Tag Archives: Other Industrials

article 3 months old

Upper For Downer

Diversified engineering & construction conglomerate, Downer EDI, is expertly managing the move to infrastructure from resources but brokers believe this is largely reflected in the share price.

-Large potential in balance sheet for acquisitions and/or buy-backs
-Large amount of upside now factored into share price
-Citi: one of the best-placed options in the infrastructure sector


By Eva Brocklehurst

Engineering & construction conglomerate, Downer EDI ((DOW)), is moving with the times, countering the mining investment downturn with new business in infrastructure and ongoing work on the National Broadband Network. Net profit in the first half of $78m beat many broker forecasts, while FY17 net profit guidance has been raised by 7% to $175m.

The results beat Macquarie's estimates in four out of the six divisions, with the main surprise in technology & communications services, driven by a ramp-up in the NBN and Telstra ((TLS)) work. The broker expects these two should remain healthy contributors to Downer's income for the next 2-3 years, which highlights the benefits of the company's diversified nature.

The company has over $400m in potential capacity on the balance sheet for acquisitions and/or buy-backs, in Macquarie's calculations, and the earnings recovery for Downer has started earlier than expected, with 8.6% growth in prospect for FY18.

Soft Result In Utilities & Mining

The broker notes the completion of a major gas project and lower-than-expected profit from the Ararat wind farm muted the results in utility services in the half year. Moreover, the completion of the Christmas Creek contract contributed to a soft result in mining earnings, where EBIT declined 34%.

A $25m reduction in depreciation flattened the first half result, but as this relates to mining and the sale of some equipment, Macquarie does not believe it detracts from the services result, which was better-than-expected.

The company remains reasonably confident that the Adani Queensland coal project will proceed, having a letter of intent for both contract mining and the coal handling plant. However, Macquarie does not factor this into its forecast, nor has the company factored it into guidance.

While there is potential to exceed provides guidance and a high level of recurring revenues with low debt, Deutsche Bank is of the view that this is largely reflected in the share price, maintaining a Hold rating. Credit Suisse is even less enthusiastic, although concedes there was no hiding the strength of the result.

While it was hard to find an area that was disappointing the broker believes the outcome is reflected in the share price response. Credit Suisse upgrades its earnings base for FY17, assuming a similar, but now higher, earnings trajectory.

Record Work In Hand

Work in hand was a record $21.1m, reflective of recent wins in rail and around 58% of revenue being generated from public infrastructure clients. The growth outlook for transport, utilities and rail is strong while there are some headwinds across mining and engineering, construction & maintenance. Credit Suisse believes the business is exiting the high capex mining cycle in good shape, but this is reflected in the multiple.

The broker struggles to get its valuation close to the share price. Hence, an Underperform rating is retained. Nevertheless, Credit Suisse suspects this will be unlikely to compel holders of the shares to sell, particularly if they feel further earnings surprises can be delivered.

Morgan Stanley also suspects, despite the upgraded guidance, that downgrades to consensus EBITDA forecasts for FY17 are likely. The broker estimates that whilst FY17 net profit guidance implies around a 9% uplift to consensus, it is in fact a -7% downgrade to consensus EBITDA. The broker acknowledges the flexibility on the balance sheet and that a possible lifting of the final dividend has been flagged, but suspects the company's ability to fully frank this would be somewhat limited.

Citi notes management has taken definitive steps to restructure and appears to be managing the downturn in resources, shifting the portfolio towards the growing infrastructure and utility sectors. The broker is of the view that the exposure to public infrastructure investment puts it in a robust position for the medium term. While the 50% jump in the share price since the FY16 result has anticipated this to some extent, the broker still believes the stock is one of the best placed options in the sector.

FNArena's database shows one Buy (Macquarie) rating, three Hold and one Sell (Credit Suisse). The consensus target is $6.25, signalling -9.9% downside to the last share price. This compares with a target of $5.54 ahead of the results targets range from $4.01 (Morgan Stanley) to $7.45 (Macquarie).

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article 3 months old

Brokers Upgrade As Navitas Finds Clear Air

Education provider Navitas has cleared the headwinds brought about by the loss of its Macquarie University contract and brokers respond with several upgrades.

-Concerns over further contract losses allayed 
-University more central in the JV structure
-Scope for further capital management?


By Eva Brocklehurst

Education provider Navitas ((NVT)) has finally cleared the headwinds created by the closure of its Macquarie University program over a year ago, and brokers have responded with several upgrades to ratings.

The first half result was messy but in line with Credit Suisse expectations at the headline. First half operating earnings of $76.6m were down 7.5% on the prior corresponding half, primarily from campus closures and currency headwinds. Guidance for FY17 suggests operating earnings (EBITDA) will be flat, ex currency, at the group level.

Credit Suisse expects university partnerships will return to growth in the second half. Further rationalisation of colleges and a possible review of the remaining assets within the professional and English programs could provide scope for further capital management, the broker contends. Credit Suisse upgrades to Neutral from Underperform on valuation grounds because of the recent share price weakness.

The result was in line with Deutsche Bank's expectations at the net profit and EBITDA levels but revenue was well below forecasts. Nevertheless this revenue weakness was offset by significantly better cost performance.

The broker is wary about the step-up in net debt and the low cash conversion during what is still, effectively, a period of transition. The company has confirmed a buy-back will resume, which Deutsche Bank suggests should provide some support for the share price.

