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Downer's confusing 'clarification'
DAVID SYMONS
June 29, 2010 - 12:11PM

With Downer EDI's credibility buffeted by claims made in BusinessDay surrounding the companys efforts to tart up year-end accounts through aggressive cash management, shares in the company posted a fresh 12-month low of $3.72 in early trade this morning, down from yesterdays close of $3.99.

In an embarrassing sequence of events, Downer first denied deferring payments to suppliers in a statement released to the ASX early this morning, going on to reverse the position shortly after 11am, providing additional clarification that cash management in its Works division included a proposal to manage creditor payments.

Investor sentiment was also hit by a target price downgrade from Goldman Sachs JBWere. The broker has maintained a Hold recommendation on Downer, while cutting its target price from $6.26 to $5.00.

The report notes that while the companys shares appear cheap at current prices, representing a 2011 price earnings ratio of just seven times, caution is required in light of significant downside risks.

In addition to concerns that Downers balance sheet is stretched with the result that an equity raising might be required to fund any material contract wins in the mining sector, Goldman analysts address the possibility that further provisions will be required on the Waratah train contract.

An area of concern is the cost of construction of the Waratah carriages. While these costs would originally have been fixed in a back-to-back contract with Changchun Railway Vehicles Co, reducing Downers risk exposure to this $700 million component of the project, Goldman is concerned that the back-to-back contract may have been voided by the 19,000 design changes that Downer has been forced to make during the design process.

Downer has already admitted that some of back-to-back contracts on the Waratah project have fallen over due to changes in specification. Goldman expects that in addition to carriages, contracts for doors, brakes and air conditioners could be amongst the areas at risk.

To date, Downer has recorded a $190 million provision against the Waratah contract due to cost over-runs in areas including design development and material supply.

Goldman estimates suggest a further provision of similar size could be required if Downer is required to wear increased manufacturing costs.

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