In a way the stockmarket was entirely rational in the way it treated Downer EDI’s second multi-million dollar provision to cover losses on its troubled Sydney suburban rail contract.
Going into a trading halt on Tuesday ahead of the Australia Day holiday and mentioning the rail contract naturally attracted the attention of sharks and others in the market and Downer’s share price was a certainty waiting to slump yesterday.
Downer duly updated the market before trading with the bad news of a new $250 million provision for losses on the contract, and the bottom fellow out of the market in DOW shares for a while as they slumped almost 25% at one stage, before staging a slight recovery to be down 20%, or 91c, at $3.61.
The company’s new provision of a quarter of a billion dollars is on top of one last June of $190 million which has been almost exhausted.
So by the time the contract is fulfilled out in 2013 or so (assuming no more problems), Downer will have gone through $440 million in making sure the Waratah trains meet their contracted specifications (i.e. making sure they work).
In an accompanying market update, Downer EDI tried the positive spin of claiming that its business was performing "solidly" apart from Waratah, and it remains compliant with its funding covenants. (i.e., the banks are not getting toey).
Downer EDI said it now expected to deliver the first operating Waratah train to the NSW Government in late April.
Excluding the trains project, Downer said it expected to report underlying earnings before interest and tax of around $132 million for the six months to December 2010.
But this figure is meaningless without counting in the new Waratah project provision.
The market will have to wait until February 15 to get the statutory accounts and a full year outlook.
The company and CEO Grant Fenn refused to rule out a share issue to help Downer rebuild its finances.
In fact the company said in a statement that it "has also maintained a high level of liquidity with more than $830 million in cash and undrawn facilities".
But this is dependent on the ratings groups.
If they downgrade the company, an issue is inevitable.
Fitch placed the company on a negative outlook yesterday (the rating is BBB).
You can almost hear the scramble as brokers and investment banks tote their cases towards Downer’s Sydney offices with plans for an issue inside.
In yesterday’s statement, Downer said:
"Downer EDI Limited (Downer) announced today that as a result of:
"A further delay to presenting the first Waratah train set to RailCorp for Practical Completion; delays in production of subsequent trains as a result of asbestos in the Cardiff manufacturing facility; and
"Changes to the manufacturing production schedule and project costs, an additional net pre-tax provision of up to $250 million will be required in respect of the Waratah train project. A detailed breakdown of this provision is provided in the Attachment to this announcement. Downer confirms that it remains in compliance with its funding covenants.
In June 2010, Downer raised a provision of $190 million against the Waratah train project, which is a contract for the design, manufacture and commissioning into service of 78 eight-car double-decker train sets (the Rolling Stock Manufacture (RSM) contract) for a fixed price of $1.9 billion.
"This provision included $50 million for potential liquidated damages based on the planned delivery schedule at that time and a management risk contingency of $40 million. The contingency was partially utilised between June and December 2010 such that $30 million remained prior to commencement of the current review.
"Excluding the Waratah project, Downer’s business continues to perform solidly. Based on preliminary, unaudited accounts for the six months to 31 December 2010, underlying earnings before interest and tax (EBIT) is expected to be approximately $132 million.
"Downer has maintained strong operating cash flow of $124 million in the six month period, 93% of underlying EBIT. This cash flow result includes $62 million of cash outflows relating to the Waratah project. Downer has also maintained a high level of liquidity with more than $830 million in cash and undrawn facilities.
"The Chief Executive Officer of Downer, Grant Fenn, said Downer remained fully committed to the Waratah train project.
"Downer is continuing to work closely with RailCorp to deliver 78 high quality, safe and reliable trains for the people of New South Wales," Mr Fenn said. "Whilst the train build is difficult and challenging, the measures we have outlined today will ensure the program can be delivered in the shortest possible time."
"The original contract milestone dates were 20 April 2010 for Practical Completion of train set 3 (the first train to enter passenger service) and 5 September 2013 for practical completion of train set 78 (the final train to enter passenger service).
"Train set 3 is now expected to enter passenger service in late May or early June 2011, which is 13 to 14 months behind schedule.
"The asbestos contamination in the facility at Cardiff has added between one and two and a half months to the schedules for the following four trains.
"Nevertheless, Downer anticipates having two trains available for passenger service by the end of June 2011 an
