How Carillion’s dividend outlived its cash flow

On 9 June 2017, Carillion paid £54.4 million to its shareholders.

Thirty-one days later, it announced an £845 million provision against the value of its contracts, suspended the dividend and lost around seventy per cent of its market value over the announcement and the two days that followed.

The dividend had been proposed on 1 March. It was Carillion’s sixteenth consecutive annual increase.

The rise itself was almost ceremonial: from 18.25p to 18.45p a share, an increase of two-tenths of a penny. The announcement carrying it was headed “Performance in line with expectations”. It pointed to a pipeline of contract opportunities worth £41.6 billion, put revenue visibility for 2017 at 74 per cent and said the group had a good platform from which to develop the business in the year ahead. KPMG’s audit opinion on the 2016 accounts was dated the same day.

The surrounding system reinforced the signal. KPMG issued an unqualified opinion that the accounts gave a true and fair view and reported no material uncertainty over Carillion’s ability to continue as a going concern. The company sat in the FTSE 250 and was held through income funds and the trackers that followed it. It was one of Britain’s largest construction and services groups, running around 450 public sector contracts and employing 43,000 people worldwide. Government departments continued awarding it work. The dividend record reached further back than the financial crisis and had survived it.

None of that looked absurd on 1 March 2017. That is precisely the problem. The formal signals of assurance were pointing in the same direction.

A long run of rising dividends is supposed to carry weight because it is expensive to fake and difficult to sustain without real cash behind it. That is what makes the record valuable as a signal. It is also what makes the signal very hard to contradict once investors, executives and the board have built their expectations around it.

The received account of what happened next is a run of bad contracts. A hospital in Liverpool, a road around Aberdeen, a hospital in Birmingham, a development at Battersea, and several hundred million pounds owed and unpaid in the Middle East. Concentrated bad luck, in a sector where lowest-price tendering leaves nobody much room. All of that is true, and none of it accounts for the shape of what followed. The condition that mattered had already been going for years, in public, in the company’s own accounts.

Across the five years to 2016, Carillion paid out sixty-three million pounds more in dividends than its operations generated in cash.

That gap is worth your attention. It does not look like a problem. In a set of accounts it looks like confidence, and it looks the same in yours as it looked in theirs.

The mechanism that kept the cash signal looking healthier also has a name and a date.

In 2013 Carillion established an early payment facility with its banks, a structure also known as reverse factoring. Its suppliers were on standard payment terms of up to 120 days. Under the facility, a bank could pay a supplier sooner, less a financing charge, and Carillion would settle with the bank later. The supplier received its money earlier. Carillion kept hold of its cash for longer.

The consequence sat in the accounts. Amounts Carillion owed the banks under the arrangement were presented as other creditors alongside ordinary trade payables rather than as borrowing. Moody’s and Standard & Poor’s later argued that the facility was debt-like, and Moody’s estimated that as much as £498 million was outstanding through it.

Carillion’s 2016 balance sheet showed approximately £148 million of bank loans and overdrafts, although total reported borrowings across all categories were £688.7 million. The issue was not that every form of borrowing disappeared. It was that a substantial debt-like obligation sat within creditors, supported reported operating cash flow and did not appear in the debt measures in the way conventional bank borrowing would have done.

Across 2013 to 2016, Carillion reported £509 million of operating cash inflows. The joint parliamentary inquiry later found that, if the £472 million drawn through the early payment facility was treated as financing rather than operating cash, only £37 million of those inflows remained.

That changes the story told by the cash flow statement. Cash generated from operations looked stronger because a growing balance of money owed to suppliers and banks was holding it up. This was the number against which the affordability of the dividend was supposed to be tested.

Sixteen consecutive increases cease to behave like sixteen separate decisions. They become an institutional promise. The dividend starts as evidence of financial strength and ends as a condition the rest of the business is expected to preserve.

Once that happens, contrary evidence no longer enters a neutral decision. Cutting the dividend means admitting that the signal on which investors, executives and the board have relied no longer describes the company. The pressure is therefore not only to find the cash. It is to protect the story the cash has been telling.

The audit opinion did not make those signals reliable. The Financial Reporting Council later found KPMG’s 2016 work on Carillion’s financial position and going concern seriously deficient. An unqualified opinion had been issued. The rigorous challenge that should have supported it had not been.

The arithmetic ran a long time before it broke. Between 2009 and 2016, House of Commons Library analysis puts Carillion’s dividends at £554m, around three quarters of the cash its operations generated across the same period. Over the six years to 2016, the joint parliamentary committee found the company paid £441m in dividends against £246m in pension deficit recovery payments, nearly twice as much to shareholders as to schemes it was already behind on. In 2016 itself, £78.9 million went out in dividends against £73.3 million of net cash flow from operating activities.

