The Troubles of Kier


Yesterday, the outsourcer Kier Group announced a major restructuring. The announcement makes grim reading. The company will divest or close down three of its business lines, with the loss of 1,200 full-time equivalent (FTE) jobs, half of them by the end of this month. The dividend will be suspended for two years. Kier's share price fell on the news, closing down 17.43%.

Remarkably, some analysts took the restructuring announcement as a "buy" indication, which might explain why its share price has recovered slightly today. I wouldn't, personally. Kier is in big trouble, and has been for some time. Admittedly, Andrew Davies, its new CEO, has wasted no time in getting to grips with the company's problems: the proposed restructuring is certainly drastic. But given how difficult the outsourcing market is now, I will take some convincing that it will be enough to turn the company round.

Interim results for the half-year ending December 2018 - the latest accounts available - report a before-tax statutory loss of £35.5m. The notes to the accounts show that the statutory loss was primarily caused by a slew of one-off costs, of which the most significant by far were substantial provisions on two major contracts (highlighted):


In plain English, this means that the company has lost £51m on those two contracts.

For a highly indebted company with not much in the way of assets it can sell, losing money on non-performing contracts is bad news. The interim results also show increasing cost of sales, rising finance costs - and a £10m loss on its existing restructuring programme. £14m of expenditure had only resulted in £4m of cost savings.

In a fine piece of spin, Kier blithely pointed out that its total debt was lower than in the equivalent period of 2017. This is true, but only because of an emergency rights issue of £264m in November 2018. And despite this, by December 2018 short-term borrowing had risen to £49m, with an associated rise in financing costs that contributed to a nasty slide in underlying profit. Sharply rising short-term borrowing and rising finance costs are always an indication of financial distress.

For me, though, the most disturbing aspect of Kier's liabilities is trade payables of over £1bn, by far the largest single item:

The notes to the accounts reveal that £200m of this relates to "payments due to suppliers who are on bank-supported supply chain finance arrangements". This means that Kier is helping a substantial proportion of its contractors to borrow their own payments from banks. Kier Group is running the same scam as Carillion - using a Government-sponsored supply chain financing scheme to flatter its balance sheet at the expense of its SME suppliers.

I haven't highlighted it, but the sharp-eyed among you will note that there is also a pension deficit of nearly £50m. And to add to Kier's troubles, these interim results also reveal that previously reported debt was understated by some £40m due to an "accounting error".

On the asset side of the balance sheet is £434m of cash and cash equivalents, which seems reassuring, though £49.7m of it is encumbered by short-term debt liabilities. But the cash flow statement reveals net cash outflows from operations of some £145m, mostly due to a painfully evident slowdown in contract activity:


This is the killer item. £434m is no sort of buffer against net outflows on that scale. Cash reserves evaporate astonishingly quickly when a company is bleeding money at that rate. And when the cash is gone, so is the company.

The cash flow statement also shows that £255m of the closing cash reserves were generated by the emergency rights issue. Without that, either the company's borrowings would have been much higher or its cash reserves much lower. The rights issue was only partly successful: more than half of the shareholders balked at bailing out the company, leaving the underwriters nursing substantial losses. Kier certainly can't rely on shareholders to shore up its dwindling cash reserves again.

These accounts were released in March. By June, the financial situation had deteriorated so much that it was forced to issue a profits warning (my emphasis):
As highlighted in Kier's FY2019 interim results, the Group continues to experience volume pressures within its Highways, Utilities and Housing Maintenance businesses. In addition, whilst continuing to perform well with double digit growth in its orderbook during FY2019, the Buildings business' revenue growth for FY2019 will be lower than previously forecast.

As a result, Kier now expects that FY2019 revenue will be broadly in line with the Group's reported revenue for the 2018 financial year and currently expects that the Group's underlying operating profit for FY2019 will be c. £25 million lower than previous expectations and that the Group is likely to report a net debt position as at 30 June 2019, which would have an adverse impact on its FY2019 average month-end net debt position.
Insufficient lucrative work, falling income, poor (if any) profits and rising debt. This is not a healthy company.

