280m and finally, Carillion requires at least £500m to satisfy their suppliers.

Cash required is £1,965m.

What sort of cash inflows are expected by 2020?

£450m from asset disposals, as management targets £300m by the end of 2018.

Net cash earnings of £300m.

So, total cash inflow comes to £750m is a generous assessment. But it still leaves Carillion with £1.215bn in DEFICIT.

Let’s say the banks are willing to refinance £400m. This would reduce the deficit to £815m. Basically, £815m is my ESTIMATED RIGHTS ISSUE by 2020.

The conclusion is to continue avoiding Carillion until the company gave concrete details of a Rights issue or a bidder update.

(P.S. The above is based on my assessment from their annual report and interim results.)

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