Slater & Gordon has announced that its profits for the 2015/16 financial year will be lower than the firm had originally forecast.
Although the firm stated that its Australian business was trading in line with its previous expectations the decrease in profit has been caused by poor November trading results.
Managing director Andrew Grech said: “We’ve previously advised the market that the performance of our UK operations during the first half has not been in line with our expectations. It’s clear to us that the slower rate of case resolutions in the first half has had a larger impact than previously thought, and that this may well flow through to a reduced profit for the full year.
“For this reason we’ve withdrawn our full year guidance and we’re conducting a review of our forecasting methods so that we can provide the market with greater clarity moving forward.”
The firm’s group chief financial officer Bryce Houghton and a number of independent advisors appointed by the board are carrying out the review. The updated forecasts will be released in January 2016.
The weak half-year results are being attributed to “cash timing differences and a poorer than expected case resolution profile”.
In November Australian listed Slater & Gordon saw its shares plummet 52 per cent following Chancellor of the Exchequer George Osborne Autumn Statement. The announcement laid out plans to remove the right to general damages for minor injuries such as whiplash.
Should the plans be enforced they could severely affect Slater & Gordon UK personal injury business. Despite being listed on the Australian Securities Exchange (ASX) around 40 per cent of the firm’s global revenue is generated in the UK.
During the last full financial Slater & Gordon’s UK revenue soared by 48 per cent, from A$143.4m to A$211.6m (£98.4m). Globally the firm saw revenue increase by 27 per cent from A$411.1m to A$521.9m (£242.9m).
However, the firm’s share price has taken a number of hits throughout the year in part due to its acquisition of insurance outsourcer Quindell’s professional service arm. Following the £700m deal the FCA launched an investigation into an overstatement of Quindell’s profits in 2014.
The FCA later ended its investigation in order to allow the Serious Fraud Office to begin its own criminal investigation.
Yesterdays announcement caused Slater & Gordon’s share price to fall 22.8 per cent from A$1.075 to A$0.83.
The UK FCA did not launch an investigation into “an overstatement of Quindell’s profits.”
Price Waterhouse Cooper had been called in to review acc policies and announced that QPP policies were ” aggressive” but did not note they were unnacceptable.
I am an accountant and former investment banker. The majority of the trade in the QPP Professional Services Division taken over by SGH was motor claims with case to cash timescales with experienced based parameters sufficiently good to support statistics based projections to support normal Work In Progress ( WIP) accruals valuations. In my view the QPP valuation of motor claims based WIP was acceptable, if aggressive.
The WIP however included a growing segment of new trade; Hearing Loss Claims. The pattern of case to cash is not well enough established to know the time period of case to invoice. My guess is that , although QPP was careful to report separately for HL claims trade, the management accounting systems used the same assumptions as those for motor claims. During a trading year , in a new trade segment, that is perfectly acceptable. It is acceptable and normal to wait as long as possible to “Adjust by journal entry” the assumptions used in new trade WIP valuation. In the year to june 15, it would have been fine to use overoptimistic assumptions until finalising the accounts so that as much real experience as possible could be factored in to final Hearing Loss claims related Work in progress valuation. In the event the new Board of QPP chose to publish results to 30 June 2015 by virtually ignoring normal accruals and instead to use near cash accounting. This was abnormal and only justifiable as the division had by then been sold to SGH. It ensured WIP was effectively reduced to absurd valuation and subsequently allows QPP to report a large profit on sale . ( it is clear that , for QPP there was an enormous loss on sale)
I believe the new QPP board change to near cash accounting was unnaceptable. KPMG could not sign the P/L account in the An report. The fact that QPP seems to have understated WIP and profits ( and consequent tax) is very unusual.
I believe the focus of the criminal investigation will be on the year to June 2014 HL WIP
when the HL WIP % of total WIP was tiny. There may have been overvaluation of HL WIP at 31 12 14….but any ovevaluation is likely to be immaterial in relation to EBITDA.
So the criminal investigation may identify a small and insignificant crime. It could lead to a slap on the wrists of previous directors.
Any student of accounts can see that SGH might experience slower case processing and may have overestimated the invoicing to Dec 2015. This may lead to a reduction in the 66% estimated profits leap in the year to 2016 ( and then a further 17% to JUNE 2017).
If SGH achieves only a 33% EPS increase to june 2016 and 17% to June 2017, that would be a 50% leap in 2 years. Most corporates would bite your hand off for 50% growth in 2 years.
SGH appears to have adequate finance in place to deal with the huge increase in WIP following the purchase of the PHD from QPP. Therefore , since it has adequate finance and has got to the point at which it is net cash generative, it seems pretty clear that with a case to cash cycle of 18 months, that SGH will report material EBITDA and PBT increases.
Since recent financial commentary is much about incomplete commentary and unbalanced reporting, SGH has been shorted to a significant degree. Shorters need a weakness and the perception is that SGH now has high gearing. It is going to reduce that gearing by a material amount in 18 months. In that context, a forward Price Earnings Ratio of 1.5 is in the theater of the absurd category.
If SGH returns to a low dull PE of 8 in 18 months. That would mean buyers today might experience 500% returns.
Ewan D H MacRae
Retired Lecturer in Corporate Finance
University of Glasgow