Up or Downer

OK, the stock’s a dog.

But might it be a counter cyclical punt? The announcement by Downer EDI that it would make a further $250 million provision for its Waratah project saw the shares fall by about a fifth. “Problems are compounding with no end in sight” Morningstar warns. “Here we go again” Macquarie Equities sighs. “We view this stock as uninvestable given management credibility, high gearing, prospect of further contract losses and overall lack of transparency despairs CBA Equities. The best times to purchase shares are when sentiment is universally negative sentiment, so might it actually be a sneaky buy for the brave?

Merrill Lynch thinks so. A Merrill report said that the provision “while disappointing” is offset by the fact that the company is strengthening its resources with a new project manager, Ross Splicer. Merrill has the stock on a low forward earnings multiple of 6.4 times, about half the market average, and a prospective dividend yield of 7 per cent, suggesting it might be a decent yield play.

There are many reasons to be bearish, though. A $250 million capital raising would be sizable — about a fifth of the company’s market cap (which just happens to match the drop in the share price). The reputation of the company’s management and engineering skills has taken a hammering. But the poor management is nothing new in Australian infrastructure projects; the level of talent is in exact inverse proportion to the seemingly endless rounds of self congratulation.

As one expert on project management told me, Australian managers tend only to be good at digging up mountains and shipping them to ports. Anything more complicated tends to be a bit challenging – investors in coal seam methane beware.

Despite the bearishness, collapse does not appear imminent (assuming everything is being disclosed by the company). Net debt to equity is not disastrous, at about 40%. Deutsche Bank estimates net interest cover on the company’s debt to be about 3.8 times.

Earnings per share growth after this financial year looks reasonably optimistic. Merrill has it at 15% for 2012 and 16% for 2013. Macquarie has it at 18% for 2012 and 10% for 2013.

So what do other brokers think? Morningstar has a hold for high risk investors, which is a logical middle of the road play, and assumes the market got its pricing about right. Deutsche has a hold and has reduced its target price to $3.75. Macquarie sits on the fence with a neutral recommendation. CBA has a sell.

So take your pick. But if Downer’s management starts to show the same diligence with its operations as it does with its executive bonus systems, there may be a case to buy on weakness – if you are brave.