Looking for trouble at RCR Tomlinson (ASX:RCR)
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| Darling Downs Solar Farm |
14/08/2019
Trav Mays
Follow @MaysTrav
1. https://www.rcrtom.com.au/about-rcr/
RCR Tomlinson (ASX:RCR) recently entering voluntary administration, whilst potentially devastating to a large number of people, the thousands of employees and
shareholders especially, offers a great learning opportunity. This post
will try and identify any potential early warning signs that we may be able to
use in the future when examining businesses. This post won’t be an examination
of the managers or the operations of the business, it will be an investigation
searching for any early warning signs within the financial statements only.
Whilst doing this examination, I
have tried to put myself in the position of the shareholder. However, given
that I know the final result I am obviously heavily influenced by hindsight
bias. With this in mind, I would like to make it apparent that I am in no way
criticising any person for either purchasing or hanging onto their shares.
Whether a person decides to purchase or to retain a portion of a business is
governed by many things, such as their risk tolerance, expertise, level of
knowledge, etc. I have made many mistakes, mostly recently Donaco (read about
that one here), my desire is to learn from
history (it’s a shame that we learn more from mistakes than successes), not to
criticise any market participant. Unfortunately learning from history is easier
said than done, as Mark Twain said “History
doesn’t repeat itself but it often rhymes”.
Company
RCR is a 120 year old Australian
Engineering and Infrastructure Company, working with some of the world’s
leading organisations to provide intelligent engineering solutions to the
Infrastructure, Energy and Resources sectors. “RCR’s core capabilities
encompass; development, engineering, procurement, construction (“EPC”),
operation and maintenance of major infrastructure and resource projects. These
include power generation plants (using a wide
range of fuels; solar, wind, battery and hydro), water and waste treatment systems, rail and road tunnel infrastructure, rail signalling and
overhead wiring systems, mineral processing and material handling plants, integrated oil & gas services
(both onshore and offshore), supply of RCR proprietary materials handling and process equipment,
and property services including facilities management, HVAC and electrical services”1.
They have had a wild ride in the
stock price, recently reaching highs not seen since just before the 2007 bust
and the 2014 oil price dive with a subsequent fall similar to that seen in 2008.
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| RCR Tomlinson's Share Price |
Warning Signs
Gross Margin
The gross margin showed clear
signs that something wasn’t right at RCR and that further analysis was
warranted. As you can see below, after improving their gross margin to a very
impressive 9.9% in 2014, it fell dramatically, to 5.1% in 2016 and continued on
its downward trajectory to 1.34% in 2018.
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| RCR Tomlinson's Share Price |
Gross margin between 2018 and
2015 was being squeezed due to a disproportionate increase of revenue (93%) and
cost of sales (111%). As you can see in Table 1, the main culprits up to 2018
for the increase were materials and other costs with employee benefits further
exacerbating the expense in 2018.
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| RCR Tomlinson's Cost of Sales |
Breaking this down further in to
RCR’s operating segments, it is clear that the initially it was just the energy
segment, reducing its EBIT margin to 1% from 5% in 2016. The energy and resources
segments include RCR’s power generation and mining operations, as with all
companies operating in these segments, they were hit hard by the extreme drop
in the oil price in 2014. The 2018 recovery of energy would be partly due to
the recovery of the oil price, with WTI crude reaching a high of US$74/barrel, still
far shy of the pre 2014 crash highs of US$105/barrel.
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| RCR Tomlinson's Gross Margin |
One of RCR’s main core
capabilities of the infrastructure segment is the renewable energy systems,
where they offer all engineering facets, design, construction, commissioning,
operation and maintenance. Whilst the administrators are still examining the
firm’s financials for the cause of their recent troubles, it is believed that
RCR took on renewable energy contracts without a firm understanding of
connection risks. Along with this, it has been stated that they offered fixed
contracts, resulting in all project over run costs being borne by RCR. These
two underlining issues came to fruition in 2018, resulting in a large loss for
the infrastructure segment of $9.8mill, far below the trailing 4 year average
profit of $30mill. This is especially troublesome for RCR, as over 70% of their
EBIT in 2017 was generated in the infrastructure segment.
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| RCR Tomlinson's Segment EBIT as a % of Total EBIT |
Trade and other payables
Another troubling sign was the
huge increase in trade and other payables, increasing from 35% of equity in
2016 to 110% in 2017. Between 2009 and 2016, trade and other payables was an
average 46% of equity, between 2017 and 2018 it increased to 116%. Interestingly,
as their trade bills increased they continued to pay down their borrowings,
reducing their borrowings/equity ratio by an impressive 73.5% between 2014 and
2018.
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| RCR Tomlinson's Debt/Equity |
Discussion
In 2016, the reduction in gross
margin could be attributed to an unfortunate project running over time and/or
cost, but when the trend continued in 2017 a deeper evaluation was clearly warranted.
This evaluation would have unearthed the huge increase in trade and other
payables, this along with a shrinking margin should have been a huge red flag
for owners, signalling that something wasn’t right. It’s easy to type this
after the fact, I too could have been persuaded by the rising share price, as
it trotted it was up to a 249% increase in a year and a half. Along with
this, a lot of great analyst believed the same and typically when they are all
in agreeance, they are usually right. Unfortunately on this occasion they were
not.
I could continue to say things
such as they should have renegotiated their debt and paid down their trade and
other payables, focused more heavily on increasing the energy margin, or sold
it off as it was only making a small percentage of EBIT, but these and other
similar statements are built on assumptions made on hearsay and speculation. We
will need to wait for the report from the administrators to make a full
examination.
The main thing I learnt from
this analysis is that trends hold the key to finding issues and signs of areas
that require a deeper dive into the weeds. It also further highlights the need for us to do
our own analysis and to not be swayed by share prices. Once the analysis has
been completed, then compare it to the price you calculated, if it is too high,
sell, if it’s low and gives you a good margin of safety, buy.
I am on Twitter Follow @MaysTrav and Linkedin if you’d like to connect, feel free to send me a msg, it’s always great to meet other ASX investors, especially those who have a different view point.
if you’d like to connect, feel free to send me a msg, it’s always great to meet other ASX investors, especially those who have a different view point.1. https://www.rcrtom.com.au/about-rcr/
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