SNC-Lavalin: When good stocks go bad - MoneySense

SNC-Lavalin: When good stocks go bad

No one saw this latest scandal coming. Now what should investors do?

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SNC-Lavalin and its investors had thought its days of controversy were behind it, but it’s now part of a political scandal that could potentially put the Liberals out of power come October. It’s unclear just what the company’s role was in the Trudeau-Wilson-Raybould affair, besides wanting to put their sordid past finally behind them, but with #LavScam now a regular hashtag on Twitter, and Canadians reacquainting themselves with the Montreal-based engineering firm’s previous bad deeds, the company finds itself in hot water once again.

As difficult as the last couple of weeks have been for SNC, it’s been just as hard for investors who had believed the company was back to its pre-scandal self. For those who don’t remember, SNC is accused of paying Libyan officials around $47 million to influence government decisions between 2001 and 2011. Company executives also made a $22.5 million construction-related payment to McGill University Health Centre’s former head. Executives have been convicted of crimes, including former CEO Pierre Duhaime, who, on February 1, pleaded guilty to breach of trust and will now serve 20 months of house arrest.

SNC’s stock plummeted after these issues came to light, and rightfully so, but by last June its share price had rebounded to its 2011 highs. With a $14.9 billion backlog of work, and all of its previous executives long booted from the business, many people were bullish on the company’s prospects again. Yet, as we’ve learned before with SNC, and many other companies, seemingly good stocks can go bad in an instant, leaving investors wondering where they went wrong.

For SNC’s investors, the last month and a half couldn’t have gone any worse. On January 25, the company said it would miss its full-year profit estimate because of problems with a project in Chile, while Canada and Saudi Arabia’s ongoing political dispute is wreaking havoc with its Middle East energy business. On February 7, the Globe and Mail revealed that the Prime Minister may have pressured then attorney general Jody Wilson-Raybould to settle still outstanding criminal charges against SNC. Then, S&P downgraded the company’s credit and on February 22 SNC slashed its dividend by 65%.

Since January 25, the stock has plummeted by about 25% and as long as the company remains in the news it’ll likely stay low for a long time. As with any stock that suddenly runs into trouble, investors must ask themselves whether it’s worth hanging on, buying more at a now cheaper valuation, or if it’s time to sell out. When Paul Harris, a partner and portfolio manager at Harris Douglas Asset Management, is faced with this kind of situation, he first asks himself if the reason for buying in the first place has changed. “Is the company fundamentally sound?” he says. “That’s what the investor needs to come back to.”

It’s also important to consider the company’s debt levels, he says. If it’s too leveraged, and if business falters in the short-term, then that’s where the real trouble can begin. “Do they have a liquidity crunch?” he asks. “Do they have enough money to allow them to run the business?” Your investment thesis should still be sound too. With the G20’s Global Infrastructure Hub saying that the world needs to spend $94 trillion on infrastructure upgrade by 2040, will SNC continue winning big engineering contracts?

According to Marketbeat, SNC is a consensus buy, thought its rating has fallen from a 3 90 days ago to 2.63 today. Harris, though, thinks the business is still sound. Cutting its dividend was the right move—though he would have liked to have seen it go to zero—as it can now pay down its debt faster, he says. All of its contracts are still sizable and besides the one issue with the Chilean mine, it’s been able to complete projects without any material cost overruns.

It also owns part of Toronto’s highway 407, which many analysts consider a crown jewel in its portfolio. Its stake is valued at $30 per share by analysts, which means, at its current price of $36 a share, “you’re getting the rest of the business for free,” says Harris. The company is also trading at an 11.7 forward price-to-earnings ratio, according to S&P Capital IQ, it’s lowest in years. “There’s a pretty compelling argument to look at the company,” he says.

However, SNC’s political issues can’t be ignored. If can’t resolve its legal problems—SNC had thought that under newly introduced deferred prosecution agreement legislation that it would pay a fine and then move on—it could be barred from bidding on Federal contracts for a decade. It may also get harder to bid on international contracts if potential clients are concerned about how it might look to deal with a company that’s embroiled in scandal. While Harris thinks the company will rebound, especially if its legal issues go away, it’s still difficult to predict where things might end up.

That’s the rub: when things go awry, fundamental analysis only goes so far. Still, short of predicting the future, ensuring that the company you’re holding is a good one is the only thing you can do, though it also helps to be patient. It can take a while before these things resolve themselves, and that’s especially true in SNC’s case. “They’re always going to be in the news now, so that’s the hard part even if they have nothing to do with what’s going on,” says Harris. “That’s the problem.”