Why I’d still shun Carillion plc shares at less than 20p


Embattled construction services group Carillion (LSE: CLLN) has been sliding ever deeper into financial trouble. And a story from Sky News at the weekend claimed it’s now “racing to secure new funding within weeks to avoid collapse.”

A spokesman said it’s finalising a business plan to present to its syndicate of lenders on Wednesday. The company made no official statement to the stock market this morning but its shares are up 17% to 22p, as I’m writing. This values it at £95m, but the trouble is, total debt is £1.5bn.

1p a share target

Sky reported that Carillion has come up with a rescue plan, which “would involve handing back some lossmaking contracts, revising the terms of others and potentially accepting financial support from the Government if it cannot secure it from private sector sources.”

This may account for the rise in the share price today. However, institutional shareholders have deserted the company in droves and I believe the price is now being driven by short-term traders and naive retail investors. They could think they see a wide margin of safety in the company’s P/E of one, but fail to appreciate the gravity and implications of its financial position.

Back in October, when the shares were trading at 47p, I drew readers’ attention to a note from analysts at UBS, who saw “no material equity value left for current shareholders” and put a 1p target on the shares. At that time, I thought this was an extreme, but far from negligible, outcome and rated the stock a ‘sell’. Subsequent events (including news of an FCA investigation into announcements made by the company last year) have persuaded me it’s a probable outcome.

In the kind of situation of extreme distress in which Carillion finds itself, a financial restructuring almost invariably involves a hugely dilutive debt-for-equity swap and fundraising and leaves existing shareholders with a token few million of equity. In Carillion’s case, this would equate to around the 1p a share of UBS’s target. As such, I rate the stock a ‘sell’ at the current price — indeed, at almost any price.

A credible turnaround stock?

Short-sellers, who went through Carillion’s accounts with a fine toothcomb a few years ago, concluded that the company’s accounting was aggressive and that its many acquisitions obscured a multitude of sins. They reckoned these issues also tainted other companies in the sector, including Capita (LSE: CPI).

Like Carillion, Capita has had to book multi-million pound impairments. However, Capita’s haven’t been as extreme and, unlike its troubled peer, it’s been able to bolster its balance sheet with an £888m sale of one of its businesses. While the company has said it expects to record further impairments in its results for the year ended 31 December, it has also said it expects year-end net debt/EBITDA to be around 2.25. This is a reasonable level and down from 2.9 at 30 June.

At a current share price of 410p, Capita trades on a P/E of 8.5. I see risk here as still elevated but infinitely lower than at Carillion. On the basis of debt being under control, the low earnings multiple and credible turnaround prospects, I rate Capita a ‘buy’.

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By putting Carillion’s accounts under a forensic microscope, a number of short-sellers avoided (indeed made money out of) the company’s implosion. However, given that many institutions missed the warning signs, it’s hardly surprising that private investors made the same mistake.

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G A Chester 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.

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