The story of Kier Group (LSE:KIE) over the last few years has been a sad one – spiralling debt, an unpopular rights issue, a profit warning, a departing CEO, an accounting error… the list seems endless. As far as stock movements go, debt would seem to be the key motivator. Over the past year, the setting for a decline in price of 85%, the company has lost value over three distinguishable events: an emergency rights issue in November, a £50m rise in debt (product of an accounting error) in March and a profit warning to the tune of £40m on Monday.
I believe the market’s sentiment towards Kier is heavily influenced by the company’s parallels to the recently defunct Carillion. Similarities between the two firms are patent, most notably a high debt, profit warnings and a dependency on volatile projects. For Carillion, mismanagement of costs on its large projects led to the writing down of nearly £1bn worth of contract value and, when combined with high debt, its demise. The problem for Kier boils down to this: does the debt structure and contract risk combine to make a repeat of Carillion inevitable? I will explore the two primary factors separately.
First, I will address the issue of the company’s debt. In November of last year, Kier showed its desperation for funds with an emergency rights issue. An equally worrying lack of enthusiasm from the market followed. In this most recent attempt to avert crisis, Kier brought its debt-EBITDA ratio down to 1x. This would be satisfactory under conditions of readily available credit and reliable profits. Sadly, these conditions may not apply to Kier. Income stability is inextricably linked with contract volatility.
On top of this, the contracts it is getting might dry up: the government has expressed a wish to minimise exposure to companies with high debt. This could well mean project loss if the debt burden creeps up again. In the near term, the company’s credit facility provides a much needed backup plan. However, this is due to be revised in 2022 and access to funds will likely be reduced. The bottom line: debt is safe for now but, if the balance sheet remains unstable, there may be no second chance.
Now let us consider contract stability, the most important and least transparent factor. In the context of this article, Kier’s key strength comes from its project diversity, approximately half its revenue is derived from small contracts. With 400 projects at an average size of 7.5m, Kier has some stability simply from quantity and diversity. Services, the umbrella that contains Kier’s larger and more risky projects, is again fairly diversified. Smaller contracts make up half of the sector’s revenue. Some “Carillion” type risk still surrounds the larger projects that do exist but it appears manageable.
Perhaps Kier isn’t so similar to Carillion after all. The situation is fragile but the company isn’t burdened with the same risk that Carillion had. If management can minimise unexpected costs, its new smaller debt pile could be sustainable. I think the current situation provides risk-tolerant investors a chance to capitalise on the irrational fear the market exhibits towards Kier.
