Minerals Buoy ALS As Life Sciences Sours

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Laboratory services business ALS Ltd confounded brokers with a slump in its life sciences division at the FY17 result, and several suggest this puts the stock's trading multiple at risk.

-Growth expected to continue in commodities as resources exploration volumes recover
-Weak performance in life science attributed to extra costs and largely considered addressable
-Company comfortable with consensus expectations for FY18
 

By Eva Brocklehurst

Laboratory services business ALS Ltd ((ALQ)) confounded brokers with a slump in its life sciences division at the FY17 result and several suggest this puts the stock's trading multiple at risk. Second half margins of 13.8% in life sciences were down -250 basis points and led to overall profits in the division falling -9%. Given the prominence of medium-term growth expectations in life sciences, brokers were disappointed with the outcome.

Morgan Stanley is concerned about the rally in the share price on the expectation of strong growth in the commodity business. The result, despite the contribution from the commodities division, missed the broker's expectations considerably.

The broker believes the weakness in life sciences potentially challenges that division's status as a defensive pillar within the business, to which investors have historically been prepared to attribute a significant multiple. The unexpected nature of the weakness and its multi-faceted nature are cause for concern, in the broker's opinion, and suggest the stock remains materially overvalued.

Net profit of $112.7m, excluding the oil & gas business, was in line with Ord Minnett's expectations. The broker considers the strong momentum in minerals a positive, especially with margins improving, yet agrees the mix shift towards commodities is, overall, negative for valuation, given the high multiple applied to life sciences.

The company has launched its 2022 aspirational targets to capitalise on the strong outlook for testing, inspection and certification from outsourcing, increased regulation and increasing global trade. Credit Suisse, assuming mid-single digit organic growth forecasts mean 6%, calculates $500m in revenue is needed from acquisitions by FY22 to underpin the company's aspirations.

Citi reviews its model on the transfer of coverage to another analyst, upgrading to Buy from Sell following recent share price weakness and an increase in valuation. Underlying net profit beat the broker's estimates, supported by an acceleration in geochemical sample volume growth and offsetting the slump in life sciences.

Citi remains attracted to the company's industry and its geographic diversity and forecasts around 13% three-year compound growth in earnings per share to FY19. This is on the back of the ramping up in contributions from acquisitions in life sciences and assuming 15-19% revenue growth in commodities.

Commodities

FY17 commodities division revenue was up 6% for the year. This division includes coal & minerals business and Ord Minnett believes there are good levels of organic growth, with sample volumes in geochemistry up 22%. Margin expansion to 20.2% in the division especially pleased the broker. Growth is expected to continue in this division as resources exploration volumes recover.

Credit Suisse suspects continued momentum in commodities, and the launch of an ambitious plan for 2022, may be enough to satisfy the market, which is expecting 20% growth in net profit per annum from FY17-20.

Macquarie also believes investors should be pleased by the operating leverage that is coming through in the mineral/commodities business. The broker observes, with less than one year into the typical 3-4 year mineral exploration recovery cycle, there is significant room for improvement. Nevertheless, the broker highlights a need for brownfield-driven exploration to shift towards greenfield for the margin mix to move back towards the 35% levels seen at the peak of the last cycle.

Life Sciences

Macquarie contends the reality for a diversified business means all systems do not fire at once and the life science business scored some "own goals" in FY17, which contributed to the weakness in earnings.

Prior weakness in Canada and Latin America was exacerbated by duplicated costs and some of the internal issues are expected to be easily fixed. While the market opportunity is evident, in the broker's opinion, execution still needs to improve. Credit Suisse also notes that the cost duplication in the UK life sciences segment from an acquisition has now been rectified and expects the causes of the decline to reverse.

Deutsche Bank is not concerned by the soft conditions in life sciences, believing it to be a relatively stable business, and continues to rate the stock a Buy, given strong growth in earnings per share and an attractive valuation relative to global peers. Ord Minnett, on the other hand, is alarmed by the trends in life sciences and estimates a -2% organic decline occurred in the second half, noting South American revenue fell -13%.

The company appears comfortable with consensus forecasts for FY18, which imply strong growth in minerals and some improvement in life sciences. Macquarie observes this also appears to pre-suppose a sale of oil & gas business, the divestment of which is nearing. The company previously flagged a book value of US$70m as a base-line for sale proceeds.

The company is planning further food testing acquisitions in Europe and North America with the aim to grow annualised food testing revenue to $200m in a year's time, up from $154m currently. All up, Macquarie believes investors should be encouraged by the strong result in minerals and the ongoing robust growth expected in FY18. Morgans, too, believes management's "comfort" with consensus FY18 forecasts implies a resolution to the life sciences issues, further momentum in commodities and a quick exit of oil & gas.

There are three Buy ratings, three Hold and one Sell (Morgan Stanley) on FNArena's database. The consensus target is $6.17, suggesting -6.5% downside to the last share price. Targets range from $3.27 (Morgan Stanley) to $7.41 (Deutsche Bank).
 

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