Strong International Student Growth

Macquarie upgrades to Outperform from Neutral, believing the company will benefit from strong, long-term international student growth. This should be underpinned by steady fee growth and the additional margin benefits of increased scale and efficiency. The broker forecasts FY18 and FY19 EBITDA growth of 8% and 7% respectively, driven by a respective 10% and 8% growth in the core university partnership division.

Fears of further contract losses have been allayed, following a run of renewals. Macquarie expects all contracts due for expiry in 2017 will be successfully renewed. Regulatory risk is also reduced, with favourable government sentiment in Australia and Canada.

Moreover, international education is economically important in the US and UK, where it contributes US$34bn and GBP15bn annually, and the broker suggests this provides a safeguard against overly adverse policy shifts.

Macquarie expects the decline in UK enrolments will cease and be followed by a period of low growth. Muted growth is expected in the US.

A positive aspect, in the broker's opinion, is the company's exposure to lower-ranked universities which are suspected to be more reliant on its services. Macquarie also believes the joint-venture structure allays concerns held by higher-ranked universities over outsourcing university programs as, under a JV structure, the university will be more central in the maintenance of standards and ultimately in the protection of its brand.

Is The Share Price Full?

The broker considers Navitas large and competent enough to withstand increased government scrutiny of the various courses on offer and their eligibility for loans. Demand is expected to lift as weaker competitors fall by the wayside. The broker also believes the company has a good chance of lobbying for an amendment to the loan cap on nursing, a key employment growth area.

Morgan Stanley is pleased there is finally clear air ahead for Navitas. The debate for the broker now centres on the level of sustainable growth and the right multiple to pay for this growth. Guidance suggests growth levels are robust but the broker notes this also comes with a wider risk profile than existed in the past.

Morgan Stanley believes the current price/earnings ratio of 20x on FY17 estimates, and 18x on FY18 estimates, is relatively full. Therefore, an Equal-weight recommendation is retained.

UBS upgrades to Buy from Neutral. With the transition from the loss of the Macquarie University contract largely completed, and the recent addition of another US college, the broker believes the market can renew its focus on the potential growth in earnings and the other attractive attributes of the stock. These include a high return on capital, strong cash flow conversion and a low-geared balance sheet.

FNArena's database contains two Buy and three Hold ratings. The consensus target is $5.03, suggesting 10.9% upside to the last share price. Targets range from $4.40 (Credit Suisse) to $5.30 (Deutsche Bank). The dividend yield on FY17 and FY18 estimates is 4.4% and 4.6% respectively.

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article 3 months old

NRW Holdings (NWH) Ready To Run

By Michael Gable 

Although NRW Holdings ((NWH)) started the year under 10c, the trend actually looks very sustainable and we expect there to be further upside.

After jumping sharply earlier in the year. the stock then spent a few months consolidating sideways to digest that move. It then rallied again during August before tracking sideways once more to consolidate that move. It now looks like NWH is on the move again and we can see potential for it to run towards resistance near 90c. Traders should place their stops near 60c.

Content included in this article is not by association the view of FNArena (see our disclaimer).
Michael Gable is managing Director of  Fairmont Equities (www.fairmontequities.com)

Michael assists investors to achieve their goals by providing advice ranging from short term trading to longer term portfolio management, deals in all ASX listed securities and specialises in covered call writing to help long term investors protect their share portfolios and generate additional income.

Michael is RG146 Accredited and holds the following formal qualifications:

• Bachelor of Engineering, Hons. (University of Sydney) 
• Bachelor of Commerce (University of Sydney) 
• Diploma of Mortgage Lending (Finsia) 
• Diploma of Financial Services [Financial Planning] (Finsia) 
• Completion of ASX Accredited Derivatives Adviser Levels 1 & 2


Michael Gable is an Authorised Representative (No. 376892) and Fairmont Equities Pty Ltd is a Corporate Authorised Representative (No. 444397) of Novus Capital Limited (AFS Licence No. 238168). The information contained in this report is general information only and is copy write to Fairmont Equities. Fairmont Equities reserves all intellectual property rights. This report should not be interpreted as one that provides personal financial or investment advice. Any examples presented are for illustration purposes only. Past performance is not a reliable indicator of future performance. No person, persons or organisation should invest monies or take action on the reliance of the material contained in this report, but instead should satisfy themselves independently (whether by expert advice or others) of the appropriateness of any such action. Fairmont Equities, it directors and/or officers accept no responsibility for the accuracy, completeness or timeliness of the information contained in the report.

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article 3 months old

Is Downer’s Valuation Becoming Stretched?

Infrastructure, engineering and mining contractor, Downer EDI, has won a major contract for Sydney trains. Brokers mull over the growth potential ahead.

-Rail projects likely to drive a positive outlook for earnings in FY18
-Over 55% of revenue now generated from servicing public infrastructure
-Yet several brokers consider the stock's valuation is stretched

By Eva Brocklehurst

Infrastructure, engineering and mining contractor, Downer EDI ((DOW)), has won a second major contract out of the three large Australian public sector projects recently up for grabs. The Sydney growth trains contract is worth $1.7bn and follows the contractual close of the Victorian government's $2bn high capacity metro project, with Downer part of the Evolution Rail consortium.

The Sydney growth trains contract includes an order of 24 double-deck trains with options for up to 45 additional sets and maintenance of the trains for an initial period of 25 years, plus two optional five-year extensions.

