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CIMIC share price crashes after short seller alleges that its “growth is an illusion”

James Mickleboro
Short Selling

The worst performer on the ASX 200 on Monday has been the CIMIC Group Ltd (ASX: CIM) share price.

The engineering-led construction, mining, services, and public private partnerships company’s shares fell almost 11% in morning trade before recovering slightly.

At the time of writing CIMC’s shares are down just under 7% to $46.60.

Why are CIMIC’s shares being hammered?

Investors have been heading to the exits in their droves after CIMIC became the latest ASX company to be targeted by an overseas short seller.

According to a note out of Hong Kong-based research firm GMT Research, its analysts allege that CIMIC “inflated profits by around 100% in the last two years through aggressive revenue recognition, acquisition accounting and avoidance of JV losses.”

CIMIC’s “growth is an illusion.”

Since 2015 CIMIC has grown its earnings by 50%, however GMT Research believes “this growth is an illusion” and the company has actually inflated its profits by $1 billion over the last two years.

“We estimate CIMIC has inflated reported pre-tax profit by roughly 100% over the past two years, or A$1bn in total, through a combination of aggressive revenue recognition, acquisition accounting and avoiding losses from its Middle Eastern JV.”

Adding that: “Key warning signs include the build-up of unbilled revenue and the low level of cash tax paid. Indeed, CIMIC has paid just A$161m in tax over the last three years on profits of A$2.8bn, implying a cash tax rate of less than 6%. It suggests profits declared to the tax authorities are much lower than reported earnings.”

Acquisition accounting concerns.

The research firm also has concerns over its $524 million acquisition of UGL. It alleges that CIMIC has used acquisition accounting with the purchase of UGL in 2016 to inflate profits.

It explains: “An acquiror can boost future profits by writing down the value of the target’s assets, such as inventory and fixed assets, or creating additional provisions or other liabilities, which can be utilised or reversed in future periods.”

It notes that UGL had net assets of $331 million prior to its acquisition and then net liabilities of $484 million when CIMIC consolidated it just a few months later.

“Following the acquisition, there was an immediate jump in UGL’s profits; it recorded EBIT of A$166m in 2017, its first year under CIMIC’s ownership, compared with just A$63m excluding provisions in its final year as an independent company. By recognising additional liabilities and probably writing down assets, we think CIMIC primed UGL for a rapid increase in profits. We estimate this has boosted CIMIC’s pre-tax earnings by around A$100m in the last two years.”

What now?

As we have seen many times before with short seller targets such as Blue Sky Alternative Investments Ltd (ASX: BLA), Corporate Travel Management Ltd (ASX: CTD), and Retail Food Group Limited (ASX: RFG), such allegations can weigh heavily on a company’s shares.

In light of this, I would suggest investors stay clear of CIMIC’s shares for the time being and wait to see how it responds to the allegations.

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Motley Fool contributor James Mickleboro has no position in any of the stocks mentioned. The Motley Fool Australia owns shares of and has recommended Corporate Travel Management Limited. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

The Motley Fool's purpose is to help the world invest, better. Click here now for your free subscription to Take Stock, The Motley Fool's free investing newsletter. Packed with stock ideas and investing advice, it is essential reading for anyone looking to build and grow their wealth in the years ahead. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson. 2019