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Why the Downer share price is crashing 26% lower on Thursday

The Downer EDI Limited (ASX: DOW) share price has come under pressure on Thursday following the release of a trading update.

At the time of writing the leading integrated services provider’s shares have crashed 26% lower to $6.45.

What was in the Downer update?

This morning Downer revealed that the underperformance of its Engineering, Construction, and Maintenance (EC&M) business means it will fall short of its FY 2020 profit guidance.

According to the release, Downer now expects its NPATA in FY 2020 to be $300 million. This compares to its previous guidance for NPATA of approximately $365 million, which represented 7% profit growth.

The company’s new guidance implies a decline of almost 12% from FY 2019’s NPATA of $340.1 million.

Why has Downer downgraded its guidance?

The main drag on its profits is project underperformance in the EC&M business.

Management explained that following the completion of a small number of loss-making construction contracts, the costs incurred during December and January materially exceeded its estimates.

CEO Grant Fenn said: “We have increased the forecast net costs to complete these projects by $43 million and these costs will be reflected in Downer’s results for the first half of the 2020 financial year.”

“We are particularly disappointed with the deterioration of these projects at such a late stage of their delivery. We do not expect any further increase in costs above our revised estimate,” he added.

Also weighing on its profits was lower revenue in the construction side of the EC&M business.

Based on current win rates and expected delays in project awards in the resources-based construction market, forecast construction revenue has reduced by approximately $300 million and forecast earnings by approximately $20 million.

In light of this underperformance, Downer plans to reposition its EC&M construction effort to markets and projects where it has competitive strength and the opportunity to drive related long-term service-based contracts.

As a result, it has provided $10 million for one off restructuring costs to reflect the net impact of staff redundancies.

However, it expects this change of focus to ultimately result in significantly improved earnings through better project performance, substantial cost reductions, and less volatility.

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Motley Fool contributor James Mickleboro has no position in any of the stocks mentioned. 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 Scott Phillips.

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