Energy Action shocks the market with a profit downgrade

My portfolio suffered a bad setback on Friday when Energy Action (ASX: EAX) announced that NPAT is expected to be about $5 million in FY 2014, roughly in line with FY 2013. Previously, the company had given guidance of $5.5 – $5.75 million. NPAT for the first-half is expected to be just $2 million. I am concerned that the company might fall short of its implicit guidance of $3 million for the second-half of FY 2014.

The share price is down about 20% on the news because the company will fail to deliver the growth that the market expected. The market punishes ‘growth’ companies that fail to deliver. For example, in recent weeks both Webjet (ASX: WEB) and Silver Chef (ASX: SIV) announced they did not expect profit growth in the current financial year. Both companies suffered share price declines after the announcements, although the market punished the latter more severely.

Personally, I’m extremely disappointed with the downgrade from Energy Action and I wouldn’t be surprised to see further share price drops. In the announcement, the company said that the “revised guidance primarily reflects a lower than budgeted earnings contribution from the Sustainability Solutions division (previously called Activ8+) and restructuring of the Sales function.”

I kicked myself when I read that. I have previously expressed concern that Energy Action was spending too much money on external consultants and advisers. In fact, two of the main subjects on which the company received advice were the ‘sales function’ and the Activ8+ business. I wonder if one of the recommendations of the consultants was to change the name from Activ8+ to Sustainability Solutions. In any event, that wasn’t enough to have the business hit its targets.

At the end of the day, it falls to shareholders to demand that new CEO Scott Wooldridge rein in external costs and return the company to organic growth. It is still quite likely that the restructured sales team will yield results in FY 2015. In my view the company should focus on attracting customers to its Australian Energy Exchange reverse-auction platform, because that will result in further sales of the Activ8 monitoring service. The Activ8 service is the best source of profits for the company, as the business has far better economics than the contract-based Sustainability Solutions business segment.

In the opinion of this Fool, the expectations of the Sustainability Solutions business were clearly over ambitious; apparently the 40% year-on-year growth was below target. Furthermore, the company failed to anticipate that the Coalition government would remove energy efficiency incentives. That shouldn’t have been a surprise.

Foolish takeaway

After the downgrade, shares are trading at about $3.25, which seems reasonable. However, I am not tempted to buy at these prices. It hurts to know that (quite recently) no fewer than four of the directors sold shares at $3.80 or above. I’m holding on to the shares I have now because I believe the company will benefit from rising gas prices. It is also positioning itself well to adapt to the increasing cost of grid electricity. The key metric to watch is the number of customers using its Activ8 service.

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Motley Fool contributor Claude Walker (@claudedwalker) owns shares in Energy Action.

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