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What investors can learn from Transfield’s downgrade

Transfield Services (ASX: TSE) has announced an earnings downgrade of 27.4% assuming the mid-points in management’s guidance. This is a significant downgrade to net profit after tax before amortisation, especially so near to the 30 June financial year-end.

The drop in earnings has management looking for new ways to sure up the balance sheet. In the Investor Day presentation released with the earnings downgrade, the capital management plan was explained. The plan includes taking capital expenditure off-balance sheet. While this may make the balance sheet appear in ‘better shape’, it is just cosmetic and is unlikely to improve the company’s ability to meet its interest obligations, although it may help it meet certain leverage targets.

It’s also uninspiring that management announced they were targeting a 20% reduction in Debtor days over the next two years. Investors need to question management as to why these types of ‘efficiency gains’ can be wrung out of the business – it should be the day-to-day bread and butter of managers.

Although there are definitely headwinds, Transfield’s business model does have a number of advantages over many other mining service providers. The diversified nature of the company to sectors outside of resources is a clear benefit. This exposure includes transport-related contracts, such as Harbour City Ferries and Railcorp, infrastructure such as ports and gas pipelines, contract services to the telecommunications sector and around $200 million per annum in contracts with the Department of Defence.

The list of mining service company downgrades is growing longer by the day and no doubt the short sellers are making some money. Transfield can now be added to a list which also includes UGL Ltd (ASX: UGL), WorleyParsons (ASX: WOR) and Fleetwood (ASX: FWD) – to name just a few.

Foolish takeaway

There is a significant and robust business in Transfield Services but investors can see from the downgrade the significant exposure the company still has to the resource sector and the effect this contraction is having on the bottom line. The pressure on resource-related contracts is likely to persist for some time and companies such as Transfield will probably find themselves having to run fast just to stand still. By that I mean all the cost-cutting and efficiency gains will be barely enough to cover the drop in earnings for a while yet.

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The Motley Fool’s purpose is to help the world invest, better. Click here now for your free subscription to Take Stock, The Motley Fool’s free investing newsletter. Packed with stock ideas and investing advice, it is essential reading for anyone looking to build and grow their wealth in the years ahead.  This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson. Motley Fool contributor Tim McArthur does not own shares in any of the companies mentioned in this article.

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