where to now?, page-2

Downer doubts grow over troubled rail project
DAVID SYMONS
June 2, 2010

THE ranks of Downer EDI doubters swelled yesterday, as its shares fell 27 per cent on news of a $260 million provision and asset impairment charge, including a $190 million provision on Sydney's Reliance Rail project.

The price collapse ended in $564 million being written off Downer's market value, more than double the value of the writedowns.

Part of the problem is that the $190 million provision is unlikely to be the last piece of bad news from the 49 per cent-owned Reliance Rail and its unprofitable $1.9 billion, 78-train Waratah project.

There is a significant question about how Reliance will fund the project, with a $357 million bank facility likely to require refinancing, possibly through an equity injection.

Speculation about this has been building for months, with Downer adamant it is not obliged to provide further equity to Reliance Rail. But the market is unconvinced Downer can walk away. If the project fails, the reputational damage would be immense.

Then there's the question of Downer's claims the project has been delayed by only five months. Talk of project timelines at yesterday's briefing were sketchy, and there is chatter that the contract could be as much as 10 months behind by the time engineering issues are resolved.

Cost overruns could also emerge along with the delays. Given the inflation rate in China, it's unlikely the Chinese company building the trains is on a fixed-priced contract.
Damage control

WITH Downer EDI chief executive Geoff Knox's credibility taking a battering following belated admission of (at least some of) the problems dogging Reliance Rail, questions are emerging regarding the performance of the company's contracting business.

While Downer has kept guidance for 5 per cent growth in underlying profit this year, other contractors exposed to the mining sector have been doing it tough. Flooding in the Cooper Basin and Queensland has forced some into damage control.

Managing adverse conditions provides a major cash flow challenge. Engineering firms have to maintain a contracting force of (expensive) staff and assets even when little revenue is coming in. If Downer has been following some competitors' strategies, it will have been nursing its balance sheet through hard times, possibly selling operating assets and leasing them back.

It has $850 million of property, plant and equipment on the books, so there's plenty of scope for massaging the numbers through asset sales at a premium to book value.

Still to come is the impact of the proposed resource rent tax. The first effects of the tax are already being felt by Downer's competitors as mining companies delay project starts.