Ann: DTZ Sale Completion & Ichthys Update, page-18

Market's reaction to today's announcement is understandable, but perhaps an over-reaction.

It's understandable because the announced project cost over-run (of US$179m) is nearly 30% of the project value, which is serious! Even UGL's 50% share, US$85 (A$100m approx.), is quite significant for a company which had Statutory NPT of only A$62m in FY2013-14 and would have total book value of A$664m after the $3/share capital return later this month. Clearly, the company needs to provide a thorough explanation of why such a large over-run has occurred, and reassure the market that the cause is not systemic ... due to poor processes or risk management (otherwise it would mean heightened risk on other projects also).

Assuming the cost over-run of this magnitude is an isolated case, which I believe is the case, today's SP fall (equivalent to $170m in capitalisation) may be an over-reaction given the after-tax loss to UGL from this cost over-run would probably be only around $70m (assuming 30% tax rate). And it is possible that the loss could in fact be reduced if the cost over-run can be partially mitigated via counter-claims against the customer, suppliers and other stakeholders.

And because the valuation of a company is based not on one aspect of its business alone but on the sustainability of its overall business model together with its future prospects, the following comments from the last AGM addresses of the CEO and Chairman are reassuring:

"The hallmark of the UGL business model remains its strong recurring revenue base. Approximately 75% per cent of Engineering’s $4.9 billion order book comprises long term recurring maintenance style contracts. Combined with a rigorous risk management framework, the volatility of UGL’s earnings base continues to be significantly lower than its industry peers."


"The Engineering order book has remained stable at $4.9 billion as at 30 June 2014. The order book is further enhanced by preferred pipeline opportunities of $1.7 billion and key rail maintenance contract extensions of over $2.3 billion."

"UGL is well positioned to build on the improving outlook and growth momentum in Australia as major infrastructure investment begins to materialise into material contracts for UGL."

Given that a large proportion of UGL's revenue is of recurrent nature, and the Australian federal government and some of the state governments are embarking upon new infrastructure initiatives, the market will see that UGL would do well if it can be reassured that the company has sound processes and risk management in place.

Meanwhile, I won't be surprised if the large speculators will continue to pay havoc with the share price, taking advantage of the fear and uncertainty that this announcement has created.