Carillion post-mortem

[tjh290633]

There is a lot of speculation, gossip and misinformation about. The only authoritative statement is the RNS. The rest is tittle-tattle. Sky, the FT and the Times are pushing their own agenda. They might be right or they might not.

TJH

[Dod101]

It's the "big dilution" I don't understand....my holding has already suffered "big dilution".. .we must be talking "homeopathy levels"?

It is not the share price they are talking about it is the share of the economic value of Carillion. Most individual shareholders will have a tiny share of the total shares in issue but you could be holding say 5%. If all or many of the loans are converted into shares (a loan for equity swap) then that 5% of the whole could suddenly become say 1% or less of the whole.Thus the shareholder will have suffered massive dilution, where is share of the whole has dropped to 20% of what it was. That is the issue about 'big dilution'. Then of course if a rights issue were to get off the ground (say on the back of some sort of Government guarantee) and if the shareholder did not take up his rights that will cause further dilution.

I have no idea of the actual percentages but it is the principle of what is meant by 'big dilution' that I am trying to explain.

Dod

[Bouleversee]

There is a lot of speculation, gossip and misinformation about. The only authoritative statement is the RNS. The rest is tittle-tattle. Sky, the FT and the Times are pushing their own agenda. They might be right or they might not.

TJH

I've just re-read it and Mandy Rice Davies springs to mind. I should, of course, be delighted to be proved wrong, but reading between the lines, it still looks like curtains for shareholders to me. I certainly won't be putting up any more money (have made that mistake too often) unless Melrose or similar got involved, unlikely with such a big, complex fish.

Do you sill hold, Terry?

[idpickering]

Were it not for Government involvement Carillion would have been in admin by now not much doubt about that. The lessons? When a profit warning comes, assume it is the first of two or three. Sell when a dividend is suspended. The actual timing of the sale is up to the holder but I do it right away.

A HYP is about income through dividends not about recovery situations. There are plenty other fish in the sea. LTBH does not mean hold at all costs and in any case pyad is not a genius such that his 'rules' need to be followed to the letter.

Dod

I agree DOD. I know I have a previous for gobbing off about Strategic Ignorance, but I have learnt that to take such a thing to an extreme is just folly. One should be aware of what's happening with your shares, and not strategically ignoring events at all. To do so is just blind ignorance. Be aware of events, and respond accordingly, in whatever way that is your want.

Ian.

[Arborbridge]

It's the "big dilution" I don't understand....my holding has already suffered "big dilution".. .we must be talking "homeopathy levels"?

Quite so, Monabri. And I've always thought that was hogwash, too.

Big dilution occurs in the way Dod explains. Believe me, it could happen, and has happened to me before. One ends up with shares either worth very, very little, or with shares which are not saleable in practice. The fact that your shares have little value at present is of no consideration to the market or the government- whatever we've sufferred is our own fault for taking the gamble

My Xirr seems to be running at -74%

[langley59]

Having paid £6500 for Carillion shares in my HYP which are now worth £313 (or zero on Monday?) and which don't pay a dividend anymore and having suffered heavily with a few others such as Tesco I have decided that for all the effort HYP simply is not worth it for me. The share passed my filters in April 2015 based on dividend yield, P/E ratio, net gearing, market cap, dividend growth and ROCE pretty well, falling a little short on dividend cover and free cashflow cover, but then hardly any of my shares passed every filter.

The FTSE 100 yields not far off 4% and buying it via the ishares ETF (ISF) gives you a very low cost ready made HYP with large weightings in typical HYP shares such as Shell, HSBC, BATS, BP, Glaxo, Lloyds etc. Yes it might be a bit too concentrated on oils or banks but the negative financial impact and heartache of one or two holdings having incompetent (fraudulent?) management who publish inaccurate financial information is greatly diminished. Supplement this with ETFs or Investment Trusts which give global exposure. Thats my conclusion anyhow from this sorry episode.

[UncleEbenezer]

It's the "big dilution" I don't understand....my holding has already suffered "big dilution".. .we must be talking "homeopathy levels"?

I wasn't aware of any dilution having taken place yet. Just a big loss due to the company's value looking very different.

Dilution is when your percentage ownership of the company falls due to someone else acquiring a stake not from existing equity. What I suspect you hold is an unchanged percentage of a much-devalued asset.

The good news is that the dilution we anticipate will leave (from where we are now) a much bigger asset. Someone acquires a stake in return for new money (a placing or rights issue), or for writing off debt (a debt for equity deal).

[Arborbridge]

I agree DOD. I know I have a previous for gobbing off about Strategic Ignorance, but I have learnt that to take such a thing to an extreme is just folly. One should be aware of what's happening with your shares, and not strategically ignoring events at all. To do so is just blind ignorance. Be aware of events, and respond accordingly, in whatever way that is your want.