Macquarie believes rail will drive a positive outlook for Downer's earnings in FY18 and the long-term maintenance business from this latest contract is the main prize. Macquarie estimates $30-40m in potential maintenance revenue per annum once the trains are built. The broker believes this latest win fits well with the company's previous win in Victoria and the Newcastle light rail, providing a solid foundation for growth in the rail business going forward.

The broker also envisages this latest contract with Sydney trains has a much lower risk than the prior troubled Waratah contract. Macquarie considers the sale of the power asset, Ausgrid, provides an opportunity for Downer from the potential outsourcing of power/utilities maintenance in NSW. The broker retains an Outperform rating.

Credit Suisse takes the opportunity to review assumptions and notes the company has positioned itself well for a move away from the challenged mining and engineering, construction & maintenance sectors.

Over 55% of revenue is now generated from servicing public infrastructure customers in Australasia and this should increase as more government spending is directed towards infrastructure. The company maintains strong cash flows and this should contribute to a further strengthening of the balance sheet, leaving plenty of head room for capital management and further M&A.

Yet, quantifying the earnings turnaround is difficult, the broker asserts. Arguably, recurring public infrastructure and maintenance work should warrant a higher multiple, but with a 44% lift in the share price after the FY16 result, and the stock trading at around 16 times forward consensus earnings per share, Credit Suisse believes there is more risk to the downside. The broker considers, despite a strong balance sheet and capacity for growth, the valuation is stretched.

That said, Credit Suisse does not discount the leverage the new contract wins provide for continued expansion of trading multiples. For example, if the Adani Carmichael mine is developed with Downer as a contractor, this could add up to $0.50 per share to valuation.

The broker remains reasonably confident in the sustainability of earnings, yet given the material re-rating post the FY16 result, downgrades the stock to Underperform from Neutral. Credit Suisse contends that the business still needs to prove the earnings multiple inherent in FY19 forecasts.

Deutsche Bank notes the manufacturing of the trains is being sub-contracted to CRRC and Downer will not generate much income from that part of the contract. The broker estimates project management will provide $50m revenue per annum for two years and the maintenance work will provide around $30m in revenue per annum once all trains have been delivered.

Delivery of Australian passenger trains has usually suffered significant cost increases and been unprofitable for the contractor but the broker suspects this one is probably lower risk, given it will be based off the last recently-delivered passenger train. Deutsche Bank adds around 1% to earnings per share forecasts for FY17-21. The broker considered the risk/reward is balanced and retains a Hold rating.

Morgan Stanley envisages the project is relatively low risk for Downer, as JV partner CRRC is accountable for train construction and Downer is assuming a project management and maintenance role. Still, the contract means little in the way of a short-term uplift for earnings.

The broker is also inclined to the view that with the stock now trading on its highest price/earnings ratio ever (16x) and with no known significant catalysts for upside ahead, there is risk to the downside. Morgan Stanley retains a Equal-weight rating.

FNArena's database shows two Buy ratings, three Hold and one Sell (Credit Suisse). The consensus target is $5.42, suggesting 9.3% downside to the last share price. Targets range from $4.01 (Morgan Stanley) to $6.40 (Macquarie).

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article 3 months old

Timing Still Unclear For Turnaround In ALS

Expectations for the minerals and life sciences business of ALS Ltd have improved but questions remain regarding the timing of the turnaround.

-Plans to divest oil & gas business and scale up food analytical business
-Little benefit yet seen in the improving geochemistry cycle
-A higher stock rating may attract further corporate interest


By Eva Brocklehurst

Analytical laboratory business ALS Ltd ((ALQ)) expects its core minerals division is on an upward trajectory while life sciences, having been affected by several issues, should now turn around. First half net profit of $51.4m was at the lower end of guidance of $50-55m.

Morgans expects the outlook for the minerals business to materially improve in FY18/FY19. The stock is trading at a price/earnings ratio of 20x on the broker's FY18 forecasts, a 60% discount to international peers. The broker believes the leveraging of ongoing improvements in mineral exploration justifies an Add rating on the stock.

The company is looking to divest its oil & gas business, which lost $13.3m in earnings in the half year. ALS expects to continue oil & gas laboratory operations, which are currently making a small loss as they are in the development phase. The FY17 result is expected to still show underlying weakness in resources, but Morgans observes industry data suggests a better environment over the coming 12-24 months.

The broker acknowledges it is difficult to pick the quantum and speed at which fortunes will turn around, but expects investors will be rewarded in the longer term by significantly higher earnings. On face value the stock appears expensive but Morgans continues to believe services businesses should be bought at the bottom of the cycle when they are expensive, as earnings will flow through.

Macquarie also suggests that for cyclical businesses that are coming out of a downturn the turnaround is never as immediate as one would wish. The share price implied great expectations entering into the downturn and guidance remains similar to consensus ahead of the result, so there were no upgrades on which to pin further optimism.

Nevertheless, the company has ended the first half with positive momentum and sample flows continue to accelerate. The broker believes the divestment of the underperforming oil & gas business is a positive as this will increase the company's focus on the core minerals, life sciences and industrials divisions.

That said, it remains unclear as to whether the company will hold onto assets if the divestment process is unsuccessful. The broker envisages the big end of town to be the logical buyer of the oil & gas business, such as Haliburton or Schlumberger.

The company is also in advanced negotiations regarding a number of acquisitions which should be completed by March. This remains consistent with the strategy to scale up the food business. The investment thesis has not changed in terms of the positive leverage to the exploration cycle and the broker considers the oil & gas divestment and sensibly-priced acquisitions are key positive factors.

