This construction company was so desperate for growth it kept ratcheting up its work in hand until it was well over $15bn. Back in the 1990s its biggest projects were worth $200 million, but fast forward five years and in the mid-2000s it had three projects that were worth over $3bn each.
In its scramble to fill its order book, Leighton's management failed to grasp the complexity of these projects during tendering, and they underbid as a result.
Following a series of disastrous cost blowouts, Leighton was fined $242,000 by the Australian Securities & Investments Commission, which took the view that the company had been tardy in revealing financial problems it had with major contracts.
But as bad as this was for shareholders, the reality is that it is quite common for contracting companies to experience cost blowouts.
Many of the contractors that the Under the Radar Report has covered are, in fact, turning their operations around after such blowouts. Matching demand and supply for any company is difficult, but it's especially difficult for companies that have big fixed costs such as plant and equipment. And the heavy competition means contracting can sometimes be a low-margin business. The room for error is substantial.
But blowouts also mean opportunities. Some that we have tipped, including Neptune Marine Services and Southern Cross Engineering, have had a particularly tough time. But just six months later these two stocks are up 15 per cent and 89 per cent respectively.
It's important for contractors to have a lot of cash to be able to withstand fallout from a dud contract. There is also value to be had when you can buy at low multiples (PE of less than eight times), essentially benefiting from their past mistakes. These companies are also prospecting for funds. Their big clients often include the likes of BHP Billiton and Rio Tinto, among the richest companies in the world, and among the few that are spending.
Trouble for contractors generally occurs when they go outside their comfort zone in the chase for cash. The companies we like all have very strong niches, such as Global Construction Services in scaffolding in Western Australia; and Swick Mining, in underground drilling for goldminers.
Source: The Australian
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