Increased Gold Exposure Lifts Emeco Outlook

Small Caps | Feb 20 2020

Emeco Holdings has lifted its gold exposure to 27% from 12% following the acquisition of Pit N Portal, which is expected to provide diversification and synergies within the workshops business.

-Rental division experiencing strong demand for heavy mining equipment
-Pit N Portal extends underground operating expertise
-Emeco Holdings considering dividends upon achieving its target leverage

 

By Eva Brocklehurst

Emeco Holdings ((EHL)) is pointing to a much improved second half as a number of new growth assets help lift overall productivity. The acquisition of Pit N Portal in January will be integrated by the end of March and will lift group gold exposure to 27% from 12%.

First half results were in line with pre-reported numbers with the operating earnings margin now above the prior mining boom, Macquarie points out. The first half margin was 48.3%, supported by ongoing improvement in utilisation and the integration of the high-margin Matilda business. Improvements in margins, to 48% from 46%, surprised Morgans in the context of comments just six months ago when the company said it aimed to hold margins steady.

Rental and workshop divisions are performing amid robust industry conditions. Macquarie notes the rental division is experiencing strong demand for heavy mining equipment in most commodities, the only soft spot being thermal coal.

Gold and iron ore contracts point to a stronger second half and FY21 in the western region, which has been challenged with tender delays as some existing contracts roll off. This has made it difficult to redeploy assets from projects which are winding down. Macquarie suspects, as the contract duration has lengthened, the market remains very tight.

Workshops

Macquarie points out workshops provide the company with the capability and critical components to keep the rental fleet functioning and mining customers working. It also allows Emeco to rebuild its fleet more cost effectively. Following the acquisition of Pit N Portal (PnP), a hard rock underground mining equipment business, the company has 900 staff that includes mechanics, boilermakers and engineers.

The consideration of $72m, Morgans calculates, represents a 3.6x multiple of PnP FY19 pro forma operating earnings versus Emecos' enterprise value/EBITDA multiple of 4.6x at the time. The company plans to extend its underground operation expertise following the acquisition.

PnP raises the stock's defensive attributes as gold offers insulation from the economic risks that can drive volatility in other commodities and affect demand. Still, Morgans points out it brings execution risks which the company will need to cater for and the market need to understand.

No guidance was specified for FY20 but the company indicated it expects improved conditions in Western Australia will help utilisation and rental margins. The PnP operating earnings are expected to grow by 15% in FY20 and FY21. This is an improvement on the metrics flagged at the time of acquisition, Morgans points out, noting the synergies with the Force maintenance business are the key attraction.

Incorporating PnP  into forecasts drives the bulk of the broker's upgrades to operating earnings estimates of 3-10% in FY20-22. While the acquisition is making sound financial and strategic sense, it will likely incur costs regarding the growing scope of the group, the broker adds.

Dividends?

The company has flagged the potential to refinance its 9.25% coupon US$322m notes post expiry of the non-call period on March 31. Moelis estimates this could deliver around $8-10m savings in interest costs per annum. The company is also considering paying dividends upon achieving its target leverage.

Moelis assumes nil dividends for now but, to illustrate, notes an assumed 30% pay-out ratio on normalised FY21 earnings per share estimates of 21.9c could imply a dividend of 6.6c. The broker has a Hold rating and $2.46 target.

The refinancing should provide a significant reduction in interest expense, Macquarie agrees. The company has $257m in unused Australian tax losses and cash tax is not expected until FY22 at the earliest, which in the broker's view will help deleveraging and support future dividends. Macquarie retains an Outperform rating with a $3 target.

Morgans asserts the re-acceleration of de-gearing and possible refinancing offer two key catalysts in the second half. The broker suspects the incentives for marginal investors to own the stock as an option are reduced, which may weigh on momentum investors. Nevertheless, the stock remains far too cheap and the broker retains an Add rating and $2.85 target.

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