Macquarie notes there has been no developments since the Bain/Advent takeover approach back in June. The share price is now moved ahead of the $5.30 indicative price and, with a focus on the earnings recovery in the minerals business, provides somewhat of a floor below $6.00, in the broker's opinion.

The results suggest to Morgan Stanley the business remains under pressure and investor perceptions of a rapidly improving geochemistry cycle are offering little benefit as yet. The broker is also concerned about a poor result in the life sciences operation, which is generally considered to be defensive. Life sciences earnings were down 5%. This is also a concern given the company plans to dramatically ramp up acquisitions in this part of the business.

Morgan Stanley is also surprised by the decision to exit the oil & gas business, as the company only acquired it in 2013. The broker believes the shares are factoring in a cyclical recovery which may not be forthcoming and finds the stock is unattractive at this point in time, retaining an Underweight rating.

The outlook commentary was positive and Citi expects management changes in Canada and Latin America should provide support for growth in life sciences. There are also positive signs for geochemistry volumes which were up 30% in the half year. Although positive cyclical indicators are emerging, the broker considers the share price already anticipates a significant recovery, which may take longer than anticipated to realise.

Citi increases net profit forecasts for FY18 and FY19 by 4% and 7% respectively, as a result of incorporating the ALcontrol acquisition and a more positive outlook for minerals. On a broader view the broker notes exploration expenditure appears to have found a bottom as there are early signs that miners are returning to low-cost exploration to shore up longer-term reserves and production profiles.

Credit Suisse's Neutral rating reflects a trade-off between the uncertainty in timing and magnitude of the earnings recovery and further corporate interest in the stock. The broker remains cautiously optimistic, noting uncertainty around oil & gas is being removed and investors are now likely to re-focus on organic and acquisitive growth.

Opportunities in life sciences remain a key driver of growth but, in time, this may be accompanied by a higher stock rating and attract further corporate interest, the broker contends. Credit Suisse also question the timing of the decision to offload the oil & gas business in the context of a broader commodity price rally and a lost option for a higher sale price if conditions improve.

The upside to Ord Minnett's valuation is restricted by a downgrade to margin forecasts and a reduction in the enterprise value/earnings multiple in life sciences. Despite the M&A activity and more bullish forecasts in the minerals business there is still not enough upside for the broker to become more positive and a Hold rating is retained.

FNArena's database shows two Buy ratings, three Hold and two Sell. The consensus target is $5.67, suggesting 8.6% downside to the last share price. This compares with $5.30 ahead of the results. Targets range from $3.27 (Morgan Stanley) to $7.08 (Morgans).

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article 3 months old

Programmed Maintenance Stabilising

The business of workforce provider Programmed Maintenance appears to be stabilising and brokers remain confident gearing levels will ease.

-Meaningful uplift required in second half to achieve guidance
-Strong free cash flow supporting the outlook
-Further cost savings and efficiencies expected


by Eva Brocklehurst

Programmed Maintenance ((PRG)) has highlighted a stabilising of its businesses with the integration of the Skilled Group acquisition almost complete. Debt levels remain the biggest issue but brokers are reasonably confident gearing is on the downward path.

The compnay's FY16 result revealed earnings of $43.4m were up 75% on a year ago. The result includes a full six months incorporating the Skilled merger. Marine revenue was down 80% and staff numbers 90% since the peak two years ago, but management believes this business is now stabilising at current activity levels and expects it to grow in FY18.

Management has retained FY17 operating earnings guidance of around $100m, which suggests to Ord Minnett a meaningful uplift is required in the second half. Still the broker is encouraged by the board's confidence in second half cash flows.

The company has suspended its dividend reinvestment plan and continues to guide to net debt being less than $200m by March 2017. A fully franked interim dividend of 3.5c was declared, down 46% on the prior corresponding half and representing a 50% pay-out of net profit after tax and amortisation.

The stock remains depressed and gearing is the biggest hurdle to a re-rating, in Ord Minnett's view. Despite a business that is relatively light on capital investment requirements, and an offshore oil & gas business which is at a trough in earnings, the stock trades on a forward price/earnings multiple of around 10 times, which the broker calculates is around a 40% discount to the Small Industrials index.

Flagging a strong track record in reducing capital intensity in the various divisions, Ord Minnett notes the company has already reduced debt from around 2.5 times earnings in FY09 to be almost net cash in 2015 and maintains an Accumulate recommendation.

The results go some way to easing Deutsche Bank's concerns following the downgrade in September and highlight the stabilising of the workforce business. Strong free cash flow indicates the risk/reward is favourable and underscores the broker's belief in the investment proposition.

The company has signalled there are opportunities although conditions remain challenging. Specifically, tenders under way in workforce and valued at $300m were noted, with an expectation that some will be won over the second half of FY17.

Deutsche Bank's FY17 earnings forecasts are unchanged and in line with guidance, while FY18 estimates are downgraded by 7% on weaker staffing earnings forecasts. The company expects staffing performance to improve over the second half with the completion of the integration of Skilled.

Macquarie highlights that the oil & gas business has now been folded into the operations & maintenance business, a move which will generate further cost savings. Moreover, the workforce business is now on a single system which should boost efficiency.

Margins improved because of the incorporation of the higher margin Skilled business and the consolidation of 20 branches. Macquarie notes a significant portion of the synergies in the half year came from this source. Margins in the property and infrastructure business were lower, as the downturn in mining capital expenditure continues to have an impact. The broker is happy that debt levels are reducing and considers the stock valuation undemanding.

