Difficulties In Life Sciences Still Plague ALS

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

While life sciences margins surprised to the upside in the first half, brokers are unsure whether ALS Ltd can sustain these comfortably over the longer term.

-Growth of 8-10% is expected in geochemistry sample volumes in second half
-Leverage observed mid cycle via the raising of geochemistry prices
-Competitive volume and price pressures continue in life sciences, particularly the US
 

By Eva Brocklehurst

A surprise rebound in margins for life sciences spurred earnings growth for ALS Ltd ((ALQ)), along with continued share gains and price rises in commodities sampling in the first half.

However, geochemical volumes appear to be softening and brokers are unsure whether margins can be sustained over the longer term for life sciences. The rebound in margins to 15.1% was key to allaying market fears after disappointing numbers for life sciences in the prior half.

FY19 earnings guidance is for net profit of $170-175m. Earnings are typically affected by the Christmas closure of the mineral exploration sector, yet the company still expects 8-10% growth in sample volumes in geochemistry in the second half.

First half results were ahead of guidance with commodities generating 25% growth in revenue and 36% growth in operating earnings (EBITDA). There was 14% uplift in geochemistry volumes and an 8% improvement in prices. While revenue growth and pricing in the commodities division were significantly above Deutsche Bank's expectations, the life sciences and industrial divisions continued to underperform.

Geochemistry sample volume growth is easing and the broker expects this to slow even further, while life sciences seems to perennially disappoint. Deutsche Bank does not believe the stock deserves to trade on FY20 PE of 22x and maintains a Sell rating.

Conversely, Macquarie has an Outperform rating, believing there is good earnings growth in prospect, and prices will step up as volume growth slows in geochemistry. The broker considers life sciences is back on a growth trajectory, albeit off a low base.

Macquarie notes the UK business performed well, including the UK water acquisition, AlControl. Restructuring benefits also helped results in Canada and Latin America. A competitive US market and lack of infrastructure expenditure ensured US life sciences profits were lower.

The outlook now appears more upbeat than it did back at the September update and Credit Suisse also expects higher geochemical sample volumes and price increases will drive earnings, partially offset by the more subdued performance from life sciences and industrials.

Commodities

Successful price increases in the first half confirm to Morgans that activity and demand are robust, supported by an increase in market share as customers seek out the company's advantage in service and turnaround times. Sample growth may moderate but the broker believes the cycle has simply matured.

Importantly, Macquarie points out the company is showing leverage mid cycle in raising geochemical prices, which reflects a tightening market and positive effect from more greenfield work. While pricing/mix lagged volume growth over the last two years, the broker observes this is now showing a better trajectory along with improved volumes.

Life Sciences

Life sciences operating earnings of $61m exceeded Macquarie's expectations for the first time in a number of years. The division, nevertheless, endures ongoing competitive and volume pressures, particularly in the US, and a more gradual recovery in margins is now considered more likely.

ALS is becoming increasingly reliant on growth via the acquisition strategy in food and pharmaceuticals, in what Morgans observes is an increasingly challenged market.

Pricing pressure persists in the US because of overcapacity and apparent political impediments to new project approvals, the broker adds. The company's view on the long-term sustainable margin in the segment has eroded over recent years and 16-17% is now considered "possible" versus an 18% target just 12 months ago.

Credit Suisse suggests management is being cautious in guiding to a lower FY20 margin. A contribution of acquisitions and cost rationalisation could provide some relief, although competitive pressure is likely to persist.

The company continues to flag complimentary acquisitions in the segment and expects to deploy $60m for M&A in the second half, in addition to the $18m in acquisitions completed to date in FY19. The company has also confirmed the buyback will be increased to $225m and extended to December 2019.

FNArena's database shows two Buy ratings four Hold and one Sell (Deutsche Bank). The consensus target is $8.12, suggesting 10.8% upside to the last share price targets range from $6.85 (Deutsche Bank) to $8.70 (UBS).

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