Forge can't afford another shock to the system

There’s a cardinal rule for chief executives with inherited problems: there is only one opportunity to blame a predecessor for unanticipated problems so make sure the new broom sweeps clean.

Forge Group’s David Simpson just broke that rule.

In November, Forge went into a near month-long suspension of trading in its shares after disclosing a $127 million earnings writedown associated with two power station projects in Western Australia.

The losses precipitated a liquidity crisis, which was only overcome with the forbearance and support of the group’s banker, ANZ. ANZ waived covenants, expanded the group’s working capital facility and deferred principal repayments. It also took up warrants which, if exercised, would be equivalent to about 13 per cent of Forge’s capital.

The two projects were inherited by Forge when Simpson’s predecessor, Peter Hutchinson, oversaw the acquisition of CTEC Pty Ltd in 2012. Simpson, who replaced Hutchinson about 18 months ago, has blamed the writedown on poor management.

Today Forge announced that it would make a further $23 million to $28 million writedown attributable to one of the WA power projects, the West Angelas Power Station. Another $14 million to $19 million of net cash would be required to complete the project, it said.

The only glimmers of positive news in the announcement were (a) that Forge still has the support of its lenders, including ANZ and (b) the writedowns remain confined to the power station projects. Forge’s credibility – and its already shattered share price – would have been destroyed had problems surfaced elsewhere within the group.

Nevertheless, the latest writedown – coming less than two months after Forge’s original near-death experience – is damaging. It says that Forge, despite that original lengthy period of suspension while it assessed the condition of the two contracts, didn’t properly identify the extent of the problems and losses.

That is the responsibility of the current management and the credibility of Simpson as chief executive has taken a direct hit as a consequence. The cloud over Forge will linger as the completion of the power projects, which Forge said in November would occur this financial year, is now dragging into the early part of the 2015 financial year.

Forge shares, which had traded above $5 before the November suspension, plummeted on the original announcement of the losses, falling below 48 cents.

They had recovered to some extent, rising to $1.74 in late December on the back of heavy buying by global institutional heavyweight BlackRock, before falling back to $1.25 ahead of the latest trading halt. Today, after the news of the additional losses, they fell below 90 cents initially before recovering to around $1.10.

The sliver of good news, as indicated, was that the losses remain confined to the two troubled power projects.

The core of Forge’s engineering, construction and asset management operations has been holding up well in a difficult environment for the sector. The pre-Christmas bounce in its share price was driven by the company’s announcement that Samsung C&T had given it a formal notification to proceed with phase three works for Gina Rinehart’s $US10 billion Roy Hill iron ore project in the Pilbara.

Forge has an $830 million share of the Samsung contract, which is critical to its order book for this year and the next. The group also won a $40 million asset management contract in December that provided some confidence that its strategy of building that segment of its portfolio to create some diversification is being executed.

The group (and Simpson) are now walking something of a tightrope. They can’t afford any more unpleasant surprises, either from the two power station contracts or from elsewhere within the group. There’s always a limit to the tolerance of shareholders – and bankers – for unpleasant surprises.