Ian.

Non-believer! (Well, aren't we all, to an extent)

Pyad's view was that whatever happens it is better to hold on and let the market take its course: that was certainly his initial position. (I believe he may have later commented that one might sell on dividends being cancelled, though I think this was a sort of reluctant concession to naysayers).
It's no good pointing to one case and saying "there you are - that proves it's better to sell" because it doesn't: one cannot prove a general principle from an example of one.

BTW, whether or not it is generally better to sell, does not - I my view - suggest that the idea of holding on is fatally flawed. HYP was never intended to be the best investment system since sliced bread. It was a good enough system to help the moderately educated investor: no one said that given intimate knowledge of accounts, one couldn't do better.
Even given that CLLN has cost me 2.5% of capital, it hasn't stopped HYP doing what it says on the tin.

Arb.

[Arborbridge]

Having paid £6500 for Carillion shares in my HYP which are now worth £313 (or zero on Monday?) and which don't pay a dividend anymore and having suffered heavily with a few others such as Tesco I have decided that for all the effort HYP simply is not worth it for me. The share passed my filters in April 2015 based on dividend yield, P/E ratio, net gearing, market cap, dividend growth and ROCE pretty well, falling a little short on dividend cover and free cashflow cover, but then hardly any of my shares passed every filter.

The FTSE 100 yields not far off 4% and buying it via the ishares ETF (ISF) gives you a very low cost ready made HYP with large weightings in typical HYP shares such as Shell, HSBC, BATS, BP, Glaxo, Lloyds etc. Yes it might be a bit too concentrated on oils or banks but the negative financial impact and heartache of one or two holdings having incompetent (fraudulent?) management who publish inaccurate financial information is greatly diminished. Supplement this with ETFs or Investment Trusts which give global exposure. Thats my conclusion anyhow from this sorry episode.

I'm interested in you comment concerning cash flow cover. If it's true, it rather supports my feeling that cash flow is a far from perfect indicator. How did you work it out? Do you have a website which you can check for this value?

[vrdiver]

Having paid £6500 for Carillion shares in my HYP which are now worth £313 (or zero on Monday?) and which don't pay a dividend anymore and having suffered heavily with a few others such as Tesco I have decided that for all the effort HYP simply is not worth it for me. The share passed my filters in April 2015 based on dividend yield, P/E ratio, net gearing, market cap, dividend growth and ROCE pretty well, falling a little short on dividend cover and free cashflow cover, but then hardly any of my shares passed every filter.

The FTSE 100 yields not far off 4% and buying it via the ishares ETF (ISF) gives you a very low cost ready made HYP with large weightings in typical HYP shares such as Shell, HSBC, BATS, BP, Glaxo, Lloyds etc. Yes it might be a bit too concentrated on oils or banks but the negative financial impact and heartache of one or two holdings having incompetent (fraudulent?) management who publish inaccurate financial information is greatly diminished. Supplement this with ETFs or Investment Trusts which give global exposure. Thats my conclusion anyhow from this sorry episode.

Just for perspective, as I measure my results on calendar years, the FTSE 100 was 7143 at the start of 2017 and 7688 at the end, showing a rise of 7.6%. My own portfolio, with dividends withdrawn, and including some Carillion (and Interserve, and Cobham...) showed a rise of 9.3%. It also payed me just over 5% yield on the starting capital over the year.

If you go down the ISF ETF route (and nothing wrong with that!) you change from HYP to passive tracker. As an income investor, I prefer the HYP approach simply because it filters out companies that pay below-average dividends. Diversification remains important, whichever route you choose.

[langley59]

I'm interested in you comment concerning cash flow cover. If it's true, it rather supports my feeling that cash flow is a far from perfect indicator. How did you work it out? Do you have a website which you can check for this value?

I calculated it as (Cashflow per share minus Capex per share) divided by (Dividend per share) from the financial information provided by my broker at the time TD Waterhouse - it may have been provided to TDW by Morningstar from memory. I have since moved from TDW and don't perform these calculations as I don't buy new individual HYP shares anymore. I looked to have a ratio greater than 2, ie. the dividend covered at least twice by cashflow both in the previous year and over a five year period. Carillion failed this on both counts and subsequent experience showed me that this was one of my more important filters, along with a ROCE greater than 20%.

[idpickering]

I agree DOD. I know I have a previous for gobbing off about Strategic Ignorance, but I have learnt that to take such a thing to an extreme is just folly. One should be aware of what's happening with your shares, and not strategically ignoring events at all. To do so is just blind ignorance. Be aware of events, and respond accordingly, in whatever way that is your want.

Ian.

Non-believer! (Well, aren't we all, to an extent)

Arb.

I'm just not following the 'rules' blindly any more. I'm a bit more cautious nowadays.

