Leighton’s Failures Could Savage Balance Sheet
Leighton’s half yearly results grabbed headlines when they reported a 66 per cent drop in interim net profit to $114.6 million, at the low end of guidance.
For 24 months, we have been warning investors about the company’s difficulties in collecting receivables in the Middle East and the likely writedowns of the Desal Plant in Victoria and the Brisbane Airport Link. And now a string of results are revealing that these issues are savaging the company’s profits which for the most recent half, were down from $340 million in Leighton’s previous first half, the six months to December 31, 2011.
But the problems may not be over. The early traffic numbers out of Airport Link are much worse than expected – even though the opening of the link has allowed drivers on the road for free – the project may go bust like other toll roads before it. We believe Leighton’s have a deferred equity contribution requirement of $200 million that may still be required to be paid.
In the Middle East, Leighton’s has not been paid for a number of projects and they aren’t small. Imagine building an equestrian centre (see image) and failing to be paid. It would send most companies bust.
A ‘crack collection squad’ is reported to have been set up to recover around $500 million worth of payments on projects including the aforementioned al-Shaqab equestrian centre in Qatar. Hamish Tyrwhitt has been quoted in the ARF as saying the company was “making progress” on recovering money owed on legacy projects because it was “engaged” with its Middle Eastern customers. One hopes Leightons is more ‘engaged’ on this than it looks, like it is on fancy european sports cars.
The carrying value of Leighton’s investment in the Habtoor Leighton Group had dropped from $379 million to $347 million due to $32 million in losses for the period, but no further impairments were announced. Once again, it could get worse.
The pressure on the balance sheet will only increase. Gearing is already at 46% and the $2.6bln of equity reported at the half year is lifted by $3.2bln of receivables. If these aren’t collected, the value of the assets will drop and the debt/equity could rise materially. A $200 million equity contribution to a broke road project and the failure to collect in the Middle East might be a worst case scenario, but it adds up to nearly three quarters of a billion.
Debt is also affecting cash flow with finance costs amounting to $70 million for the half and being partly responsible for the NEGATIVE operating cash flow.
Thats right NEGATIVE OPERATING CASH FLOW.
Roger Montgomery is the Founder and Chairman of Montgomery Investment Management. Roger has over three decades of experience in funds management and related activities, including equities analysis, equity and derivatives strategy, trading and stockbroking. Prior to establishing Montgomery, Roger held positions at Ord Minnett Jardine Fleming, BT (Australia) Limited and Merrill Lynch.
This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.
Luke Thomas
:
It is no surprise that Leightons have run into issues with desal plant project in victoria. Leightons have a clear and delibrate strategy of coming in low on tenders and then trying to make a profit by claiming variations to the contract. (I know this because I have experienced this myself and they are well known for this in the construction industry) In this case the Victorian government have held there own aganist excessive claims and Leightons gets trapped with an unprofitable contract.
Andrew Legget
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Sorry all, i believe in continuous disclosure and the above is no longer valid.
My values are far north of $5.00. This was my emotional worst case scenario option i will keep where return on equity falls to about 30% and was using the FY12 equity figure. My more measured approach left me with values of $10.62 for FY13 and $10.59 for FY14.
Some more disclosure, my figures are mine so as i do not have access to management forecasts etc (other than the presentation) i am working things out on my own so i could be completley wrong, plus you might disagree with my growth estimation, dividend pay out ratio and even the discount rate so this is not an endorsement or recomendation at all for others to use. If you do use it, it is at your own risk.
Andrew Legget
:
Hi Roger,
Again very interesting post, this blog is such a great resource at reporting time and this reporting period has thrown up some really interesting stories and things for business based investors to think about. Your account of Leghtons does not paint a rosy picture at all.
I am currently picking through the JBH announcement and presentation. Not really any surprises, some evidence of some trends occuring (software sales for instance). I’ll need to have a think about how i feel about their strategies for combatting the issues they are facing.
I wish i had the time to go back and check and maybe do a bit of an exercise as i don’t remember seeing the word “competitive” show up so much in a JBH presentation. This stood out to me.
Trying to have a bit of a thought as to how this might impact valuation, i have a feeling my value after it all will fall for them.
I went neutral (previously “fan”) on this company a while back so it is no longer high on my list. I’d happily grab COH and WOW and many others before them.
Looking forward to hearing many more stories of reporting season from the team at Montgomery HQ.
Andrew Legget
:
For those that might be interested in my comment about the valuation, i meant to add this to the original. I cannot forsee them being able to sustain and earn 50-60% return on equity currently (especially once the debt inflating the ROE falls further). I will continue to meditate on this but i think i need to downgrade the potential return on equity they will earn over the future so a lower ROE means lower value. My first run ended up being around the $5.00 mark. But this is by no means a final one.