UBS believes the company has, arguably, been in a state of transition for some years, ever since the merger with Integrated in 2007, but is confident earnings have troughed, which should translate into improving returns going forward.

There are four Buy ratings FNArena's database. The consensus target is $1.98, suggesting 13.5% upside to the last share price. Targets range from $1.80 (Ord Minnett) to $2.10 (Deutsche Bank). The dividend yield on FY17 and FY18 forecasts is 4.9% and 5.8% respectively.

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article 3 months old

Incitec Pivot Outlook Hinges On Key Prices

Prices for Incitec Pivot's key fertiliser products are subdued and brokers are unsure when the market will signal a nadir has been reached.

-Promised capital management likely pushed out to FY18
-Decline in softs inventories, higher prices required as signal for fertiliser prices
-Cash-flow outlook suggests moderation in gearing metrics


By Eva Brocklehurst

Earnings weakness is expected to persist for Incitec Pivot ((IPL)) as prices of its key products for fertilisers are subdued and its explosives business remains tough. The question for brokers is when the market will signal prices have reached a bottom.

Morgans suspects the challenging conditions may even worsen in FY17. Materially higher interest expenses are also expected to affect profit growth. The broker observes the company's commentary at its earnings release was notably downbeat. Structural changes in the US coal market and a cyclical oversupply of ammonium nitrate in Asia-Pacific and the Americas are expected to weigh in FY17.

Morgans upgrades FY17 earnings forecasts by 1.8% because of lower gas and higher urea price assumptions but net profit estimates are reduced by 9.1% because of the expected higher net interest. Given the tough operating environment the broker believes the capital management that was promised following the commissioning of the Louisiana ammonia plant (WALA) is likely to be pushed out to FY18.

earnings declined 26% in FY16. The fall was driven by a sharp decline in fertiliser commodity prices in the second half. Fertiliser earnings were down 63%, explosives down 6% while industrial chemicals were up 26%.

Deutsche Bank also expects the cyclical reduction in global fertiliser prices may continue into 2017. The broker believes the Louisiana plant will provide a step change in earnings over the next two years and the company will fulfill its promise to return capital upon attaining reliable production. The Australian explosives business, meanwhile, is likely to benefit from higher coal and iron ore prices. Moreover, North American coal trends are improving and inventory declining, the broker notes.

Morgan Stanley remains bearish, especially for the near-term. While investors may be hopeful of a cyclical recovery, the first half could test their resolve. At some point the company will benefit from better fertiliser markets but the broker does not believe that time is now. Earnings per share estimates are lowered by 14-18% for FY17-18. Without a definitive indication that earnings have hit a low Morgan Stanley considers the stock significantly overvalued.

The broker acknowledges recent improvements in urea prices may be a turning point but notes that DAP (di-ammonium phosphate), ammonia and soft commodity prices continue to show negative momentum.

Goldman Sachs concurs. A significant decline in soft commodity inventories and subsequent stronger pricing are required in order to become more positive on the company's fertiliser and ammonia business. The broker, not one of the eight monitored daily on the FNArena database, maintains a Neutral rating.

Overall, earnings were in line with UBS estimates, although net profit was 3% ahead because of lower net interest. The company's manufacturing performance stood out, with production above nameplate capacity across Moranbah, Cheyenne, and Phosphate Hill. Adjusted net debt was also lower than the broker estimated, at $1.4bn.

UBS reduces forecasts for earnings per share by 7% which reflects lower average fertiliser price assumptions and a higher Australian dollar, partly offset by the realisation of $65m in additional cost reduction initiatives. The broker upgrades to Buy from Neutral, believing fertiliser commodity prices are bottoming. Also, the cash-flow outlook, even at spot prices, suggests a moderation of gearing metrics.

Macquarie agrees the explosives business is holding up well despite the challenging markets, while Moranbah hit record production of ammonium nitrate, yet also observes the company's language is softer regarding the near-term prospects for capital management, suggesting the timing is heavily dependent on the fertiliser price and the Louisiana plant running reliably.

Substantially lower capital expenditure after the completion of the plant should mean the gearing ratio falls to 1.8 in FY17 and capital management is more likely in FY18, in the broker's view.

Relative to its global peers, Macquarie notes that Incitec Pivot has the benefits of no potash exposure and a weaker Australian dollar. It also has a company-specific earnings driver in the form of the Louisiana plant, which could allow a significant step up in the free cash flow profile.

Ammonia prices have traditionally traded as a substantial premium to urea in the last 15 years but the broker notes the gap has closed in recent months and the two are now almost a parity. Macquarie does not believe parity will be sustained based on historical relationships.

Confidence with respect to phosphate pricing is critical to Credit Suisse's viewpoint. While there is some optimism in relation to improving coal production in Australia, Moranbah is at full capacity and, beyond some de-bottlenecking of the plant, company benefits little from any upside.

The broker expects the company to be the beneficiary of improving urea prices, where there appears to be some stabilisation in recent months. Credit Suisse asserts ammonia prices are also close to bottoming but believes it would be premature to call for a floor in phosphate prices at present, given large capacity increments are expected in 2017.

The results exceeded Ord Minnett's expectations, primarily because of a higher level of benefit from the business improvement program. The broker observes the company acted swiftly to make deeper and more widespread cuts to its cost base in the wake of persistently deteriorating macro conditions. Ord Minnett raises EBITDA and net profit estimates by an average of 8.5% and 3.6% respectively for FY17-19.

