Forge: Third time unlucky

Forge Group’s (FGE) latest profit warning doesn’t quite look so bad on the surface with the embattled engineering group attracting some corporate interest, but the details driving the downgrade shows things aren’t getting better for Forge.

Management has proven that downgrades come in threes when it issued as many dismal updates in two months, with earnings before interest, tax, depreciation and amortisation (EBITDA) now expected to come in at a loss of $20 million to $25 million for the current financial year. This stands in contrast to the group’s earlier forecast for a profit of between $45 million and $50 million.

The market had been anticipating the loss. Consensus estimates puts the group’s EBITDA at a loss of $55.9 million.

Further, Forge has hired Euroz Securities to manage “third party” interest (aka takeover approaches) in the group following its dramatic fall from grace.

It seems investors are not quite sure what to make of the news, with the stock tumbling 10% on the on first trade before clawing back some of the losses to trade down 6.7%, or 6 cents, at 84 cents at 11.36 am AEST.

Outside of corporate interest, more alarm bells should be going off for investors. Today’s update shows that the two problematic power plant projects are starting to infect the rest of the group.

Management admitted that the cash crunch sparked by the Diamantina and West Angelas projects has forced the group to focus on squeezing cash from other major contracts at the expense of profits.

Claims by chief executive David Simpson that the two projects have been “isolated” from the group seem over-optimistic, if not over-simplistic. Can a company ever be really insulated from large problem projects?

The answer is clearly “no” given that Forge went on to confess that rectifying the two projects has taken up so much management resources that the group has been neglecting new project opportunities, which management said will impact on short-term earnings.

What is even more telling is the fact that Forge has to compromise on profits to get cash. Shareholders would have thought the $60 million emergency loan facility offered by Australia & New Zealand Banking Group (ANZ) would more than adequately cover any short-term shortfall.

It seems Simpson has underestimated the scale of the problem even as he personally took charge of both construction projects. He told Eureka Report back in November that he was confident there would be little fallout from the projects as they were 90% completed.

Forge is also complaining about challenging market conditions with rising cost and margin pressures. The group had played down gloomy domestic conditions in the past by pointing to its very strong order book.

As mentioned when I downgraded the stock at the end of November, the only ones that are likely to make money on the shares are day traders and ANZ as the bank has been given warrants that would allow it to buy an equivalent of 13% of Forge’s shares for 1 cent a pop.

Shares in Forge crashed from $4.18 to 68.5 cents on November 28, when the group first released details about the Diamantina and West Angelas projects. It subsequently rallied to $1.74 on the last day of 2013 before trending lower.