Mouchel provides a textbook example of spotting problem accounts.
This morning, shares in Mouchel (LSE: MCHL) crashed from yesterday's close of 31p to as low as 15.2p. As I write, they have bounced back to trade at 19.4p, down 37%.
What caused such a dramatic crash in the share price of this small-cap consulting and business services company?
Mouchel's triple whammy
In a trading update today, Mouchel shocked its investors with three announcements.
First, on 15 June, the group had reported that it expected a "significant one-off profit on one of its long-term contracts to offset lower profitability than originally expected". Today, the group admitted that, "as a result of an actuarial error, the one-off gain will be £4.3 million lower than previously expected."
Second, as part of its year-end audit, Mouchel "reviewed contract risks and project claims, taking into account the continuing challenging business environment". As a result, it has increased provisions in line with the reduction in the above one-off gain.
Third, Richard Cuthbert, Mouchel's chief executive, has tendered his resignation with immediate effect.
What a complete horror show! No wonder Mouchel's shares have plunged more than a third today.
Five lessons to learn
In March, Mouchel's share price plummeted a third from 150p to 100p as it spurned two takeover bids from bigger rivals Costain (LSE: COST) and Interserve (LSE: IRV). In hindsight, its directors and investors should have leapt on these offers, as their stakes would be worth a multiple of today's value.
However, for the seasoned sceptic, five warning flags were already being waved above Mouchel.
1. Falling revenues and margins
In the six months to 31 January, Mouchel reported a 13% slump in revenues, plus a near-halving of operating margins to 3.3% from 6.3%. Together, such falls can produce a toxic cocktail that poisons profits -- and are strong signs that a business is under severe stress.
2. Sector shocks
As a member of the Support Services sector, Mouchel relies heavily on government spending, especially in its Highways division and Government and Business Services unit.
Last year, two FTSE 250 firms in the same field went bust: first Connaught in September 2010 and then Rok in November. With two bigger rivals going to the wall, the signs were not good for Mouchel.
3. Hefty net debt
At the end of July, Mouchel had net debt of £87 million, which was greater than its market value at the time. Today, with the firm valued at below £22 million, its net debt is four times its market cap. Yuk!
4. Pension problems
At 31 January, Mouchel had a pension deficit of £35 million, despite pumping in special contributions totalling nearly £16 million in the previous two years. Thanks to falling asset prices this year, this deficit may have swelled and will surely exceed today's market cap. That's another black hole to be filled.
5. Heavy exceptional items
What investors should look for are steady, sustainable and rising earnings.
Alas, Mouchel has a long history of booking one-off, exceptional items to its profit-and-loss account. In 2009 and 2010, these totalled almost £100 million. Surely the point of 'exceptional' costs is that they are the exception, rather than the rule?
An outright gamble
In short, Mouchel's problem accounts were there for all to see. Thus, today's profit alert should not have come as a shock. In many ways, it was almost inevitable.
Given the question marks over the company's survival, I would not buy Mouchel shares at any price. In my view, piling into its shares now is more akin to gambling than investing. You could get a short-term bounce, only to lose the lot later!
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