Morningstar | SNC-Lavalin Issues Another Profit Warning and Announces Reorganization; Lowering FVE
We lowered our fair value estimate for SNC-Lavalin from CAD 34, to CAD 33, after the no-moat engineering and construction firm issued its third profit warning this year. Management announced that second-quarter results will fall below its prior expectations as a result of revised cost forecasts on lump-sum turnkey, or LSTK, projects in the resources and infrastructure segments. Additionally, the company will take roughly a CAD 1.9 billion noncash impairment charge in the oil and gas business as a result of the unit’s poor performance this year and management's decision to no longer pursue LSTK contracts in the segment.Interim CEO Ian Edwards also announced steps to derisk SNC-Lavalin’s portfolio. The reorganization will include splitting the company into two reporting units: SNCL engineering services (including the EDPM, nuclear, infrastructure, and capital units) and SNCL Projects (including the resources segment and infrastructure EPC projects). The firm will also cease bidding on LSTK contracts, though it will continue to perform its contractual obligations on existing contracts (including the REM light-rail project). Furthermore, the company is considering options for the resources segment, which could include a potential divestiture of the oil and gas business.
Although shares are trading in 4-star territory, we continue to urge caution, as legal risk and weakening fundamentals, which are reflected in our negative moat trend and very high uncertainty ratings, could drive a wide range of outcomes. We believe management's decision to move away from LSTK projects is a step in the right direction, as execution problems on fixed-price contracts have continued to plague the company in recent quarters. That said, while the announcement clears some uncertainty around the future direction of the company, the restructuring will take time.
SNC-Lavalin Group is an engineering and construction group, and is engaged in the ownership of infrastructure and in the provision of operations and maintenance services. Co.'s segments are: mining and metallurgy, which provide tailored solutions for projects in the aluminum, gold, copper product sectors, among others; oil and gas, which includes projects for oil and gas and resources companies; power, which includes projects and services in hydro, and nuclear and thermal power generation, among others; infrastructure, which include infrastructure & construction, and operations and maintenance; capital, which invest in equity or subordinated debt into projects for public services.
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