The proposed restructuring will be expensive, costing £28m in both of the full years 2019 and 2020. This will presumably include the costs of laying off all those people. The company says the aim is to deliver "sustainable cost savings" of £55m from 2021. I'll believe it when I see it.

An aspect of this restructuring announcement that I find particularly interesting is the change in how Kier intends to manage its debt. When looking at Kier's financials, I was struck by the focus on "average month-end debt". This is an odd term, since it implies that month-end debt is somehow different from debt the rest of the time. It appears that Kier has been in the habit of dressing up its balance sheet at month-ends to make it look less indebted than is in fact the case. Consequently, there has historically been considerable volatility in its working capital. This is highlighted in the restructuring announcement:
The disposals and other actions outlined above are expected to deliver a material reduction in the overall indebtedness of the Group. They will also reduce the historical volatility in the Group's working capital profile. Going forward, Kier will focus on managing its retained businesses to deliver long-term profits and a sustained reduction in the Group's underlying debt levels rather than targeting lower debt positions at reporting dates.
Being honest about its debt levels will require quite a culture change in Kier's finance division.

Kier's procurement and accounts payable departments need a culture change, too - not least because in the wake of Carillion, suppliers are less willing to tolerate long payment delays and participate in "supply chain finance" scams:
Kier understands that certain suppliers have experienced a reduction in the level of trade credit insurance available to them; Kier is working with those suppliers to mitigate the impact of this.
 In plain English: Kier must treat its subcontractors better.

But Kier's overwhelming problem is that it is bleeding money at an unsustainable rate. The disposals and headcount reduction will staunch the outflows to some extent, but if is to survive long-term it needs to increase its cash income substantially. The restructuring announcement cheerfully says that the plan is to "embed a culture of performance excellence with a particular focus on cash generation to deliver reduced average net debt." This sounds like MBA mumbo-jumbo to me. Until I see some credible proposals for increasing net income and ending the cash drain, I remain sceptical that this company has a long-term future.

Related reading:

Clearing out Carillion's cupboards
The Misery of Mitie
The sad story of Maplin electronics
Interserve Teeters On The Brink Of Insolvency - Forbes
After Carillion, Capita's Profits Warning Comes As No Surprise - Forbes


Comments

  1. This comment has been removed by the author.

    ReplyDelete
  2. Dear Frances,
    I am completing writing a book on The Economics of Kindness: The Birth of a Green Cooperative Economy, where I found myself referencing People's QE in these terms. My question to you is "am I nuts?" It seems a little too easy, as if there must be something I have missed.

    "When the Bank of England came to the rescue there were many ways in which its £375 billion could have been distributed. The Bank of England is not governed democratically, however, and most politicians don’t understand how central banks create money, so there was no public debate over the way the money could have been distributed. These could have been their options:

    1. The Bank of England could have distributed it to every woman, man and child in the form of Helicopter Money, amounting to £6,000 per person, or £18,000 for a family of three.

    2. The government could have created Affordable Housing Bonds, given the bonds to approved housing agencies, and asked the Bank of England to buy the bonds off the agencies, giving them the funds to build affordable housing. If each new home received £100,000 in seed money, allowing it to attract private investment, the Bank’s money could have built 3.75 million affordable homes, towards the four million homes that are needed.

    3. The government could have created Household Debt Bonds, given the bonds to approved debt agencies with various strings attached, and asked the Bank of England to buy the bonds off the agencies, giving them enough money to retire most of Britain’s household debt (£428 billion in 2019, £15,400 per household excluding mortgages).

    4. The government could have created Climate and Ecological Emergency Bonds, given the bonds to approved agencies, and asked the Bank of England to buy the bonds off the agencies, giving them £375 billion to spend on solutions. With leverage from the banks, this could have increased to £1.5 trillion.

    5. The government could have created Health Care Bonds, given the bonds to the National Health Service, and asked the Bank of England to buy the bonds off the NHS, giving it £375 billion to invest in improved health and social care, including writing off its £4.3 billion accumulated deficit and increasing its annual operating budget of £130 billion by 10% a year for 30 years.

    6. The government could have created Abolish Poverty Bonds, given the bonds to the Treasury, and asked the Bank of England to buy the bonds off the Treasury, giving it the income needed to increase welfare payments, increase minimum public sector wages to a Livable Wage of £9/£10 an hour, offer a tax incentive to every Livable Wage employer, and raise the taxable income threshold, lifting millions of households out of poverty.

