Australia | Aug 03 2007
By Greg Peel
Hands up. Who remembers a market this side of the sixties that has offered so much upside potential in mining and engineering services? No one?
Exactly.
In August 2005 Downer EDI (DOW) was trading under $6. It reached as high as $9 before CEO Stephen Gillies dropped a bombshell in August 2006 – just ahead of the result – admitting that historic fixed-price contracts had led to a write-down of $300 million in profit. The share price dropped like a stone to nearly $5.
But it won’t happen again, said Gillies.
Well, it has. Right on cue Gillies announced yesterday that a further $130 million in profit will be written down this year for exactly the same reason. Having made it back above $7, the stock was knocking around under $6 again yesterday. As the henchmen were heard tramping down the corridor, Gillies threw himself on his sword.
Suffice to say, analysts are pretty dirty. The problem now is that management has said that THIS time there aren’t any new problem contracts. While this has been taken as heartening, the analysts are once bitten, twice shy. More clarity please, which hopefully will come with the result this month. UBS, for one, notes Downer has a contract out with Energy Systems that doesn’t expire until February.
So what to do as an investor?
The conundrum is that Downer should be doing well, should be looking at sustainable earnings, and shouldn’t really be trading on as low a multiple as it is. There will now be a new CEO who will really have to kick butt. Importantly for investors, Downer has a very open register which makes it ripe for the picking – takeover wise. But can the company be trusted?
JP Morgan’s approach is to say that if you’re already in Downer, there’s no point in fleeing now. It would be a shame to crystallise a loss when the company really does have potential upside. However, if you’re not an investor, there’s no sense in rushing in. The result comes out on August 21 and hopefully there will be more clarity provided at that stage.
GSJB Were has responded by dropping its valuation discount in case of any further bombshells. It moves from a 20% to a 35% discount to the average FY08 PE ratio of the ASX 200 Industrials. That puts the analysts’ forward multiple on Downer at 10.7x.
There has been a mass reduction in target prices, such that the average in the FNArena database has fallen from $8.01 to $6.89. This includes UBS’ unmoved $8.00 – the analysts are waiting to hear more. Earnings forecasts were slashed by varying amounts depending on where they started, with most vicious being Macquarie with a 58.6% reduction for FY07.
The only rating downgrade was from ABN Amro, which moved from Buy to Hold. This puts the current B/H/S ratio at 1/6/0, with only Credit Suisse blithely hanging on to Outperform. CS just doesn’t want to conceive it’s possible that “after two major embarrassments, the current board and senior management have again miscalculated (or deluded themselves) sufficiently that they will not deliver solid clean results for the future”. CS also highlights the takeover potential.
While this current market is not a good place to judge the relative performance of any stock, Downer is trying hard today at 2.5% up so far.