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Why I’d sell Carillion plc to buy this stock

It’s been exactly four weeks since Carillion (LSE: CLLN) dropped its profit warning bombshell onto the market. Now that the dust has settled it’s perhaps a good time to reflect on what has happened, and more importantly what the future could hold for the troubled support services giant.

All-time low

Shares in the Wolverhampton-based facilities management and construction services group plunged to an all-time low last month as investors reacted to a whole host of concerns brought to light in a very worrying first-half trading update. At the core of the announcement was that the company now expects profits for the half to be lower than previously envisaged, with net debt moving in the opposite direction.

The market reacted immediately and the resulting sell-off left the shares trading 39% lower by the end of the day. But it didn’t end there, the shares continued their slide over the coming days, eventually dropping below the £1 mark for the first time since the start of the millennium, and further still to today’s levels just above 50p. It’s hard to believe that Carillion was trading above £2 per share as recently as June – this has been a truly monumental collapse.

Fighting for survival

The FTSE 250-listed group admitted it has a cash flow problem, and with construction contracts drying up, average net borrowing for the first half is now expected to be £695m, much higher than the £586.5m for the whole of 2016. The company also cut its full-year revenue guidance to £4.8bn-£5bn, thus confirming that overall performance would be below management’s previous expectations.

Consequently, the 2017 dividend has been suspended, and the group’s CEO Richard Hawson has stepped down with immediate effect. As you’d expect, the board has promised to undertake a strategic and operational review of the business. But I now see Carillion as a hugely risky investment as it could take a very long time to sort out the problems and get back on track.

Healthy financial position

Another engineering and construction services firm trading on a very humble valuation at the moment is Babcock International (LSE: BAB). But unlike Carillion, I believe the FTSE 100-listed group is the perfect pick for those wishing to take advantage of the company’s established links with the Ministry of Defence.

The financial year has started well, as visibility continues to improve, with around 82% of revenue now in place for 2017/18 and 55% for 2018/19. The order book and bid pipeline of opportunities have remained stable at around £19bn and £10.5bn, respectively, following contract wins.

Unlike Carillion, Babcock continues to maintain a healthy financial position, and expects to further reduce debt during the second half of 2017/18. With the shares currently trading at a four-year low, I believe this could be a great opportunity to snag a bargain at just 10.5 times earnings for the year to March.

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Bilaal Mohamed has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.