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Downer on downward spiral over rail doubt
DAVID SYMONS
June 23, 2010

THREE weeks on from Downer EDI's belated confession that all is not well with its Reliance Rail contract, and shares in the company are still spiralling lower.

Downer shares touched a 12-month low of $4.04 yesterday, down from $6.27 immediately before the company recorded a $190 million provision against the rail contract.

Restoring the company's credibility will be nearly impossible so long as operational and financial uncertainty surrounds Reliance Rail, but what could be tackled is increasing expectation that a sizeable capital raising is coming.

It is unlikely that sentiment will improve until the perception that the company needs to raise capital is dealt with.

There are two key drivers for a capital raising. The first is the looming need to contribute more equity to put 49 per cent-owned Reliance Rail on a surer financial footing. The project is now geared to 94 per cent, with $2.3 billion of debt supported by just $137 million of equity.

Of course, Downer chief executive Geoff Knox vehemently denies that Downer is set to contribute to a recapitalisation of Reliance Rail. But there are plenty in the market who reckon failure to participate in a recapitalisation - possibly walking away from the contract - would cause immense damage to Downer's reputation.

This could cripple the company's ability to win future business.

Then there's the problem that Downer's credit metrics are stretched, even without taking a capital recapitalisation of Reliance Rail into account. According to CBA analysis, if Downer were to bring its credit metrics back in line with credit ratings agency requirements for a BBB rating, while continuing to pursue growth opportunities such as a major contract win with Fortescue, an equity raising of between $250 million and $400 million would be required. Downer is rated BBB- by Fitch.

Adding weight to the expectation of an equity raising is the expiry of both a medium-term note and a New Zealand bond in the next three years. Replacing these facilities would be tough if Downer is only rated BBB-.