Ian.

[monabri]

But if the books are being cooked, any divi cover calculation is meaningless. The CLLN divi cover was 1.8 (1.7?) so reasonably robust one would think.
I think what we are looking for is the measure(s) that the shorters used to identify the issue and what made them say "hey, what going on here?"

[Arborbridge]

I calculated it as (Cashflow per share minus Capex per share) divided by (Dividend per share) from the financial information provided by my broker at the time TD Waterhouse - it may have been provided to TDW by Morningstar from memory. I have since moved from TDW and don't perform these calculations as I don't buy new individual HYP shares anymore. I looked to have a ratio greater than 2, ie. the dividend covered at least twice by cashflow both in the previous year and over a five year period. Carillion failed this on both counts and subsequent experience showed me that this was one of my more important filters, along with a ROCE greater than 20%.

THanks for that. I think I did look at the Morningstar site, but I found what they gave as cash flow ambiguous and couldn't find out how they had calculated it. I don't remember the wording now, but it didn't seem a clear cut number - I must go back and check!

So, anyhow, from what you say, CLLN failed on cash flow at about the time you bought it? Interestingly, one of my better investments was Go-ahead group which had poor cash flow for several years but no harm came of it - that's one reason why I'm not convinced how good an indicator it is.

[Dod101]

But if the books are being cooked, any divi cover calculation is meaningless. The CLLN divi cover was 1.8 (1.7?) so reasonably robust one would think.
I think what we are looking for is the measure(s) that the shorters used to identify the issue and what made them say "hey, what going on here?"

Taking your point re dividend cover, it is only as good as the reported profits. It does not need the books to be cooked to get dicey profits. As has been said earlier in this thread, the profits may be all 'book' profits, with little or no cash being earned in the business owing to slow collections, booking profits as contracts progress, ahead of interim payments being receive4d and so on. That is one of the problems with contractors, they appear to have many ways of recognising profit and will often report to their short term advantage.

Shorters may have inside knowledge, they may be better at reading situations than you and I or they may just have better noses. Last year at this time when I said investors should bail out it was the high dividend yield that would have been my concern, because that in itself is to me a warning sign (anything more than say 50% above the market average needs to be looked at very carefully)

Dod

[Arborbridge]

THanks for that. I think I did look at the Morningstar site, but I found what they gave as cash flow ambiguous and couldn't find out how they had calculated it. I don't remember the wording now, but it didn't seem a clear cut number - I must go back and check!

Well, I think I've answerd my own question. You are right - the cash flow to equity will be near enough cash lofw per share less CAPEX. THat only leaves the uncertainty being what they consider to be capex (maintenance capex or development capex) - but by subtracting all of it, at least one is one the safe side.

[idpickering]

But if the books are being cooked, any divi cover calculation is meaningless. The CLLN divi cover was 1.8 (1.7?) so reasonably robust one would think.
I think what we are looking for is the measure(s) that the shorters used to identify the issue and what made them say "hey, what going on here?"

I don't think we've seen the end of this sorry tale just yet. Lots of finger pointing to come and it'll drag on I suspect.

Ian.

[Arborbridge]

I looked to have a ratio greater than 2, ie. the dividend covered at least twice by cashflow both in the previous year and over a five year period. Carillion failed this on both counts and subsequent experience showed me that this was one of my more important filters, along with a ROCE greater than 20%.

cover x2? Hmm.. Well we'd better sell ULVR, then for the past three years show cover of 0.96,(2014) 1.45,(2015) 1.37 (2016)

I grant not as bad as CLLN, but not far off: 1.45, 1.00, 0.78 (2016).

But looking at the borrowings, CLLN have been steady at £630m-ish, whereas ULVR have been ballooning from 9.6 billion to 13.9 billion. Not only that, but CLLN's net gearing is far healthier than ULVR.

In other words, it isn't as easy as coming to a conclusion by one particular factor.

[Dod101]

Dead right Arb. Quality of earnings seems to me to be the key. Your ratios for Carillion are well and good but it totally depends on the earnings numbers and how reliable they are.

Dod

[Arborbridge]

Dead right Arb. Quality of earnings seems to me to be the key. Your ratios for Carillion are well and good but it totally depends on the earnings numbers and how reliable they are.

Dod

Doh! - back to culture, then

So, if I had been checking the CLLN ratios, would I have seen enough to make me sell? That's an interesting question. I might have seen the deteriorating cash flow - but how long a piece of rope would one give? Cash flow can come right in time - it isn't the be all and end all - I would have expected to see something else, such as ballooning borrowings or net gearing to indicate a company under stress.

One needs an accountant's eye: I doubt whether John Doe could pick up on what is really going on - and indeed, we have to say none of CLLN big backers did either! - or if they did, they gambled that it would come right, as I did in my own serendipitous way.