ALS Still Needs Accretive Acquisitions

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

ALS is enjoying positive trends in geochemistry & metallurgy but its life sciences division still lags commodities as margin pressures remain stubborn.

-Commodities division exposed to an improving exploration cycle
-Needs accretive acquisitions to generate valuation upside
-Life sciences earnings and margin expected to recover slowly
 

By Eva Brocklehurst

Life sciences remains the weak spot for ALS ((ALQ)) although the growth strategy is being maintained, targeting bolt-on acquisitions, and brokers observe a more cautious outlook at the FY18 results.

No explicit guidance was provided this time, unlike FY17, Macquarie observes, yet the company is expected to return to its previous practice of providing first half guidance at its AGM.

Morgans notes ALS recently flagged $100-150m in acquisitions in FY19 but at the results briefing made no further mention of this target. The broker accepts executing accretive acquisitions in a highly competitive environment is difficult but this is something the company needs to do in coming years to generate valuation upside.

Credit Suisse also found the outlook less upbeat than that provided in November as the company cites continuing cost pressures in many of its businesses. ALS reported net profit of $142.2m, up 21% and at the higher end of its guidance range. This was supported by moving the loss-making oil & gas laboratory assets to discontinued operations.

Nevertheless, CLSA does not believe this feature detracts from the cyclical recovery in the commodities division, which now appears entrenched. Meanwhile, life sciences continues to lag as margin pressures remain stubborn.

CLSA remains positive about the exposure to an improving exploration cycle, and expects rising average realised prices should now supplement volume growth.

The broker, not one of the eight monitored daily on the FNArena database, notes the share price has fallen from its recent highs and the multiple eased materially. Hence, CLSA retains an Outperform rating and $8.00 target.

The company is becoming increasingly reliant on arresting the margin pressure in life sciences and executing on its "Project Everest" strategy but Morgans suspects the market will take a wait-and-see approach on both of these aspects.

This is particularly in light of the fact that the Alcontrol acquisition contributed to a further fall in the earnings (EBIT) margin to 12.5% in the second half. The company has admitted that integration took six months longer than expected but expects a full $10m contribution to operating earnings (EBITDA) in FY19.

Citi continues to be attracted to the cyclical recovery in commodities and the growth potential in life sciences. The broker also likes the industry and geographic diversity of ALS, and the strong balance sheet.

Life Sciences

Management stated that life sciences, 40% of earnings, was affected by integration-related disruptions, particularly in the US, but expects a slowly improving outlook linked to new project approvals and contract wins.

Competitive pricing pressure is reflected in the tempering of medium-term margin guidance for life sciences to 17-18%, from 18% previously, although Morgans points out there was little detail on when this will be achieved. The broker incorporates a 14.6% margin in FY19, implying a slow recovery.

Life sciences earnings were short of Macquarie's expectations, as was the margin. Yet the broker acknowledges recovery is continuing in Latin America and cost reductions in the Americas and the UK should drive higher margins.

Citi expects 17% growth in life sciences earnings in FY19, supported by the uplift from Alcontrol and an improved demand environment in the US.

Commodities

The commodities division reported underlying earnings (EBIT) of $123.5m, up 43%. The company has highlighted that sample flow into the geochemistry business was 26% above the levels of a year ago and remains optimistic about recovery and demand for services.

Citi expects commodities, 50% of earnings, to grow at a three-year compound rate of 18% to FY21, underpinned by cyclical recovery, exploration expenditure and market share gains. The broker forecasts EBIT margins to improve by 180 basis points to 25.6% in FY19.

FNArena's database shows two Buy ratings, two Hold and two Sell. The consensus target is $7.51, suggesting 3.0% upside to the last share price. Targets range from $6.50 (Ord Minnett) to $8.45 (Citi).

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