Shares of outsourcing group Mitie Group (LSE: MTO) fell by as much as 16% when markets opened on Tuesday, after the group issued another profit warning.
Mitie shares have since bounced back and are down by 6% at the time of writing. But today’s news is still grim. In a reversal of November’s guidance, the company no longer expects to see a recovery in profits during the second half of the year.
Underlying operating profit for the year to 31 March is now expected to be £60m-£70m, implying at best a flat performance from H1, when the figure was £35m.
Chief executive Phil Bentley has only been in charge since 12 December. But today’s update shows that he’s already identified problems with the group’s strategy, trading and balance sheet.
What’s gone wrong?
Mitie said today that its Property Management and Technical Facilities Management divisions have been hit by contract deferrals, where new awards have been delayed. The group’s Cleaning division is said to be “underperforming”.
But perhaps the biggest worry is that after reviewing Mitie’s balance sheet, Mr Bentley has decided to take “a more conservative judgement on contractual positions”. This will result in an extra £14m of one-off charges this year. This is presumably because the company has reduced the expected level of profit from its existing contracts.
Given this news, I wasn’t surprised to see that Mitie’s finance director Suzanne Baxter has been replaced. New finance chief Sandip Mahajan, starts work today and will be appointed to the board in February.
Is Mitie’s dividend safe?
Management expects Mitie to continue operating within its banking covenants. But the group’s net debt rose to £231.7m during the first half of the year, which I estimate is likely to be more than two times full-year earnings before interest, tax, depreciation and amortisation (EBITDA).
I think there’s likely to be pressure on Mr Mahajan to reduce Mitie’s debt. So I wouldn’t be surprised to see another dividend cut in the full-year results.
Given the fresh uncertainty about Mitie’s future earnings, I think it’s too soon to invest. At the very least, I want to see the group’s full-year accounts before deciding. In the meantime, I believe there are much better buys elsewhere.
This 4.1% yield looks promising
One of Mitie’s closest peers is outsourcing giant G4S (LSE: GFS). This much larger group has already been through a sticky patch, but has emerged successfully. Earnings per share were expected to rise by 15% to 15.3p in 2016.
A further 15% increase is pencilled-in for 2017. This puts G4S on a forecast P/E of 14, with a prospective yield of 4.1%.
This may not seem expensive, but the catch is that like Mitie, G4S still has a lot of debt. Net borrowings of £1,782m represented a multiple of 3.2 times EBITDA at the end of June 2016. That’s uncomfortably high.
In my opinion, the final test of the group’s recovery will be whether G4S manages to hit its target of reducing net debt to less than 2.5 times EBITDA by the end of 2017.
I’m optimistic about the outlook for G4S, but I don’t think the shares are obviously cheap. I’d rate this stock as a hold — or perhaps a speculative buy — at current levels.
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Roland Head 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.