Forge over the barrel

Profit warnings are always messy affairs but very few can match Forge Group (FGE) for complexity and ambiguity as the mining contractor lodged its third request in a week to extend the trading suspension of its shares.

We know things were going to look ugly even on its first request for the suspension, but the update given today leaves more questions than answers for anxious shareholders who have seen the share price plunge 28% to $4.18 over the two months to November 1st – the date when the group asked for a trading halt as it worked out the impact of two troubled contracts.

Investors have no clearer idea of the quantitative damage that the Diamantina and West Angelas power station construction projects would have on current year’s earnings, except that Forge has all but admitted it is in breach (or will be) of its debt covenant.

This is why the group is desperately scrambling to do an accelerated capital raising as it tries to reassure the market that “all existing banking facilities remain in place” and that its other projects are performing to expectations.

Those words won’t be comforting. Forge is essentially over a barrel and existing institutional shareholders will be demanding a very big discount to its last share price if they are even to consider a raising.

While key shareholders are doing their due diligence, “mom and dad” investors will be left pondering how it went so terribly wrong for such a sector darling.

I always knew there is always a risk of one of my favourite small cap stocks (Forge was one) would blow up, as that is the nature of small caps, but I wouldn’t have guessed it would be Forge as management has (or rather, used to have) an excellent track record in managing projects.

Indeed, investors have been led to believe all was well at the group’s annual general meeting just a week before Forge went into a trading halt.

Analysts polled on Bloomberg were bracing for a 16% drop in 2013-14 net profit to $57.3 million before the bad news, but that will prove to be way too conservative. Forge is likely to be posting a loss instead if it writes down the value of the Diamantina and Angelas projects by 20% as that would wipe off around $115 million from its bottom line.

Another difficult to swallow fallout from this debacle is the impact on dividends. That’s easier to answer: don’t expect any. Forge should have been on a yield of 5.5% (once franking credits are included) for 2013-14, but it is near impossible for them to justify any payout when it is scrounging around for cash.

The biggest question for shareholders is whether to participate in the capital raising. It will all boil down to whether we have confidence in management – and that is one commodity in very short supply for Forge right now.

But before we pass judgement, we need more details, which will certainly come before Forge resumes trading by next Monday (assuming it doesn’t extend its suspension for the fourth time).

We will advise on a course of action then, but until that time we suspend our recommendation on the stock and investors should not act on our previous recommendation.

Forge is part of the Uncapped 100.