There are four Buy ratings, three Hold and one Sell (Morgan Stanley) on FNArena's database. The consensus target is $3.26, suggesting 4.8% upside to the last share price. Targets range from $2.36 (Morgan Stanley) to $3.95 (Deutsche Bank).

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article 3 months old

Orica Outlook Improving But Challenges Continue

Mining services business Orica will be flat out making sure its business improvements stay ahead of increasing costs and price re-sets, brokers believe.

-If cost reduction benefits are achieved a small improvement in earnings in FY17 may be forthcoming
-Orica may not be as leveraged to a volume recovery as current multiples imply
-Competitive dynamics heightened for delayed Burrup plant


By Eva Brocklehurst

Mining services business Orica ((ORI)) has a more positive outlook in terms of the cyclical volumes for explosives but its FY16 result indicates some structural problems remain. Brokers believe FY17 is shaping up as a year where the company will rely heavily on its business improvement measures to counteract price re-setting and increases to input costs.

The company did not provide specific earnings guidance and management has stated it remains conservative, despite some optimism on market conditions. Orica was careful not to call a bottom to the market but indicated there had been some stabilisation in prices.

The headwinds outlined by the company include a $60m negative impact on price re-setting as well as a $50-$70m negative impact for previously-negotiated input material contracts. Increased depreciation and amortisation expense, as commissioning of the Burrup project nears, is expected to be offset by business improvement initiatives.

Macquarie observes the Australian business has shown good sequential volume to date, although traditionally the second half is seasonally stronger. Collectively, the broker calculates $120m in price/input costs are expected to be offset by $30m in non-recurring costs plus business improvement initiatives. Macquarie observes, therefore, there is a bigger ask in terms of the cost reduction program this year, which increases the risk in execution and for which strong volumes may yet be required as an offset.

The stock is considered relatively fully valued and with a potential earnings recovery slated for FY18 rather than FY17. Macquarie prefers Incitec Pivot ((IPL)) in the sector. The broker acknowledges the previous problems with Minova have stabilised and there is more positive commentary regarding Indonesia, as well as coal market improvements and a $10m benefit for Bontang plant from lower ammonia prices.

Yet Macquarie cannot avoid the impression that cost reductions are required to do the heavy lifting. The share price has run up strongly on the back of higher coal prices and a more positive cyclical backdrop, but this appears factored in and a Neutral rating is retained. Be that as it may, the broker believes the stock should still trade at a premium to domestic contractors based on its less cyclical and relatively low-risk earnings.

Ord Minnett notes the impact of pricing re-sets in the explosives business has been severe in recent years, part of which relates to the flowing through of price terms from contracts signed previously. The broker notes there has been very little re-opening of existing contracts in the last 8-9 months and further price re-sets have not been ruled out. The broker factors in a further $20m in price re-sets in FY18.

The current market supports a further strengthening of volumes into FY17, Credit Suisse asserts, and if cost reduction benefits are achieved believes it likely that Orica will generate a small improvement in earnings in FY17. Improving export coal fundamentals are likely to support Australasia while the North American market is being driven by a less adverse outlook for domestic thermal coal. Growth in other regions appears to be a broadly-based improvement story.

Deutsche Bank believes the recent rally in commodity prices is positive, as this reduces the risk of further reductions in miner production volumes and mine closures. While the company is forecasting flat ammonium nitrate volumes the broker believes there is upside risk to its assumptions, given the improving outlook for explosives, while pricing appears to have bottomed.

The main surprise in the results for UBS was free cash flow, driven by lower net working capital and capex in FY16. The broker incorporates a lift in explosives volumes and additional cost reduction benefits into its forecasts to offset around the headwinds relating to lower explosives pricing and higher raw material inputs.

UBS acknowledges its forecasts incorporate a high degree of certainty around the company's ability to execute on another round of cost reductions and believes the stock is now fully valued, with a premium built in for a more positive cyclical outlook.

Given Orica only produces 50% of what it sells, UBS remains concerned that higher input costs and deteriorating end-prices for explosives mean earnings might not be as leveraged to a volume recovery as what current multiples are implying. The broker believes regional oversupply of ammonium nitrate will restrict Orica's ability to realise margin expansion.

The broker's Sell rating is based on the tougher outlook ahead for the main market of Australia. UBS is more cautious about domestic Australian explosives volumes and margins because of weak end-markets for coal and a regional oversupply through to 2020. The broker envisages a combination of weak demand, ammonium nitrate oversupply and a negative mix in the key Australasian and North American regions will weigh on growth prospects for the next several years.

Morgans is less concerned and found the result reasonable in the light of difficult market conditions. The broker believes the stock is fairly priced and that the self-help initiatives will largely offset the industry legacy issues. On the other hand, Morgan Stanley also highlights the need to have faith in offset targets and retains an Underweight rating. In the broker's calculations, the rally in the shares has placed the stock on the richest price-earnings ratio it has ever traded.

Meanwhile, the Burrup plant was delayed by unspecified commissioning issues, one year behind schedule, and is expected to begin operation early in 2017. It is expected to break even on EBITDA (earnings before interest, tax, depreciation and amortisation) in the year.

Despite the benefit of the later start, Morgan Stanley believes the outlook for the plant has materially deteriorated. Recent contract losses suggest the competitive dynamics may have dramatically intensified. Unless Orica can secure substantial new volumes the broker believes the risk is growing that it may need to impair Burrup.

