Downer EDI defends call to delay disclosing accounting irregularities that saw $660m in value wiped

The engineering company has defended its decision to wait three days before it disclosed historical accounting irregularities of up to $40m to the market.

Downer Edi lost $660m in market value as shares fell 20 per cent on Thursday.

Downer EDI says its knowledge of historical accounting irregularities was “insufficiently definite” to immediately disclose to the market, as it defended a three-day delay for investors and the ASX.

The group lost $660m in market value as shares fell 20 per cent on Thursday, after it outlined ongoing misreporting of revenue and work in progress on a $170m contract, which resulted in an earnings overstatement of up to $40m.

Downer also cut its annual profit guidance by up to $60m for the financial year as wet weather added to the pain inflicted on shareholders.

Downer’s outgoing chief executive Grant Fenn and senior management had became aware of ongoing misreporting of revenue and work in progress on the contract with a power company on December 5, three days earlier. The contract was struck in 2019.

“At that time the information was confidential, comprised supposition, and was insufficiently definite,” Downer said in a response to a letter from the ASX.

Downer said that the amount of overstated work in progress was difficult to assess given that orders were not completed and were still being worked on in the field, and an investigation was required to determine the extent and the reasons.

Shares had been 7 per cent lower in the five days before the disclosure on December 8, after Mr Fenn announced on December 1 he would hand control of the company to chief operating officer Peter Tompkins.

Two per cent of the loss came over Tuesday and Wednesday of last week as the company initiated a “detailed investigation”.

The group’s trading results for October and November and forecast for December were analysed on Wednesday.

“As a result of this investigation and analysis, after the close of the market on Wednesday and based on the information currently available, it was concluded that there were accounting irregularities in Downer’s Australian utilities business of the kind described in the announcement and a need to give the trading update contained in the announcement,” the company said.

Downer EDI chief executive Grant Fenn found out about the matter on the night of December 5.

Shares rebounded 0.3 per cent on Monday to close at $3.71, after falling on Friday to $3.70, their lowest point since April 2020. Mr Fenn told an investor call last Thursday that the group had initially found that revenue had been recognised prematurely for thousands of separate jobs related to the contract.

“It overstated the profitability in each period since it began and hid that the contract had been a loss,” Mr Fenn said.

The irregularities are estimated to result in a historical overstatement of pre-tax earnings in the order of $30m-$40m at the end of November 2022, accumulated across financial years 2020, 2021, 2022 and 2023.

Downer has been downgraded by several brokers since Thursday, with Macquarie saying the incident pointed to a failure of the group’s systems and processes, as well as the way projects are reported. UBS slashed its target price by 35 per cent to $4 and cut the stock to “neutral”, while Macquarie cut its rating to neutral and target price by 28 per cent to $4.05. UBS equities analyst Nathan Reilly said the irregularities highlighted internal control weakness within the business.

“While individually immaterial, with the annualised impact of the issue amounting to 2 per cent of EBIT, investors will be seeking reassurances that this control deficiency is not indicative of a more widespread issue,” Mr Reilly said.

Prior to the earnings downgrade, Downer in August had expected 10-20 per cent growth in underlying profit. It now expects underlying profit of between $210m to $230m for the financial year, assuming no further material Covid-19, weather, labour shortages or other disruptions.

The discovery of accounting irregularities is the latest in a series of misfortunes for Downer EDI, which has seen more than $1bn wiped from its market capitalisation in the past month.

In November, Downer suffered a first strike after more than 56 per cent of shareholders voted against the remuneration report at its annual meeting.