Carillion disaster shows that a crisis does not always make a buying opportunity

Carillion, is on the verge of collapse - it just goes to show, when a share price crashes, it does not always mean a buying opportunity is created.


Article updated: 15 January 2018 at 11:00am Author: Michael Baxter

Since this article was written, the company has filed for liquidation and shares have been suspended.

Carillion, the UK’s second largest construction company, is on the verge of collapse - it just goes to show, when a share price crashes, it does not always mean a buying opportunity is created.

Sometimes, bad news can be good for investors.

Consider BP, shares were trading around 600p, and then the Deepwater Horizon disaster occurred, and shares more than halved in price. But was this a buying opportunity? BP was (and is) a good company but the Gulf of Mexico disaster was enormously expensive, and then, just as the company seemed to be emerging from the crisis, the oil price collapsed. Despite this, shares are now trading at 534p. Okay, shares have been higher, but then so has the oil price, if you had bought into the company after the oil spill you would have made a tidy profit.

But what about Carillion?

The last time I wrote about the company was in July 2017, after the company issued a profits warning. It had big problems, but was the sell-off in shares over-done?

In fact, shares dropped from around 188p to 55p within a few days. But it was with some trepidation I re-visited the article - did I conclude shares had been over-sold? Well, I am relieved to say I didn’t. But I make no special claim of prophetic powers. Truth is, it was quite obvious the firm had deep problems, all that has happened since, is that the disaster has played out in slow motion.

Now banks have rejected the company's business plan and shares are down to 14p. (since suspended)

Carillion’s problem is that it operates in a business where margins are very tight, government contract work is risky, and its risky because it is highly complex and the penalties for overrunning are high.

But you just knew the company had deep problems when its big hope for recovery related to winning a contract for the massively unpopular HS2.

You have to wonder at government decision making. Why did it award the contract to a company as troubled as Carillion in the first place? This is not being wise in hindsight, at the time of the announcement, the media was full of warnings.

Talk that the company needs to get bailed out raises interesting questions. I am not a fan of bailing out troubled companies, but sometimes such a bailout is the lesser of two evils. It is just that it seems to me that if Carillon was allowed to go under, the work it is contracted to, would carry on and jobs would be created by the companies that inherit the contracts.

We have too many zombie companies at the moment, we don’t need any more.

Of course, this begs the question that if Carillion operates in such a high-risk area, won’t its rivals that take on the work be just as vulnerable?

Is the lesson of Carillion, beware of construction companies that do a lot of work with the government? Or did it just have the wrong management?

Time to buy

It also tells us that a collapsing share price does not necessarily mean a buying opportunity. Then again, it often does.

There is a form of human bias that afflicts us all, called availability bias. We tend to focus on headlines and think the problem is more widespread than it really is. Maybe, with BP, there was an element of that.

When stock markets crash, availability bias can become dominant and good companies get caught-up in the sell-off, which can indeed create a buying opportunity.

I am a tad worried about stock prices at the moment, and, as I have said here before, I think bitcoin is a bubble. We may see a tech crash following the bursting of bitcoin, but reading some of the words being uttered by some of the doomsayers, I think they are confusing companies such as Amazon, with a massive PE, but enormous potential for profits with fads such as bitcoin.

If we see a stock market wobble, or even some kind of mini crash, there will be the Carillion’s who get caught out, and there will be good companies, with strong or even outstanding prospects that get caught up, and it is for such firms that the buying opportunity is created.

Read more about Carillion

These views are those of the author alone and do not necessarily reflect the view of The Share Centre, its officers and employees.

Michael Baxter portrait photo
Michael Baxter

Economics Commentator

Michael is an economics, investment and technology writer, known for his entertaining style. He has previously been a full-time investor, founder of a technology company which was floated on the NASDAQ, and a director of a PR company specialising in IT.