Citi is quite confident that the turnaround has begun and the improvements ushered in are positive, although acknowledges these will take time to be realised. The company has a new customer-centric model based on geography rather than function and has enhanced its executive team. Minova is turning around and gearing has been reduced. The broker suspects the latter could play an important role in improving the medium-term growth profile.

Volume stability is a prerequisite for price stability, Citi asserts, and this should become more entrenched over the next 12 months. As there is insufficient upside to the broker's target price of $17.50, its recommendation is downgraded to Neutral from Buy.

FNArena's database contains one Buy (Deutsche Bank), five Hold and two Sell ratings. The consensus target is $16.15, suggesting 1.1% downside to the last share price. This compares with $15.11 ahead of the results. Targets range from $11.03 (Morgan Stanley) to $19.20 (Deutsche Bank).

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article 3 months old

Soft Quarter Signalling More Weakness For Wesfarmers

Brokers raise the spectre of whether soft September quarter sales numbers for Wesfarmers, particularly at Coles, are a sign of more weakness to come.

-Main negative is the deceleration of sales growth at Coles as Woolworths steps up price investment
-Sales growth at Coles now more difficult to obtain and expected to be modest
-Resources business seen doing the heavy lifting for Wesfarmers at present
-Uncertainties also prevail in the fashion, hardware and resources


By Eva Brocklehurst

Brokers raise the spectre of whether soft September quarter sales numbers for Wesfarmers ((WES)) are a sign of more weakness to come. Sales were weak across the main divisions. Food and liquor grew 1.8%, which represents the worst growth in several years. Bunnings slowed to 5.5%, as a result of clearance activity at former competitor Masters and a softer market, which are acknowledged to be temporary factors. Target's like-for-like sales slumped 22% while Kmart was encouraging, growing sales 8.2%.

The main negative was the deceleration in sales growth at Coles supermarkets. Management suggested this was driven by slower market growth as well as intense competition. Deutsche Bank warns there are risks in calling one quarter a trend, but believes competitor Woolworths ((WOW)) is improving in an environment where deflation is constraining market growth, while Aldi continues to gain share.

The broker does not believe there was a sharp market-wide decline in consumption volumes, but looking at the three consecutive quarterly declines in like-for-like growth, suggests this does coincide with the improvements Woolworths has made, even if it just means Woolworths is now “less bad”.

Overall, the broker contends that the sustained run at Coles has been supported by a strong top line, which has enabled the supermarket to provide incremental value for customers and grow or, at the least, preserve margins. Sales growth is now likely to be difficult to obtain, which could undermine this value loop that has been crucial to the success of Coles. With Coles being the main driver of Deutsche Bank's valuation the broker's rating is downgraded to Sell from Hold.

Cash generation is sound for Wesfarmers overall, Ord Minnett asserts. Bunnings is able to continue to generate a strong return on capital through continued earnings growth and capital recycling. The value focus and cost reductions at Coles are expected to position it well to address a challenging competitive backdrop. Still, the broker expects only modest earnings growth in the near term.

Industrial and resources divisions are improving, although this carries some risk and weighs on the price/earnings multiple in Ord Minnett's calculations. While accepting that blaming the weather is a weak stance, Macquarie's recent channel checks confirm the comments from Wesfarmers that a cold and wet spring has adversely affected apparel, home improvement and supermarket sales.

Resources business is doing the heavy lifting for Wesfarmers at present but it, too, was affected by weather, with total production down 11.8% on the prior quarter. The lower production will delay the benefit of higher coking coal prices but the company is expecting to break even in the first half. The first half is lining up as a tough period the broker believes, with risks to earnings increasing, but the longer-term proposition of strong balance sheet, earnings growth and dividend yield remain intact.

Macquarie is one of the more optimistic regarding Coles, doubting the supermarket has ceded share at this stage, although acknowledging it will need to to do more to offset the increased aggression in the market in recent months.

The broker does not envisage Coles straying from a long-held strategy of leading the market on value, which implies price leadership will not be given up lightly, although it could be at the cost to margins over the medium term. Macquarie forecasting a 10 basis points EBIT (earnings before interest and tax) decline in food and liquor over FY17 and slower comparable store sales growth of 2.3%.

Target's turnaround remains uncertain as brokers note the chain exists in a tough fashion segment. Credit Suisse expects around a 10% re-basing of sales in FY17 and, if Target successfully moves more towards an EDLP (Every Day Low Prices) model, the sale price offset could feasibly be around a three percentage point fall in markdown and supplier costs over time.

Credit Suisse would like to scrutinise the Woolworths and Metcash ((MTS)) results to determine the extent to which the slowdown in Coles was competitively driven. Pricing behaviour in food appears rational, given that Woolworths has dropped a significant profit into rectifying a poor price position. That said, the risk is that Coles moves its focus to near-term profit requirements.

Based on a circa 10% decline in fuel volume, the Coles convenience business has probably dropped 5-10% in value due to the acquisition of Shell's business by Vitol, the broker estimates. A reduction in the decline in gross margin offsets the earning impact of lower sales volumes in Coles in Credit Suisse forecasts for FY17.

Morgan Stanley reduces profit forecast for Coles by 12% and, while the non-food retailing business have also slowed, these are less of a concern given strong market positions. The broker reduces margin estimates significantly, estimating 4.6% for FY17 margins versus Woolworths at 4.4%.