The 10 July announcement ended the dividend record and erased around seventy per cent of Carillion’s market value over the announcement and the two days that followed. By the half-year results at the end of September, the total contract charge had reached approximately £1.2 billion, enough to wipe out the profits reported over the previous eight years.

On 15 January 2018, Carillion entered compulsory liquidation with roughly £29 million in cash against liabilities of nearly £7 billion. Around 30,000 suppliers and subcontractors were owed something in the region of £2 billion between them. Most are estimated to have recovered less than a penny in the pound.

None of this needed inside information. Three things were on the public record before 1 March 2017, and each was available to anyone who went looking.

In March 2015, the UBS analyst Gregor Kuglitsch published research arguing that Carillion was more heavily leveraged than it reported. He pointed at the extended supplier payment terms and the reverse factoring by name, and said a profit shortfall was likely. That was two years before the peak, and it identified the mechanism rather than the symptom.

On 22 September 2015, Markit Securities Finance reported that Carillion was the most short-sold stock in the STOXX 600, with short interest having doubled to 25.1 per cent of shares outstanding. By August 2016, IHS Markit had it carrying twice the short interest of any European company reporting that week, with 21 per cent of the shares out on loan. Short interest is not a diagnosis and it does not prove that the sellers are right. At that level, it is a question demanding an answer, and the data was public.

On 13 October 2016, Phil Oakley wrote a short piece for Interactive Investor headed "A stock in one chart: Carillion dividend risk". He noted that the pension deficit was the largest in the FTSE 350 relative to market value, that the £47m of extra cash put into the scheme in 2015 was money not going to shareholders, and that the dividend, which had cost £78m in 2015, might have to be cut. He read the forecast yield of 7.7 per cent as the market already pricing that cut in. It ran on a free retail investing site, four and a half months before the results.

For the investors, lenders and incoming chairs reading this, that is where the diligence question sits. The accounts carried formal assurance, but the quality of the challenge behind that assurance was later found wanting. The harder question is whether anyone with influence over the decision was required to read the payables line against the dividend line, and whether their conclusion could survive contact with a sixteen-year record.

A different move was available, and it can be dated. Balfour Beatty faced many of the same market pressures, including lowest-price tendering, weak UK construction demand and a legacy defined benefit pension, alongside its own sequence of profit warnings from 2013 to 2015. In January 2015 it cancelled a planned £200m share buyback. At its 2014 results that March it decided not to recommend a final dividend in order to keep the cash, saying it expected to reinstate the payout by March 2016. It had already sold Parsons Brinckerhoff to WSP, with net proceeds of around £753m, and it agreed a revised funding plan with its pension trustee. What that cost at the time was public and immediate. Balfour cut its payout to nothing for the year and told the market it was in trouble before the market had finished working it out. Carillion had the same options in 2014 and 2015. It is a comparison rather than a controlled experiment. The companies had different contracts, assets and exposures. The important difference is the choice Balfour Beatty made when preserving the distribution came into conflict with preserving cash. In March 2026, Balfour Beatty reported average net cash of £1.2bn and a record order book of £22.7bn.

The principle does not depend on scale. A distribution is a claim on cash you have collected. Profit you have recognised is a different thing, and so is an order book. A business that pays out more than it collects is spending what it doesn’t have and will need later, and the spending stays invisible for as long as the payables can be stretched to cover it.

The check takes an afternoon and requires neither a board process nor an auditor.

Take your last full year and begin with net cash flow from operating activities, after interest and tax. Put beside it everything distributed to owners through dividends or drawings, every unavoidable long-term cash commitment, including pension recovery payments, and the capital expenditure required to keep the business operating.

If the distributions are larger than what remains, the difference came from somewhere: cash accumulated in earlier years, asset sales, new borrowing or the extraction of working capital.

Then test the quality of the operating cash. Did it improve because customers paid more quickly and completed work converted cleanly into cash, or because the amount owed to suppliers increased? Did contract assets, accrued income or unbilled receivables grow faster than revenue? Has cash conversion moved beyond the normal cycle for your business?

Do the same for the most recent quarter. If recognised profit is accumulating in amounts recoverable on contracts while suppliers are waiting longer to be paid, the same shape is beginning to appear in miniature.

If the gap between what your business reports and what it actually collects were widening now, an analysis like this would find it.

The harder question is what happens next.

Who has the authority to say that the dividend, drawing or distribution is no longer evidence of strength? Who can stop it before another year is added to the record?

And have you made that person responsible for protecting the cash, or for protecting the story?