Shares in outsourcer Carillion (LSE: CLLN) have taken a beating this year. After multiple profit warnings and a change of management, the stock is down 93% year-to-date, and I believe that the company’s fortunes are unlikely to recover any time soon.
Its problems can be distilled down to one mistake; management bidding on contracts with overly-aggressive margin assumptions. City analysts have long been critical of the company’s business model and its weak cash flow and these concerns finally materialised in July when it announced that it was taking an £845m writedown on its construction book after a review of its contract book. Following this shock, management announced an additional £200m writedown a few months after. These charges plunged the group into a £1.2bn loss.
Weak balance sheet
With revenues under pressure, attention has turned to the group’s debt. Carillion has always made heavy use of debt due to the way its contracts are structured, the company has to foot the bill for part of its work before clients pay in full. With razor thin margins and revenues under pressure, creditors have started to question whether or not the group can repay its debts.
In mid-November, the company told the market that it had asked lenders to delay a crucial banking test from December to April 30 and on Friday, it announced that lenders had agreed to push the test back to this new deadline. Analyst estimates of average net debt for the group for the year to December have risen from £775m in July to as high as £925m. As well as this debt, Carillion is also wrestling with a £650m pension deficit.
To help pay down debt, management has stated that it will try to dispose of £300m of non-core assets. The only disposal so far has been the £47.7m sale of the group’s healthcare facilities management business to peer Serco.
Set to struggle next year
Based on Carillion’s slow pace of disposals, and the company’s lack of headroom with lenders, I believe that it will struggle to survive in its current state through 2018. Even though the business employs around 40,000 people across the globe, bad management in previous years is coming back to haunt it.
Due to the size of the business, lenders might not pull the plug, although they could force the firm to restructure. In this scenario, it’s likely Carillion would be forced to conduct a rights issue to raise additional funds. Because the company’s current market cap is less than £100m, and it has a total debt pile of more than £1.3bn, any rights issue will be extremely dilutive to existing shareholders.
Time to sell
So overall, I believe that it is running out of time and unless the company can sell a significant portion of its business quickly, it’s likely management will be forced to conduct a cash call or declare insolvency next year.
