Fund Managers Slam CIMIC's Shock $1.8 Billion Write-Down, Downer Slashes 2020 Profit Guidance

Fund Managers Slam CIMIC's Shock $1.8 Billion Write-Down, Downer Slashes 2020 Profit Guidance

With every passing day, the business environment at the global stage is becoming uncertain and there is a high level of dynamism with back to back occurring events. Australian business environment is prone to a higher risk of uncertainty with the recent incident of bushfire. We have seen a fall in the consumer sentiments as well as a fall in the value of AUD.

There might have been some ease in the international trade space because of the cooling down of trade tensions between the US and China. The truce between the world’s largest economies could likely impact Australian international trade as well as domestic trade favourably. Moreover, the tussle between the US and Iran could weigh heavy on the Australian companies operating in the Middle East.

Read: Consumer Sentiment Falls Further, Westpac Forecasts cut in the Cash Rate

Several Australian companies are forced to revise their financial guidance and make considerable reductions in their earnings for the future. In an attempt to be prudent, the companies are acknowledging the rising uncertainties in the business environment and the inability of the business to perform well even with the availability of ample resources but with the impact of uncontrollable market forces.

Here we shall discuss the revisions made by two companies in their guidance for the future.

CIMIC Group Limited

Engineering-led construction, mining, services and public-private partnerships leader, CIMIC Group Limited (ASX:CIM) concluded an exhaustive, strategic review of its financial investment of a non-controlling 45% interest in a company operating in the Middle Eastern region, BIC Contracting (BICC).

CIMIC Group works across the lifecycle of assets, infrastructure and resources projects and comprises of the following:

  • Construction business- CPB Contractors, including Leighton Asia and Broad
  • Mining and mineral processing, including Thiess and Sedgman
  • Services and specialist services- UGL
  • Public-private partnerships arm- Pacific Partnership – all supported by in-house Engineering & Consultancy Activities

In this context, in a reassessment of its financial exposure to BICC, CIM shall report a one-off post-tax impact of around $1.8 billion in its 2019 financial statements that shall define the total exposure of CIMIC related to BICC. As CIMIC’s financial guarantees of certain BICC liabilities materialise, the above-mentioned impact comprises of an expected cash outlay, net of tax of around $700 million during 2020.

As an effect of the same, CIM will not declare final dividend for the year 2019. However, the company aims to generate sustainable shareholder returns by delivering innovative and competitive solutions for clients while providing safe, fulfilling careers for its employees. CIM is also a constituent of the Dow Jones Sustainability Australia Index and FTSE4Good Index.

While conducting the strategic review CIM has commenced a confidential M&A process in respect of its financial investment in BICC, for which discussions are in place with parties that could possibly acquire BICC in part or all of it.

Moreover, discussion with the lenders, creditors, clients and other stakeholders in view of the increased deterioration of local market conditions are keeping BCCI engaged.

Upon evaluation and consideration of all the available options, CIM finds it compelling to make an exit from the Middle-East region and looks forward to concentrating its resources and capital allocation towards growth prospects in its key core markets and geographies like Australia, New Zealand and the Asia Pacific.

In line with its guidance for 2019, CIMIC forecasts to report NPAT of around $800 million, which does not include the BICC impact.

The CIM stock decreased by 19.868% intraday and closed at a price of $28.030 on 23 January 2020 and has a market capitalisation of $11.32 billion.

Another company with revised guidance for FY20 is the Downer EDI Limited (ASX: DOW).

Being a leader in offering integrated services in Australia and New Zealand, Downer EDI Limited engages in creation and sustenance of the contemporary environment while working closely with its customers using world-leading insights and solutions to design, build and sustain assets, infrastructure and facilities.

  • DOW employs more than 53,000 people across more than 300 sites, primarily in Australia and New Zealand;
  • The company has a presence in the Asia-Pacific region, South America and Southern Africa;
  • Downer also owns 88% of Spotless Group Holdings Limited;

Owing to the underperformance in Engineering, Construction and Maintenance and other factors, Downer EDI Limited has revised its NPATA guidance for the financial year 2020 down to $300 million. As a result, the Company has increased the forecast net costs to complete these projects by $43 million, which shall be reflected in H1 FY20 results of the company.

The reduction in the NPATA guidance for FY20 is due to the following reasons:

  • Project underperformance in EC&M
  • Progress of work to achieve practical completion on a small number of loss-making construction contracts in the EC&M division;
  • The costs incurred during December 2019 and January 2020 materially exceeded the company’s estimates;
  • A detailed review of customer claims and variations has reduced revenue recognised to date;

Chief Executive Officer of Downer, Grant Fenn believes that the company is disappointed with the worsening of the projects at their delivery stages and it is likely that there shall be no further increase in costs above the revised estimate.

  • Softer revenue in EC&M construction for the remaining part of the financial year

A review of the anticipated pipeline of construction work for the remaining part of the financial year was carried out by Downer based on the following:

  • Current win rates and expected delays in project awards in the resources-based construction market;
  • The significant grid and connection issues now confronting the Renewables sector

Conclusively, there is a reduction of $300 million in the forecast construction revenue of DOW and a reduction of approximately $20 million in forecast earnings of the company.

  • Unbudgeted restructuring costs in EC&M

Downer looks forwards to reposition its EC&M construction effort to markets and projects which have the potential to offer competitive strength and the opportunity for Downer to gain traction in related contracts that are long-term and service oriented. As a consequence of this plan and to reflect the net impact of staff redundancies, a provision of $10 million has been made by DOW for one-off restructuring costs.

Moreover, the change in EC&M’s construction focus is anticipated to produce substantially enhanced earnings since the change shall imply

  • improved project performance,
  • significant cost reductions and
  • decreased volatility.

  • Delayed project commencement in Mining

DOW’s adjustment to its forecast start dates for two mining projects following recent customer advice has had an impact on forecast earnings for the second half of the year at $12 million pre-tax. DOW is the preferred services provider at the two mining projects.

Over the recent period, DOW’s mining division has persistently shown strong performance, and the same is expected to achieve EBITA of between $90 million and $100 million for FY20 following the adjustment in the forecast start dates.

The performance of the overall services business of Downer has performed well in H1 FY20 in all spheres like transport, utilities, facilities, mining and the asset services business within EC&M, along with an increment in the work-in-hand to approximately $46 billion up from $44.3 billion at 30 June 2019.

DOW forecasts cash conversion of around 40-50% of EBITDA for FY20, including the updated guidance. Earlier in November 2019, the company was of the view that its cash performance for the FY20 would be weaker as compared to its performance in recent years.

DOWs existing liquidity of $1.65 billion comprises of:

  • cash of $515 million and
  • committed undrawn facilities of $1.14 billion as at 31 December 2019.

For the future, Downer expects to grow its service-oriented businesses that entail comparatively low levels of capital while being capable of delivering predictable revenues in the long term and improve margins over the period.

Bottomline

The back to back downgrades in the earning guidance of the Australian businesses may be a matter of worry for some. But the investors are hopeful that this too shall pass. The vigilance of the companies in acknowledging the uncertainties in the business environment is worth acknowledging. With some companies expecting to release their results in February, it shall be interesting to see if they are able to surpass their earning guidance or even reach break-even, which may be crucial for the future of some businesses.


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