Corruption case rocks Leighton and Hochtief

Leighton’s is making front page news in the Fairfax press on allegations of corruption, kickbacks for contracts and awarding incompetence and mismanagement.

- Majority shareholder Hochtief drops 8% in Frankfurt

- Former board members and CEO accused of signing off on the deals

- LEI’s cash flow remaining a key concern of the company

- Support: $15.80 and $15.20 Resistance: $20.10 and $20.41

The allegations are centred on dealings in Asia and the Middle-east, particularly in Indonesia and Iraq.

The Fairfax report states a $42 million payment was made to a corporate in Monaco that was nominated by Iraqi officials who then awarded a $750 million oil pipeline contract to the company.

Fairfax also alleged the Indonesian barge project was obtained in similar fashion along with projects in Malaysia.

This story has rocked both LEI and majority shareholder HOTG, with HOTG dropping 8% in European trade and LEI picking up trade on the Australian open to find itself down 9% and as much as 10% in early trade.

While the allegations are explosive they were known to both Australian Federal Police and ASIC and the market was aware of these allegations.

This begs the question, is the price action overdone or justified?

On an interim view; probably overdone. The company does not see any new allegations in this story and are ‘deeply concerned about suggestions of impropriety’. When a market overacts to tabloid news this hard we look to the underlying business for direction.

On current company guidance, CY2013 net profit is expected to hit $520 to 600 million with work-on-hand (WIH) estimated to be approximately $40.1 billion. Adding in the newly awarded contracts and WIH moves to $42.5 million come December 31.

LEI’s gearing is also falling, down from 48% in the first quarter to 36% at the end of the first half and earnings do look solid based on all WIH being collected. The concern here is around LEI’s current cash flow.

Cash flow contracted to negative 9 million dollars in 1HCY13 and despite LEI expecting a $500 million cash recovery in the second half of the year, some of this could be slipped as contract payments are miss, which affect full year profits.

With that in mind and the fact some contracts may now be under pressure from the allegations out of Fairfax, LEI’s share price slide may take a little while to recover from this initial shock. If there are signs of contract slippages, support around $15.80 may be test in the medium term. We do expect a pop in the interim as short term trades pick up the dips and stop out inside a 3 to 5%. 

All-in-all it will be a volatile trading period for Australia’s largest contract provider.

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