The main question for UBS is what Coles does in the face of the heightened competition, considering it is driving the structural shift in the industry, as well as the impact slower sales will have on margins. The broker forecasts Coles to grow market share at 12 basis points per annum over FY16-20, yet also considers it increasingly challenging for Wesfarmers to maintain current rates of momentum in both Coles and Kmart into FY17. UBS believes Wesfarmers is fairly priced at current levels, given uncertainty over housing (Bunnings), grocery (potential price war) and the resources business.

The consensus target for Wesfarmers on FNArena's database is $41.59, signalling 1.8% in upside to the last share price. Targets range from $38.00 (Deutsche Bank) to $45.00 (Ord Minnett). The dividend yield on FY17 and FY18 forecasts is 5.0% and 5.2% respectively. There is one Buy rating (Macquarie), five Hold, and two Sell.

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article 3 months old

Potential In Qube But Down The Track

Qube Holdings is developing a solution to the complex and inefficient NSW logistics industry and several brokers point out the company's longer term potential.

-Ord Minnett values the investment in the Moorebank hub at 90c a share
-Several brokers looking for better entry points to the stock
-Diesel trends needs to stabilise before Morgan Stanley is more constructive


By Eva Brocklehurst

Finding a solution to the inefficient and complex logistics industry in NSW is difficult but Qube Holdings ((QUB)) appears to be heading down that track. That's the view Ord Minnett takes in initiating coverage on the stock. The going may not be easy but in the longer run, if the Moorebank intermodal terminal is successful, it will be rewarding. The Moorebank intermodal will include a large freight hub and a rail shuttle to Port Botany.

Sydney's largest integrated intermodal terminal will realign stevedores - the port operators - with inland logistics and ultimately should lead to a greater acceptance of rail as an alternative to road freight in the state. Ord Minnett foresees efficiency gains and lower freight costs for customers as a key benefit. By 2026 the broker expects Moorebank could contribute up to a third of Qube's earnings and values the investment in the hub at 90c a share.

Meanwhile, in the company's ports and bulks division the reliance on iron ore and mineral concentrates has fallen to 20% of revenue from 47%. Moreover, the cash cost of key iron ore customers has reduced to US$50-55/t and given a forecast for iron ore prices to be US$55-65/t, the broker suspects the worst may be over in this division.

On first glance, Ord Minnett concedes the stock may appear relatively expensive, trading on a FY17 price/earnings ratio of 26x, but believes this fails to capture the likely long-term contribution from both the Patrick stake and Moorebank. The broker takes up coverage with a Buy rating and $2.85 target.

Shaw & Partners, over a five-10 year perspective, envisages potential for value creation with the unique investment opportunity at Moorebank. Nevertheless, Shaw is unconvinced the stock will outperform in the next 12 months given its high multiple. It is expected to take three years for earnings per share to return to FY15 levels.

Downgrades from the market after the interim result in February are also considered probable. The broker, not one of the eight stockbrokers monitored daily on the FNArena database, has also recently initiated coverage on the stock with a Hold rating and $2.30 target. Shaw would be a buyer of the stock closer to the $2.00 level.

Positive catalysts may be forthcoming with the announcement of anchor tenants at Moorebank, post financial close, and Credit Suisse concurs that the strategy to vertically integrate supply chains will deliver attractive returns in the medium to long term. A final decision from the Commonwealth government on the environmental impacts of the Moorebank site has been overdue since August.

The broker agrees also that mineral resource exposure may mean FY17 revenue falls and the earnings contribution from Patrick may be lower than expected. Patrick will face greater competition when the third terminal operator (VICT) opens in Melbourne next year. Market share may decline and price competition could affect margins. The broker concludes that the market is over-estimating the revenue growth potential and earnings contribution from Patrick and believes a more attractive entry point to the stock could eventuate, retaining a Neutral rating.

Credit Suisse estimates the reduction in trucking from the co-location of rail terminals, import/export and warehousing could provide 20-25% efficiency gains and, while the company will likely share these gains to entice customers to Moorebank, it could still capture a fair slice.

Qube acquired Patrick Container Terminals, along with JV partner Brookfield Infrastructure, for $2.9bn in August, and while this has strategically aligned its supply chain, Credit Suisse believes the price paid was very full. Qube now owns the Moorebank location, after acquiring Aurizon's ((AZJ)) stake, which gives it full control of the site.

The volume and price cycle needs to stabilise before Morgan Stanley becomes more constructive on the stock. Diesel fuel data suggests first half volume challenges are both widespread and growing. Monthly diesel fuel sales are considered a rough proxy for industrial demand in logistics and bulk shipping. Morgan Stanley finds the data sobering.

July diesel volumes fell 7%, representing the weakest monthly growth rate in the data set which goes back to July 2010. In addition, growth has been negative for three consecutive months which suggests the decline in diesel demand is more than a one off.

Morgan Stanley has also analysed data which indicate that both volumes and prices are weak in the company's container-driven business, which affects, either directly or indirectly, 65% of earnings. The broker also believes valuation is full and looks for better entry points to the stock, with the first half results offering the first opportunity to assess the severity of the unwinding in volumes and pricing.

The database has four Buy ratings and four Hold for Qube Holdings. The consensus target is $2.63, suggesting 16.1% upside to the last share price. Targets range from $2.30 (Credit Suisse) to $2.90 (UBS).

See also, Qube Facing Complex Outlook on September 26 2016.

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