Interactive Investor

ISG in profits warning shocker

1st December 2015 13:34

Harriet Mann from interactive investor

Plagued by challenges, ISG's construction business has tripped up the group for a second time this year. Optimism that problems which surfaced back in February had been resolved was clearly misplaced, and shares in the accident-prone builder have been smashed again.

Yet, despite warning that the division will miss full-year profit forecasts, the company still plans to resume dividend payments at the half-year results. That may give management an easier ride at the AGM on Friday.

While some issues clearly lie with ISG's older contracts, a focus on margin and risk control to aid its recovery has damaged volumes at the UK construction business. Include delays to the start of some projects, and deferral of profit to later periods will wipe £5 million off group profit.

Plummeting 30% to 142p, ISG's shares are again testing two-year lows. That's reversed all the gains made since the first warning 10 months ago wiped out over 60% of the company's value. Clearly, after reassuring the market since that challenges were behind it, news of further problems was always going to be taken badly.

Mainly a matter of timing

But this should be put into context, as it's mainly timing of contracts rather than a repeat of previous problems, argues Numis analyst Howard Seymour.

Although management expect business to pick up in the second half, the broker still downgrades full-year pre-tax profit guidance by 28% to £13 million, giving earnings per share (EPS) of 19.2p.

The construction division will just make breakeven this year, but bosses still plan a return to the dividend list, with a 3.8p payout pencilled in for the interim figures.

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"The reason for the downgrade is twofold," explains Seymour. "Disappointing outcomes on older contracts previously identified reflects time taken to close out these contracts, and here we expect c.£1.5 million of cost increase plus £1.5 million of provisioning against further slippage.

"Additionally, the group is signalling that, with a volatile cost backdrop, two-stage contracts are taking longer to commence and the resulting lack of revenue, coupled with ongoing associated cost base, will add £2 million of losses. Closing out discontinued activities is proceeding in line with expectations."

Still 'significant value' in ISG

But the rest of the group looks good, with the fit out and engineering services markets strong - six major projects are worth £300 million - and ISG's retail and overseas divisions are performing in line with expectations.

The order book is also up 12%, with £840 million to be delivered this year - which just highlights the progress made without support from its construction business.

Downgrading his recommendation to 'add' and his price target from 335p to 245p, Seymour concludes: "We continue to believe that there is significant value in the group as illustrated by good performances outside UK Construction, though do expect that this is unlikely to be realised until there is certainty that construction issues have been resolved."

That explains why if you strip out ISG's cash pile - expected to have grown to £50 million by year-end, equivalent to 102p per share - the shares trade on a measly 2 times EPS forecasts for the year to June 2016.

Even Seymour's target would give an annualised price/earnings (PE) ratio for 2016 of 10 times - toward the bottom end of valuations in the building and facility services sector, and with good reason.

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.

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