article 3 months old

Transfield Still Has Hard Yards Ahead

Australia | Sep 01 2014

-Cash flow, debt remain issues
-Progress made on margins
-Dept of Immigration key contract

 

By Eva Brocklehurst

Transfield Services ((TSE)) may have improved its performance during FY14 but the result has received mixed reviews. A number of issues remain to be worked through and broker opinions depend on just how confident analysts are in a light at the end of the tunnel.

CIMB worries about the need to normalise a number of factors on the balance sheet to arrive at the achievements the company indicates it has made. In particular, the difference between statutory and management-derived cash flow figuring requires a number of adjustments. The broker is always uncomfortable with having to make adjustments to the cash performance in this sector as cash flow is important to understanding true performance. Moreover, the significance of the contract with the Department of Immigration cannot be underestimated. Even outside of the issue of operating cash flow, or the level of debt, the broker considers the stock is too expensive. CIMB is concerned too that the bulk of FY15 growth is emanating from a single contract.

In contrast, Credit Suisse does not believe the valuation is demanding, given material business and balance sheet de-risking, and raises its rating to Neutral from Underperform. Management is making progress in dealing with unprofitable contracts, improving margins through a reduction in overheads, which Credit Suisse applauds. In FY15 the company will have benefit of a full contribution from the Immigration contract, and six months of an expanded Defence Department contract as well as a ramp up in NBN volumes. Credit Suisse acknowledges the concerns regarding the concentration of business with Immigration but does not expect this will be a major problem in the near term. The broker upgrades forecasts by 20% and 36% for FY15 and FY16 respectively, with the drivers being an improved earnings outlook and 17% reduction in depreciation.

The company has done well to push through cost reductions but JP Morgan is of a similar view to CIMB, believing the share price is not reflecting the challenges in end markets or the risks relating to gearing. On the positive side, the company does have good visibility on near-term earnings and could achieve margin improvement on ramping up of contracts, but there are limits to further material savings in Australasia. All up, high gearing dampens the broker's enthusiasm amidst the prospect of further headwinds from competitive end markets. Investors are not being fairly compensated for the downside risk, in the broker's view. JP Morgan downgrades to Underweight from Neutral.

Infrastructure outperformed Macquarie's expectations but this was offset by disappointment in the Americas and higher than expected corporate costs. The company's interests in the US delivered weak outcomes which included delayed work from key clients and problems with work flow. Transfield also exited the Chilean operation at a cost of $3.7m.The company has shifted more of its contract base to fixed fee and schedule of rates, which is a good step in Macquarie's view. The broker also likes the 46% win rate on new contracts as well as the 72% renewal rate.

Exposure to outsourcing in infrastructure management remains the key attraction in the stock for Macquarie. The more Transfield deals with its operational issues and stretched balance sheet the more the broker likes it. The company also exhibited a greater degree of confidence in the outlook, with competitive capability seemingly enhanced, given the indications in recent contracts. Add improving margins to the mix and Macquarie is happy to retain an Outperform rating.

 On FNArena's database Transfield has on Buy, three Hold and two Sell ratings. The consensus target is $1.47, suggesting 13.2% downside to the last share price and compares with $1.09 ahead of the results. Targets range from $1.13 to $2.03.
 

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