Comparative review

In Cage match: UGL vs Transfield back on 28 Sep 10 (UGL: Avoid – $15.10; Transfield: Avoid – $3.69) we said we might look again at these two contractors if their prices fell below $11 and $2.50. They have, so that’s what we’ve done.

The decision on Transfield Services is relatively straightforward. While the share price has halved over the past two years, earnings have slipped 12% and free cash flow has dropped 70% if you’re being charitable.

We’re also a bit concerned about management, due to some less-than-candid commentary in the company’s annual reports. Just look at the chairman’s address in 2009 (a year that saw writedowns, a statutory net loss and a rescue rights issue) if you want to see an example of skirting the issues: ‘Our resilient business model delivered quality results’ just doesn’t cut it. AVOID.

UGL is harder, because its track record has been so good over the past decade, and earnings per share, before amortisation, have continued to grow over the past couple of years – from 92 cents to 101 cents. But free cash flow has more than halved and, after taking off amortisation, earnings per share have fallen from 87 cents to 81 cents.

As with Transfield, we’re also slightly uneasy about management’s candidness. We raised our eyebrows, for example, at management’s use (in the 2012 annual report) of growth in revenue and market capitalisation to justify Richard Leupen’s humongous pay over the years, without mentioning that these were enhanced by a doubling of shares on issue over the period.

Contracting is an opaque business, dependent on large, complex and often risky contracts. Shareholders depend heavily on management to make the right decisions and keep them informed, and this sort of thing doesn’t inspire confidence.

The chances are that UGL will continue to grow by enough to justify its price to earnings ratio of 13 before amortisation and 10 after. But we also can’t discount the possibility of a nasty blow-up and we’re happy to watch from the sidelines. AVOID.