    7. The government could have created Green Infrastructure Bonds, given the bonds to the Treasury, and asked the Bank of England to buy the bonds off the Treasury, giving it the income needed to finance infrastructure investments in roads, sewers, water, and so on.

    8. The government could have created Plutocratic Bonds, given the bonds to the banks in exchange for toxic investments, and allowed the banks to lend ten times that much money to wealthy people, enabling them to speculate in the housing market and buy stocks and bonds.

    Option #12 was chosen without any debate. The central banks used their newly created QE money to buy bonds and derivatives off the banks, pouring money into their accounts with no strings attached.


    ReplyDelete
    Replies
    1. Hi Guy,

      Ramanan told me you were trying to contact me. No, you aren't nuts. The Government and the Bank of England between them could have done much of what you suggest.

      I think helicopter money (suggestion 1) should have accompanied what we now know as QE in 2008, and there should also have been a partial or total debt jubilee (suggestion 3, which has also been made by Steve Keen, Johna Montgomerie, and the Bank of England's Michael Kumhof).

      Suggestion 2 is needed right now. The house price crisis has really built up since the 2008 crisis. We need to make housing affordable again. SImilarly, suggestion 4 is desperately needed now, and in large quantities.

      The Government & BoE couldn't have done your suggestions 5, 6 and 7, because as both the NHS and the Treasury are part of the Government, this would have breached Article 123 of the Lisbon Treaty which prohibits direct monetary financing of government. The UK government has a specific opt-out from Article 123 to allow it to maintain the Ways and Means overdraft facility at the Bank of England, but it is otherwise obliged to comply.

      Suggestion 8 has some merit, which may surprise you. Buying toxic investments from damaged banks can be the best way of resolving them. This has been tried and tested in many countries now. The debate is over the extent to which the private sector should bear losses before governments get involved. In Europe, the private sector must now bear substantial losses first. But that creates social problems when bondholders are small investors, elderly people whose life savings are in bank bonds, as is the case in much of Southern Europe. Government intervening to protect these people may be socially the best solution.

      However, suggestion 8 is technically flawed. Bailouts aren't usually done by exchanging newly-created government debt for toxic securities. They are nearly always done by partial or total nationalisation. Also, there is no money multiplier - banks don't lend "ten times" the reserves the Bank of England provides. Further, most bank lending is not to wealthy people, it is to middle class people. Nor do banks lend to people to enable them to buy stocks and bonds. The wealthy don't need banks to lend them the money for investment.

      Your "option #12" (did you mean 8?) is incorrect, I'm afraid. Central banks generally bought bonds from institutional investors such as pension funds, not directly from banks. And they didn't (and still don't) buy derivatives at all. Most QE purchases are of government debt.

      It would be useful to discuss this further offline, I think. You can contact me via my email frances@coppolacomment.com.

      Delete
    2. (2) Houses are cheap (enough) to make, the shortage is of land with planning permission. Government or central bank funding for houses will primarily benefit the owners of land with planning permission...

      (3) Rewards irresponsible behaviour at the expense of prudent people.

      (4) Risk of gov. picking the wrong tech and turning it into a broken windows policy. Also people who care about climate change are usually very rich (relatively to the median human, planet survival is a hobby for people whose personal survival is not at stake).

      (5) Spend on healthcare OK as such, but GCSE Math fail on the law of compounding. 10% a year for 10 years is a giganormous increase, at that speed you quickly end up with the NHS the most expensive health system in the world (per head). Brits are not so sick that they need to spend more than everyone else on health.

      (6) The feeling of poverty is relative, so the poverty line goes up as you throw money at it, it may help to an extent.

      (7) Infrastructure better funded by grants than project bonds, which need a cashflow which doesn't work well with public goods. Only good for toll roads.

      (1) is probably best, though the amount needs to be better calibrated than a dumb division of another number from another policy with a very different action mechanism.

      Delete

Post a Comment

Popular posts from this blog

Lessons from the Long Depression

The myth of monetary sovereignty

The Bitcoin Standard - a critical review