Australia | Aug 29 2018
A deterioration in the energy segment of the satellite services market and a downgrade to 2018 earnings estimates has severely punished Speedcast International.
-Secures largest customer for an additional three years
-Lack of free cash flow a major disappointment
-Risk/reward relates to successfully integrating Globecomm
By Eva Brocklehurst
Speedcast International ((SDA)) is being punished severely by the market after delivering a downgrade to 2018 earnings estimates, as price pressures remain evident across the satellite services industry. The main driver of weakness was the energy division as an expected turnaround did not materialise.
Macquarie notes a material deterioration in market conditions, given the company stated a year ago that it expected an upswing in 12-18 months. The broker remains cautious, given the high hurdles for offshore developments.
The broker is concerned about the rapid deterioration in the energy segment and the downgrade to 2018 guidance. Speedcast's scale and market leadership across key vertical markets is attractive but Macquarie wants evidence of organic growth in order to drive a re-rating.
The punishment in the share price is an over-reaction, Canaccord Genuity believes, as Speedcast has announced an accretive acquisition of Globecomm and secured, conditionally, its largest customer for an additional three years.
The company reported first half operating earnings (EBITDA) of $60.4m, 14% ahead of the prior corresponding half, albeit weaker than the preceding half. Speedcast has provided updated 2018 operating earnings guidance of $135-145m, down from the guidance offered in May of $155m.
Morgans is unimpressed. The broker focuses on cash flow and notes operating cash flow was down -26% and, as capital expenditure was higher, free cash flow was non-existent. The broker acknowledges the dividend was held in place and net profit was up strongly.
The company continues to target net debt to pro forma operating earnings of 2.5x but this has not eventuated in the last few years, the broker observes, as Speedcast continues to make debt-funded acquisitions. Morgans does not have a problem with higher gearing for a defensive business with strong free cash flow but is disappointed that Speedcast's net debt has increased. The broker downgrades to Hold from Add and slashes its target to $4.09 from $7.21.
UBS notes the company is committed to accretive M&A as the second pillar of its growth strategy and has shown it can deliver accretion, having consummated numerous acquisitions at multiples well below where the stock is currently trading. In the case of the recent Harris CapRock transaction the price reflected an historically declining earnings profile. Value accretion, therefore, hinges on turning earnings around and a recovery in the energy division, in the broker's view.
Issues
Canaccord Genuity suggests a pilot phase for the Carnival Cruise contract tender process negatively affected first half earnings, while a challenged contract in Peru also detracted. Carnival Cruise is the company's largest service contract and, despite the stock trading at all-time highs prior to the result, the broker believes concerns around this transaction had limited increases in the share price.
The contract should grow gradually to around $75m by the end of the three-year period, from its current revenue run rate of $45m. The energy segment missed the broker's forecasts as well, yet all these issues are expected to reverse somewhat in the second half. Canaccord Genuity, not one of the eight stockbrokers monitored daily on the FNArena database, maintains a Buy rating with a $6.16 target.
CLSA, also not one of the eight, downgrades to Underperform with a target of $4.36. Guidance substantially disappointed the broker, with some customer churn and pricing pressure noted. The company expects a strong recovery in offshore rigs, offering the explanation that it is now more exposed to deepwater drilling, which is likely to recover later in the cycle. Still, CLSA expects the market to remain competitive and price pressure to continue upon contracts being renewed, as is evident in the cruise segment.
Meanwhile, contributions from the NBN contract are rather lumpy, stepping down to US$10-20m in FY19 from US$30m in FY18, and the company needs to fill the gap. The broker has questions about the earnings visibility, too, as a recovery in energy could be tempered by price pressure, and bandwidth growth in the cruise division may not be as strong as anticipated.
Globecomm
Speedcast will acquire Globecomm for $135m, to be funded by debt. Hence, flat earnings are expected in 2019. Morgans believes the key risk/reward relates to the company's ability to successfully integrate this acquisition and deliver the free cash flow that will de-gear the balance sheet. Upside risk should also come from a prolonged oil & gas recovery, although this is yet to eventuate.
UBS suggests the acquisition is inexpensive and allows the company greater access to more sensitive sectors in government. Nevertheless, Globecomm under private equity and other ownership has been underwhelming.
The broker calculates the acquisition, while accretive in 2019, should lift pro forma gearing to 3.3x. UBS reduces its target to $4.50 from $6.00 but still envisages upside to around $6.00 if the energy division rebounds. FNArena's database shows three Hold ratings. The consensus target is $4.53, signalling 13.8% upside to the last share price. This compares with $6.51 ahead of the results.
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