A month ago we wrote about Utilitywise (AIM: UTW) and the commission repayment it was making to one of its energy suppliers. This was due to an overestimation of expected usage by a group of customers, which meant the related fees due to Utilitywise were to be reduced. It represented a serious setback for a share which has been in a downtrend since 2014.
Too cheap to be true
Our conclusion expressed in the Digest section of the latest GCI monthly was to ‘Avoid’ the stock. That was despite brokers’ revised forecasts showing the shares on a p/e of 4.8 for the current year, falling to 3.6 in July 2018. Rather than illustrating terrific value, this rock-bottom rating told us ‘all we need to know about investors’ view of earnings quality’.
That low opinion of profit quality has been quickly vindicated by more bad news. The company is changing its accounting policy to align revenues more closely with cash flows. An extension or renewal sale will now be recognised when the contract starts, rather than on signature. This means revenues for the year which starts tomorrow are now forecast by broker finnCap to be £94.8 million rather than £107.9 million. In addition contracts will be valued at 80 per cent of expected lifetime revenue rather than 85 per cent, which ties in with the amount billed on the invoice. There’s also been a £4 million shortfall in underlying trading performance.
These adjustments also mean that there’s a deficit in distributable reserves on the balance sheet: so there will be no dividend for this year, though the company aims to reinstate one as soon as possible. This kicks away another prop to the share price.
Is that it?
The upshot on the p&l is that earnings go from a previously forecast 21.6p to a revised 8.4p. So in reality, the stock was never on that bargain-basement rating of 3.6 times earnings. This was what the market was telling us by taking the shares down so far. Today’s further decline gives a current-year p/e of around 6. Whether Utilitywise can emerge from the ashes depends on how cash flow evolves over the next couple of years and the absence of further shocks.
The moral is to treat with suspicion stocks with a significant discrepancy between reported earnings and cash flow. We should also respect the market, which is pretty good at sniffing out situations where the numbers don’t add up.