Interserve fails to reassure as debt pile continues to weigh heavily

Russ Mould
23 November 2018

“Chief executive Debbie White and her team are clearly doing their best to steady the ship at Interserve but the admission that net debt will end the year higher than expected, not helped by how the cash inflow from the troubled Energy from Waste business will be lower than hoped, means the company has yet to reassure shareholders and potential investors about the key issues that face it,” says Russ Mould, AJ Bell investment director.

“It is encouraging to see management stick to its cost-reduction forecast for the year of £15 million and continue to predict a strong increase in earnings, when the company reported an adjusted operating profit of £85 million but a stated loss of £225 million, after £310 million in charges, write-downs and accounting restatements.

“But Interserve now expects net debt to come within a range of £625 million to £650 million for the year, against a previous forecast of £575 million to £600 million.

“Presumably one culprit here is the still-problematic Energy from Waste operation, where project partner Renewi’s acknowledgement of further delays sparked a fresh slide in Interserve’s shares this month.

“Interserve notes that key project milestones have been met and this has triggered cash payments, but additional delays in the third quarter have also triggered fresh penalty payments. These will reduce the expected cash inflow from the project to £15 million for the year, although that still represents an improvement of the £40 million outflow suffered in the first half.

“These additional penalties highlight the challenges which continue to face the company and the support services sector overall:

•        Complex company structures with limited operational synergy between different activities  and geographic operations within the groups

•        A reliance on big, complex contracts which require careful management and can become very expensive if something goes wrong

•        Operating margins which are thin – 2.7% in the UK and 2.1% overseas for support services and 1.4% in the UK and 3.1% overseas for construction in the first half

•        Balance sheets that are stretched after a long period of growth, often through acquisition, as exemplified by Interserve’s £250 million purchase of Initial Facilities from Rentokil. And thin margins plus lots of debt is a terrible combination if anything goes wrong, as seemingly can happen with some of these firms’major contracts.

“These factors explain why Interserve’s shares trade at their lowest level since the mid-1980s. Debbie White and her team are clearly aware of them and this year’s refinancing bought the company some time while the cost-cutting plan kicks in and asset sales are used to start reducing the crushing debt burden.

“But some shareholders – and potential investors – may be wondering why a new plan designed to reduce debt is only being unveiled in 2019, when the share price slide suggests the company’s situation remains acute.

“And the lower the share price goes, the more shares Interserve will have to issue, and the more dilution shareholders may suffer, should management decide that an equity raising is required to buffer the company’s finances.” 
 

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