Shares in construction services companyISG(LSE: ISG) are slidingthis morning, down 27% at the time of writing, after the group issued a dismal trading update.
Management announced today thatthree contracts entered into more than 18months ago had continued to impact on its performance, and added it is in protracted negotiations over a large construction contract entered in 2012 and has decided to make a provision against the contract.
As a result of these provisions, management now expects ISGs full-year results to be c.7m below previous expectations. Whats more, ISG also announced today that it isdiscontinuing its London Exclusive Residential activities and closing itsTonbridge office at a total cost of 17m. In other words, ISG issued a severe profit warning this morning.
That being said, management did note that, excluding the construction contract difficulties, ISGs its half-year performance came in ahead of its expectations.
Still,these loss provisions and restructuring costs, which total 24m, are set to throw the group into a loss this year.
In particular, the City was expecting ISG to report a full-year pre-tax profit of 14.9m for the year ended 30 June 2015. With write-offs and charges totalling 17m, ISG is set to report a loss of 2.1m for this year.
Nevertheless, despite this profit warning ISG remains well capitalised and has a strong order book.Net cash as at 31 December 2014 was 38m, up 15% year on year, while the groups order book isvalued at 1bn.
Slim pickings
ISGs business is low margin by nature, which only serves to amplify the groups troubles when they occur. For example, the groups average pre-tax profit margin for the past five years has been in the region of 1%, not leaving much room for error at all. Even before the loss provisions announced today, ISGs pre-tax margin for 2015 was expected to be in the region of 0.8%.
Further, before todays profit warning ISG was trading at a surprisingly high valuation of 15 times historic earnings. Thats a premium valuation more suited to a high-growth tech company, rather than a low-margin, cyclical construction business.
And this valuation explains the markets negative reaction to ISGsprofit warning. The group has quite clearly failed to live up to expectations.
Moreover, it remains to be seen if ISG can return to growth. City analysts have not yet updated their forecasts for the company based on todays news. Additionally, it remains to be seen if todays loss provisions are the end of the story.Indeed, with industry leaders likeBalfour Beattystruggling to turn a profit in the UK constructionmarket, it seems as if the odds are stacked against ISG.
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Rupert Hargreaves has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don’t all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.