Australia | Apr 20 2017
Brokers observe little valuation impact on Aurizon Holdings after Tropical Cyclone Debbie hit the Queensland coast early this month, although downside risks to the stock remain.
-Most of the negative impact on earnings likely to be recovered through the regulatory regime
-Could affect dividends, depending on whether the company looks through the cyclone impact
-Several risks to the downside prevail including the UT5 and freight reviews
By Eva Brocklehurst
Tropical Cyclone Debbie's impact on coal rail network operator Aurizon Holdings ((AZJ)) has been further quantified. Brokers find no valuation impact for the below-rail business, while the impact on the above-rail business is considered minor.
Tonnage guidance for FY17 is now 190-200mt versus 200-212mt previously. Guidance for operating earnings (EBIT) is reduced by $100m, to $800-850m. Three of the networks are now up and running, earlier than previously anticipated.
Cyclones are a regular occurrence in this part of Queensland and around $70-80m of the earnings impact is associated with the above-rail network, where the costs are likely to be recovered in FY19 through a higher regulated asset base.
Thus the impact on valuation for the company is neutral regarding the network business. The only drag Macquarie envisages is with the above-rail freight business where the impact is slightly ahead of expectations. Around11-12mt is expected to be lost from the system in April as a result of closures.
While the disruptions from the cyclone are non-recurring, Morgan Stanley envisages a risk of incremental delays to the company achieving its cost reductions in FY17 and FY18. This would be negative for valuation, in the broker's opinion, particularly if it reduced or delayed the company's ability to generate free cash flow in FY18.
The company has revealed the anticipated delays in coal deliveries, highlighting damage to the Goonyella system at multiple sites. Coal traffic has now resumed on the networks with the exception of Goonyella, which should re-start from April 26, albeit at reduced capacity.
Citi does not believe there will be any lasting impact on the company and with many miners able to operate, in contrast to the floods in 2011, there is scope for some higher tonnage in FY18.
Ord Minnett takes a slightly different view, noting the damage done to the central Queensland coal network by the cyclone, in particular the main system of Goonyella, is far worse than that sustained from Cyclone Yazi in 2011.
The broker assesses the cost of network repair for Yazi was $6m versus Debbie's $40-50m. Ord Minnett downgrades its forecasts for operating earnings by -14% for FY17 to reflect the impact, while upgrading FY18 estimates by 3% and FY19 by 12% because of assumed recovery through the regulatory processes.
The broker believes the impact would have been worse had the company not shifted its above-rail coal customers to new contracts, where roughly 70% of the revenue is fixed. Significant downside risk is still factored in, associated with the upcoming UT5 decision on rail access, the freight review, iron ore volumes and above-rail coal margins because of increased competition.
UBS incorporates a delay to the UT5 regulatory review process and, following Cyclone Debbie, downgrades forecasts for earnings and dividends per share by -15% and -5% for FY17 and FY18 respectively. The first year of normalised earnings is now estimated to be FY20, in which the broker forecasts earnings and distribution per share of $0.30.
The changes largely reflect a difference in timing and are neutral to valuation yet UBS believes they serve to highlight the volatility that occurs year to year in earnings and cash flow, which limits the infrastructure characteristics of the business and the ability to gear up.
In particular, UBS expects the business to generate a 20% free funds from operation/debt coverage in FY17, which is below the minimum 30% hurdle set by ratings agencies for the company's current rating.
The policy is to pay out 70-100% of earnings and the company has made no comment on the implications for the dividend from the downgrade to operating earnings guidance in FY17. Morgans assumes the company sticks to a mechanical application of the policy, resulting in a downgrade to second half forecasts for the dividend.
However, there is upside to the broker's forecasts if the board, instead, looks through the impact of the cyclone, given the strength that is building in free cash flow and the prospect for regulatory recovery in the future.
There are four Hold ratings and four Sell on FNArena's database. The consensus target is $4.86, signalling -6.1% in downside to the last share price. The dividend yield on FY17 and FY18 forecasts is 4.7% and 5.1% respectively.
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