What is it about Australian contractors and the construction of power stations? When they go wrong, they go wrong horribly.
Late last year two dud power station contracts saw contracting group, Forge, collapse with the loss of 1,500 jobs, up to $800 million in debts to creditors, employees and others (including the ANZ for $289 million).
Yesterday it was the turn of UGL Ltd (UGL) which slipped out an update on a power station contract joint venture in the Northern Territory and stunned investors with news of a $200 million cost blow out.
That sent the shares south at a rate of knots and they ended down 14.6% at $5.89, just above the 52 week low of $5.62 which was only reached early last month.
UGL 1Y – UGL shares tank on $200m cost blowout
In fact it was a statement which gave with one hand and took with the other from UGL yesterday.
The statement confirmed the sale of the property management business DTZ and a capital return of $3 a share to shareholders later this month, but it also provided the shock news of the unexpected problems with a power station contract.
The culprit is the power station it and its partners are building for the huge Ichthys liquified natural gas project in the Northern Territory in a joint venture with US engineering group CH2M Hill.
The joint venture, which is led by CH2M Hill, will take $US170 million ($198 million) of provisions due to design changes and delays to the project.
CH2M Hill will book a US85 million charge in its September quarter accounts.
UGL did not confirm whether it would take provisions in its accounts, or how large such provisions would be, saying only that it would update the market on or before its half-year results in February.
“UGL is still reviewing the cost-to-complete estimate and given ongoing discussions with the client regarding the claims position and project acceleration does not feel in a position to reliably measure the provision at this stage,” the company said in yesterday’s statement.
UGL won the $550 million contract in April 2012 as part of a 50-50 joint venture with CH2M Hill to design and construct a power station for the Ichthys project to supply electricity for an onshore facility based at Blaydin Point in Darwin. So the cost overruns of close to $200 million represent a jump fo 36% in the cost of the power station, which is quite a sizeable error.
US giant GE is supplying gas and steam turbines for the project.
UGL said the joint venture is meeting with its clients – Japanese engineering groups JGC and Chiyoda and US engineering group KBR – to discuss the issues and “accelerate the project”.
The cost blow-outs will be handled by new UGL chief executive Ross Taylor, who takes over from outgoing UGL CEO Richard Leupen on November 24.
UGL also has a new chairman, with Kate Spargo having replaced Trevor Rowe at the company’s annual general meeting last week, so she has been lumbered with this problem as well.
The warning came as UGL completed the sale of its DTZ property arm to US private equity group TPC for $1.22 billion.
UGL will return $500 million, or $3 per share, to investors on November 27.
In yesterday’s statement the departing CEO did his best to reassure shareholders the company was well placed, despite the power station contract problems.
Mr Leupen said, “The sale of DTZ enables the Board and management of UGL to refocus on the engineering services business, with a clear strategy unambiguously centred on a single industry. As a standalone engineering and maintenance services company, UGL will adopt a capital structure and dividend policy appropriate for its operating requirements.
"A robust balance sheet positions UGL strongly for future growth opportunities including reinvestment in the core business to drive organic growth with the flexibility to consider future acquisition or diversification opportunities.
“With established capabilities in rail, maintenance and transport infrastructure, the Company is very well positioned to take advantage of the current and future growth opportunities in the Australian economy. This is underpinned by a solid base of recurring revenue providing future earnings stability.
“Over the coming months we will continue to work with JKC and our JV partner CH2M HILL to progress the design and procurement issues on the Ichthys LNG power project in order to resolve the claims position,” Mr Leupen said
The problem the company and its partners in the power station have is that the first estimate of losses or cost blow outs is always the best – the losses and cost of fixing the problems always grow as the companies involved do more detailed work on the problems.
It was the escalation in costs that brought Forge Group undone with its power station deals. UGL is much bigger than Forge, but that doesn’t mean it will escape these cost overruns without financial pain. A proper estimate of the cost to UGL and its shareholders has merely been put off by the company.
