ALS Between A Rock And A Hard Place

This story features ALS LIMITED. For more info SHARE ANALYSIS: ALQ

-Significant investment in oil & gas
-Risks skewed to the downside
-Life sciences not compensating
 

By Eva Brocklehurst

Laboratory service provider ALS ((ALQ)) is between a rock and a hard place. The rock is its major clients, the minerals explorers. The hard place is the current downturn in oil and gas drilling activity. The company delivered initial earnings guidance for the first half of FY15 at its AGM recently. It was subdued. Profit guidance for the first half is $74m, 18% below Goldman Sachs' prior expectations and 26% below the prior corresponding half. The reasons for the downgrade remain the same as have prevailed for the past six months: market volatility, pressure on sample testing volumes, rate reductions in the coal business and oil and gas revenue slippage in the northern hemisphere. Positive aspects were few and far between, but brokers noted life sciences and industrial business segments are improving.

Goldman continues to view the stock's 10% discount to the market as appropriate. The ongoing weakness in mineral sample testing is consistent with many broker views that the company is caught in the middle of a multi-year downturn in exploration activity, amid ongoing cost discipline in the mining sector. Goldman notes the company's oil services business has been affected by the shift in oil and gas drilling activity in North America to production from exploration. The company has invested heavily in growing this segment in order to diversify its earnings base and generate revenue synergies by leveraging its laboratory testing skills. With net debt increasing, Goldman expects ALS will now focus on organic growth and reducing gearing. The broker maintains a Sell rating.

Deutsche Bank also has a Sell rating, unable to envisage a minerals recovery occurring in the next 12 months. The broker thinks the stock is expensive, trading on a price/earnings ratio of 16.6 times FY15 estimates, while revenue is volatile and could disappoint further. The deferral of oil and gas work may just be a shift in revenue to the second from the first quarter, but the broker observes significant changes to management commentary emanating over the last eight months. The broker attributes the changes to clients becoming more cautious regarding spending and not management performance. Deutsche Bank now considers the oil and gas segment is more volatile than previously thought. The net impact is a 12% reduction in key forecasts for FY15 and 5% for FY16-18.

The second half includes the seasonally weak December-January period so BA-Merrill Lynch suggests the risk is skewed to the downside in the near term. Geochemical sample volumes were down 27% in the June quarter and that is consistent with indications that drilling activity is ebbing. Furthermore, Merrills can find no evidence that suggests the market has bottomed, although the broker does note that its global commodities team is becoming more constructive on the outlook for gold and base metals. In order for the broker to become more positive on the near-term outlook for ALS  there needs to be a sustained level of pricing strength in gold and copper, to entice miners away from a focus on just improving cash flow. That said, the broker has a favourable opinion of the company and thinks the business can deliver in a recovery.

UBS is attracted to the company's leading position as a provider of minerals testing and its track record, but observes the acquisition of Reservoir has brought specific risks, being principally a coring business rather than a more traditional lab-based acquisition. Hence, it provides no relief in the current downturn in exploration. JP Morgan notes the growth in the company's life sciences and industrial business, but does not think this is happening fast enough to offset the weakness in the resources based operations. Moreover, life sciences is highly price competitive and this should keep margins in check.

This broker also has little visibility on a recovery. Junior miner equity raisings appear to have stabilised recently but a number of producers have witnessed their market caps fall into the junior miner category. Moreover, a good percentage of the capital raising implemented recently is for capital works, remediation costs or day-to-day operations. Macquarie considers there is a lot to like in the business as it is geographically diversified but, at the moment, earnings momentum remains negative.

The FNArena database is a sea of Sell recommendations. There are five, and the consensus target is $6.57, suggesting 15.0% downside to the last share price and compares with $7.21 ahead of the AGM. The dividend yield on FY15 and FY16 earnings is 4.3% and 4.8% respectively.
 

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