ALS Outlook Mixed, Opts For Buyback

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Laboratory services business ALS provided a mixed outlook for FY18 after its first half result and has announced a buyback following divestment of its oil & gas segment.

-Asset care business retained
-Rate of growth in commodity sampling slows in second quarter
-Maintaining flexibility to take advantage of expansion opportunities
 

By Eva Brocklehurst

ALS Ltd ((ALQ)) earnings grew less than brokers expected in the first half, driven by weaker profit growth from the commodities unit and margin declines in life sciences. There was significant working capital outflow and impairment charges, which resulted in a reported loss of -$8.9m. Underlying profit was just inside the low end of the $70-75m guidance range.

Citi found cash conversion surprisingly low, highlighting significantly higher working capital. However the broker was encouraged by a beat on margins in commodities and the accelerating flow of samples, while noting life sciences continues to be a drag on performance. Management attributed this largely to the increased price competition in environmental testing.

Life sciences reported first half revenue of $366m and an operating earnings (EBIT) margin of 15.3%. Revenue growth was experienced across all geographies versus the previous corresponding half but there were competitive pressures in the US and UK which led to lower earnings in North America and Europe.

In summary, Citi reduces life sciences estimates, which partly offsets upgrades to commodities and the buyback, estimating the buyback to be around 4% accretive in FY19.

Meanwhile, the company has announced it will retain the asset care business, following a review and the receipt of non-binding expressions of interest. Support for the business growth plans will continue, including capital investment, geographic expansion and development of technical and systems capabilities.

The industrial division was flat because of the softening market conditions for asset care in both Australia and the US, which Deutsche Bank notes was offset by positive revenue contributions from Tribology. The broker decreases estimates for both the commodities and industrial divisions and reduces the margin assumption for commodities. Revenue estimates for life sciences are increased.

Citi remains attracted to the company's industry and geographic diversity and forecasts 29% compound growth in earnings per share to FY19, given a ramp-up in contributions from life sciences acquisitions and a cyclical recovery in commodities. Commodities recorded operating earnings (EBIT) of $56m, supported by the geochemistry business.

Commodity sample volumes increased 34% in the half, but Deutsche Bank notes the rate of growth did slow from the first to the second quarter, from 39% to 29%. The coal segment faces competitive pricing and reduced activity in exploration and resource definition, and continues to be affected by price volatility and market uncertainty.

The results were messy in Macquarie's opinion, with around -$7m in restructuring costs below the line and a -$63m asset impairment from the coal/industrial business. Macquarie notes the mid point of FY18 guidance – net profit of $135-145m — implies a similar second half to its forecasts, but around -5% below consensus, which is considered a proxy for likely reactions in the share price.

The broker observes price sell-offs have tended to create opportunities in the past few years, while the buyback should be supportive of the stock along with ongoing positive momentum in geochemistry. The broker retains its expectations for the mineral exploration cycle but believes further improvement needs to be demonstrated in life sciences.

Buyback

Following divestment of the oil & gas business and a review of ongoing capital requirements the company has determined a buyback is the most efficient means of returning excess capital to shareholders. The on-market buyback will be up to $175m.

The buyback is not expected to alter the existing dividend policy or business strategy and the company intends to maintain flexibility to take advantage of growth opportunities that may arise. Management is interested in opportunities in the food and pharmaceutical testing sectors.

Deutsche Bank does not believe a buyback is the most appropriate use of capital as a stock is close to 3-year highs, and also considers this a signal that life sciences acquisitions are proving difficult to complete in the current environment.

FNArena's database shows three Buy ratings and three Hold. The consensus target is $7.85, suggesting 7.0% upside to the last share price. Targets range from $6.88 (Ord Minnett) to $9.20 (Citi).

This stock is not covered in-house by Ord Minnett. Instead, the broker whitelabels research by JP Morgan.
 

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