It is a sad week for investors in Forge Group (ASX: FGE) as the total extent of losses on two power station projects were revealed yesterday.
Diamantina and West Angeles Power Station projects will cause a profit write-down of $127 million, and a further cash outlay of $45 million will be required to complete both projects. To put this in perspective, Forge's net profit after tax for FY2013 was only ~$62 million.
The profit write-down on Diamantina Power Station came from a variety of different causes including "inadequate allowance for scope growth, large cost overruns in structural, mechanical, piping and electrical works, poor project management and delays in settling a number of claims, as well as the significant acceleration costs allocated in getting the project back on schedule".
The profit write-down on West Angeles Power Station comes as a result of inadequate allowance for scope growth, poor project management and a number of unsettled claims. In short, it sounds like everything that could go wrong, went wrong.
One small blessing with this fiasco is that Forge managed to avoid a capital raising that would have caused a ridiculous dilution of shareholders' investment, considering it would have had to occur at a price approximately one-eighth of Forge's last closing price. Instead, Forge successfully amended its debt facilities with financier ANZ (ASX: ANZ) and postponed principal repayments of existing debts.
Naturally, "a number of leadership changes" have been made within the Forge Group Executive and Forge Group Power divisions. There are new project managers and delivery leadership teams on both power station projects, and Forge Managing Director and CEO David Simpson will have direct oversight of both projects in order to ensure their completion and fulfilment of customer expectations. Both projects should be completed in FY 2014.
Foolish takeaway
In the words of Forge Chairman David Craig, "The scale of the underperformance of these two projects and the fact that the issues came to light in such a short space of time, is unacceptable to the Board". I'd say it's also unacceptable to everybody else including shareholders, who are going to be fairly outraged at this turn of events.
Thankfully Forge senior management has at least responded well to this trial, reaffirming my previous positive regard for them. Prospective investors are better off steering clear, at least for 2014.
