Why the UGL Limited share price has crashed today

UGL Limited has seen its share price plunge more than 20% in early trading after the engineering and services company warned it could face up to $200 million of contract losses.

In early trading, the UGL share price is down 27.5% at $2.50.

UGL is a contractor on the Inpex Ichthys LNG project, with a number of contracts and joint ventures. The UGL-Kentz JV is a 50.50 joint venture that was awarded a $740 million contract in February 2014 for the structural, mechanical and piping construction (SMP) package.

UGL also has another 50/50 joint venture with CH2M Hill, which was awarded a $550 million contract for the construction of a combined-cycle power plant (CCPP). In February 2015, UGL was forced to recognise a $175 million provision for the CCPP project, following a reforecast of the cost estimates.

UGL says it has raised claims with both projects with the client JKC Australia LNG Ltd (another joint venture between JGC Corporation, KBR and Chiyoda Corporation), with ongoing delays and disruption attributable to JKC. UGL says the commercial negotiations are becoming protracted and a formal dispute resolution process may be needed.

If the negotiations break down or aren’t resolved, UGL could be forced to book up to $200 million in additional provisions – on top of the $175 million already raised.

UGL says that excluding the Ichthys projects, the company continues to perform in line with guidance. The company says it expects to deliver 3% earnings before interest and tax (EBIT) margins on revenues of around $2 billion this financial year (FY16) and 4% EBIT margins on revenues of at least $2.3 billion (both excluding Ichthys).

This situation is one in which many contractors such as UGL, Downer EDI Limited (ASX: DOW), Cimic Group Ltd (ASX: CIM), GR Engineering Services Limited (ASX: GNG) and RCR Tomlinson Limited (ASX: RCR) can find themselves.

Even with the best risk management frameworks and systems in place, problems can occur that the client might be unwilling to pay for and the contractor might have to wear – or a dispute arises over who is responsible.

Foolish takeaway

As much as UGL might like to claim that ‘excluding the Ichthys projects’ it is performing as expected, the problem is that those projects are material to the company and raising provisions could see UGL make substantial losses on both. No wonder shareholders are abandoning ship today.

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Motley Fool writer/analyst Mike King doesn't own shares in any companies mentioned. You can follow Mike on Twitter @TMFKinga

The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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