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Investors are taking a gamble on the Kier share price: here’s what I’d do

When I’m thinking about investing in a company after a big profit warning, I find it often pays to take a step back and look at events over the last year. Are the latest problems an isolated incident, or do they represent an ongoing issue that’s spiralling out of control?

Shares in construction and contracting firm Kier Group (LSE: KIE) fell by 40% on Monday and have now fallen by 85% over the last year. Today, I want to take a fresh look and explain why I think getting involved now could be an expensive mistake.

Worse than I expected

Back in March, the firm revealed that accounting errors meant year-end debt would be higher than expected. I warned this was a big concern for shareholders, who had already been forced to bail out the firm once in December.

My view was that further bad news seemed likely. But to be honest, I didn’t expect the news to be quite this bad. In an unscheduled statement earlier this week, Kier revealed a fresh round of problems.

Lower-than-expected volumes of work mean revenue will be flat this year, versus previous expectations for growth of about 7%. Adjusted profits are now expected to be £25m lower than anticipated. On top of that, restructuring costs will now be £15m above expectations.

Unsurprisingly, the end result is that debt levels are now likely to be higher than previously expected. The key figure to watch here is the average month-end net debt, which was last reported at £430m.

This is the second time in four months the firm has flagged up an increase in debt levels. For shareholders, I think this is a big worry. Here’s why.

The next Carillion?

Will Kier Group follow its former peer Carillion into administration? Not necessarily. Kier is still expected to be profitable this year. But the company’s debt situation worries me.

Back in December, former chief executive Haydn Mursell raised £250m in a rights issue at 409p per share. But only 38% of the new shares were taken up by existing shareholders. The remainder were placed with institutional investors at a cut-down price of 360p per share.

Today, with Kier shares trading at about 150p, even the placing price looks too expensive. The problem for new chief executive Andrew Davies is that if further cash is required, he may struggle to persuade shareholders to part with any more. The December rights issue was meant to fix Kier’s debt problems — but it hasn’t.

What happens next?

It’s possible Davies is ‘kitchen sinking’ this year’s results — bringing forward as much bad news as possible so next year’s performance is better. But I struggle to believe he’d take things this far.

In my view, even Kier’s much-reduced dividend is likely to be suspended this year. There’s also a risk a debt restructuring will be needed to reduce borrowing to sustainable levels. If this happens, I suspect the only viable option would be a debt-for-equity swap.

In this scenario, the firm’s lenders would become majority shareholders in Kier in return for writing off some debt. The value of existing shares would probably fall to almost nothing.

I may be wrong, but why take the risk? Even in the best of times, Kier was a low-margin contractor. I believe you can do better with your cash.

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Roland Head has no position in any of the 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.