Why Shares In ISG PLC Plunged Over 20% Today

Shares in construction services company ISG (LSE: ISG) are sliding this morning, down 27% at the time of writing, after the group issued a dismal trading update.

Management announced today that three contracts entered into more than 18 months ago had continued to impact on its performance, and added it is in protracted negotiations over a large construction contract entered in 2012 and has decided to make a provision against the contract. 

As a result of these provisions, management now expects ISG’s full-year results to be c.£7m below previous expectations. What’s more, ISG also announced today that it is discontinuing its London Exclusive Residential activities and closing its Tonbridge office at a total cost of £17m. In other words, ISG issued a severe profit warning this morning. 

That being said, management did note that, excluding the construction contract difficulties, ISG’s its half-year performance came in ahead of its expectations.

Still, these loss provisions and restructuring costs, which total £24m, are set to throw the group into a loss this year.

In particular, the City was expecting ISG to report a full-year pre-tax profit of £14.9m for the year ended 30 June 2015. With write-offs and charges totalling £17m, ISG is set to report a loss of £2.1m for this year. 

Nevertheless, despite this profit warning ISG remains well capitalised and has a strong order book. Net cash as at 31 December 2014 was £38m, up 15% year on year, while the group’s order book is valued at £1bn.

Slim pickings 

ISG’s business is low margin by nature, which only serves to amplify the group’s troubles when they occur. For example, the group’s average pre-tax profit margin for the past five years has been in the region of 1%, not leaving much room for error at all. Even before the loss provisions announced today, ISG’s pre-tax margin for 2015 was expected to be in the region of 0.8%. 

Further, before today’s profit warning ISG was trading at a surprisingly high valuation of 15 times historic earnings. That’s a premium valuation more suited to a high-growth tech company, rather than a low-margin, cyclical construction business. 

And this valuation explains the market’s negative reaction to ISG’s profit warning. The group has quite clearly failed to live up to expectations. 

Moreover, it remains to be seen if ISG can return to growth. City analysts have not yet updated their forecasts for the company based on today’s news. Additionally, it remains to be seen if today’s loss provisions are the end of the story. Indeed, with industry leaders like Balfour Beatty struggling to turn a profit in the UK construction market, it seems as if the odds are stacked against ISG.

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Rupert Hargreaves has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.