5 things you need to know about UGL Limited's market update

UGL Limited (ASX:UGL) is the second best performing stock on the S&P/ASX 200 Index this morning after it issued a rosy outlook. But its not out of the woods yet.

Brendon Lau

Brendon’s passion for shares started by accident in 2003 and he has worked in various roles around capital markets ever since as a trader, stock analyst and markets reporter with the Australian Financial Review. Most of his wealth has come from share investing than any other asset class, and that has given him the financial freedom not to work full-time, if he chooses to. Brendon is a medium to long-term investor who aims to hold positions for a year or longer and is focused on fundamental analysis, although he will occasionally use technical indicators to time his entries and exits. Brendon has an MBA from Melbourne Business School and is RG 146 certified. He lives in Melbourne with his wife, three kids and two dogs.

Published June 1, 2015 11:42 am AEST

A rosy update from UGL Limited (ASX: UGL) will put renewed focus on merger and acquisition opportunities in the embattled engineering services space.

UGL is among the best performing stocks on the market this morning as it surged 7.3% to a six-month high of $2.49 after management issued a trading update that declared that the worst was over for the group.

While the positive reaction in UGL's share price is understandable, I think it is too early to say it is out of the woods.

Here are five things investors need to know about the latest update:

Management is forecasting total revenue of $3.1 billion and underlying earnings before interest and tax (EBIT) of $75 million for the current year. This is ahead of consensus sales estimates of $2.7 billion. If the sale of its property business is excluded, UGL says revenue and EBIT is forecast to come in at $2.3 billion and $47 million, respectively.
While revenue in 2015-16 is expected to be flat at around $2.3 billion, UGL is expecting "improved profitability" due to the benefits from its restructure and efficiency review. This means EBIT margin is expected to improve one percentage point to 3% next year with 70% of that year's revenue locked in.
But it's 2016-17 that is causing the most excitement as management is predicting "a substantial change in revenue of at least $300 million" because of its exposure to transport infrastructure and liquefied natural gas (LNG) plant maintenance.
UGL's order book stands at $5.1 billion and management is targeting annual cost savings of $33 million from 2015-16 onwards due to a cut in 200 full time jobs.
Management thinks that the $175 million provision for UGL's problem Ichthys project is "adequate" with 30% of the construction completed.

Taken at face value, the update should trigger a further re-rating of the stock, particularly given the recent corporate interest in the sector with UGL coming under the spotlight as a potential target.

But it is the last point about Ichthys that gives me most concern. History has shown that the damage caused by problem projects is nearly impossible to forecast accurately.

Forge Group gave similar reassurances about its troubled projects (and those were around 80% completed!) just before its collapse and losses related to the Gorgon contract continued to escalate for Leighton Holdings, now renamed Cimic Group Ltd (ASX: CIM).

There's value in the sector but I think it is too early to believe the risks have been substantially reduced.

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