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Tight Rental Market Enhances Emeco Holdings

Small Caps | Jun 19 2019

Brokers have become favourably disposed towards Emeco Holdings, as the market for earthmoving equipment rental is tight after significant rationalisation of industry participants.

-Emeco Holdings at its most profitable since listing
-Strong demand on Australia's east coast in coking coal
-Miners increasingly restraining capital expenditure on equipment


By Eva Brocklehurst

Earthmoving equipment provider Emeco Holdings ((EHL)) continues from strength to strength, having simplified its business model to focus on the Australian mining rental market.

Brokers have become favourably disposed towards the stock, with the company's latest operating update inferring further earnings upside. Sector demand has improved and the equipment market is tight. This is characterised by expanding original equipment manufacturer order books and lead times.

The rationalisation of industry participants has also significantly improved the operating environment in earthmoving, Bell Potter points out. The company is now the most profitable it has been since listing and returns on capital and rental operating earnings (EBITDA) margins are at their highest levels since 2006.

Morgans also notes the company's report on Australian mining fleet deployment versus production levels shows the industry has extracted strong gains in the last five years without any material growth in fleet size. This is likely to have stemmed from mine site efficiencies, stretching the usage of existing equipment and tightening availability. Macquarie agrees the company is well-placed to leverage a diversified asset base amid industry conditions which remain favourable for heavy equipment leasing.

Bell Potter initiates coverage with a Buy rating and $2.63 target, noting the prospective earnings leverage to any increases in demand and estimating that a 100 basis points uplift in average operating utilisation has scope to yield between $1.4-2.4m in earnings.

An expansion in the rental fleet is expected to contribute around $25m to FY20 earnings and the company has guided to operating earnings of $211-213m for FY19. Moreover, free cash flow is expected to materially increase after an accelerated capital expenditure program in FY19.

The broker believes the current stock price is undemanding, particularly in light of the operating leverage within the rental business. The company has exited geographic regions outside of Australia and this provides a more sustainable earnings profile through the cycle.

Customers are predominantly mid or junior miners and mining contractors that have become averse to capital expenditure on equipment. This is particularly the case for marginal production increases, overburden stripping or short mine life projects. Miners are increasingly restraining capital expenditure and at the same time contemplating production expansion to serve growth in demand.

Hence, brokers consider the company well-placed for the transition to a production cycle in the resources sector. Management has lowered gearing levels and, combined with recent upgrades to the credit rating, this should provide options for refinancing senior notes, Bell Potter suggests.

The company will consider dividends and share buybacks after the notes are refinanced in March 2020, although continues to evaluate strategic acquisitions. The business has had, historically, a large presence in coal mining, reflected in strong growth in eastern Australia. Nevertheless, the business model is inherently flexible.

Coking coal is the major generator of revenue and demand is strong, while thermal coal exposure is less than 25% of total revenue. Emeco Holdings has also signalled there is no financial impact from recent negative developments in the gold sector in Western Australia.

Demand remains particularly strong on Australia's east coast in coking coal and while the west has been slightly softer over FY19, the company has flagged a significant increase in bidding activity. Macquarie expects early works with civil/mining contractors at new iron ore mines could provide upside risk to FY20/21 numbers and maintains an Outperform rating and $2.60 target.

Morgans expects modest 4-5% operating earnings growth in the base business is readily achievable as the company improves utilisation and cost efficiencies, calculating a 20% return on capital in FY19. The broker considers the stock oversold at current levels and retains an Add rating and $3.22 target.

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