Tag Archives: Transport

article 3 months old

Acquisition Prospects Floated For SeaLink

Ferry, barge and cruise business, SeaLink, is managing the transition from the construction phase at Gladstone and broker attention now turns to acquisitions.

-Growth supported by recent acquisitions, potential in New Zealand
-Strong operating cash flow, with benefit of working capital release from Gladstone roll off
-Fuel costs increasing, which could result in lower margins


By Eva Brocklehurst

Ferry, barge and cruise business, SeaLink ((SLK)), expects to report improved profit in FY17, assuming seasonal conditions remains stable over the remainder of the year. Nevertheless, the stock was sold off after the first half results, as Gladstone and south-east Queensland missed forecasts with the winding back of ferry and barge requirements for the construction phase of the Gladstone operation.

Ord Minnett believes the sell-off was overdone. While trimming forecast by around -3%, the broker believes the impact is isolated to FY17 and relates to the transition in earnings at Gladstone. The broker upgrades FY18 forecasts and believes the balance sheet is flexible enough to fund acquisitions, opportunities for which abound.

Earnings in FY17 are expected to provide a foundation from which growth can be achieved through various means. Ord Minnett retains a Buy rating and $5.00 target.

Kangaroo Island revenue was up 4% but was affected heavily in the first half by strong wind conditions. This resulted in around 15 days being cancelled. Looking forward, Morgans anticipates margins should improve with four more coaches to be deployed on the island. This should also reduce sub-contracting costs.

Of note, the broker points to fuel prices creeping higher, having increased by 32% in the half year. While some of this growth in costs can be attributed to a larger fleet, the broker suspects and increasing fuel price will result in lower margins. The company does have some ability to pass this through and find savings by moving suppliers.

The Captain Cook Cruise business in New South Wales and Western Australia benefitted from a first full half contribution for the WA branch, resulting in revenue being up 46%. This was also supported by a 12% uplift from lunch and dinner cruises as well as a stronger charter market.

North Queensland and Northern Territory business delivered 4% revenue growth, with higher contributions from Magnetic Island and Mandorah services being the main drivers. The company has further penetrated the cruise ship market, with improvement in its charter services, up 60% on the prior corresponding half.

Potential Lies In Acquisitions

Morgans considers the stock a clean way to play the in-bound and domestic tourism segment. Nevertheless, SeaLink is trading on a price/earnings ratio for FY17 estimates of 18x and offers 6% growth on the broker's forecasts, suggesting it is fair value. First half operational earnings (EBITDA) were up 38% and imply margins of 25%, in line with expectations.

While the skewing capital expenditure to the first half was higher than Morgans expected, the company has stated there are no major capital expenditure plans in the second half. No specific guidance was offered for FY17, although the company expects profitability to be higher than the prior year.

The broker believes the outlook is robust and sustainable, as international tourism numbers are growing by around 11% per annum and local tourism is solid. Benefits should accrue from the additional commuter routes which are opening up, and the re-deployment of the five Capricornian vessels (Gladstone).

With construction contracts now finalised and a roll-off of earnings of around $2m anticipated in FY17, the company reveals it has been able to add services and extend both hours and vessels for both operating contracts in Gladstone.

In the broker's opinion the largest driver of outperformance will be accretive acquisitions and the company is expected to seek these out both domestically and offshore. Of note, the company's non-compete clause in New Zealand expired late last year. Given the proximity and ease in which vessels can move around these waters, Morgans believes it logical for the company to re-enter the NZ market.

Bell Potter notes the business in Sydney Harbour is delivering improving returns as the company changes its strategy. The Captain Cook Cruises division (NSW and WA) reported an 88% increase in operating earnings. Sydney has reported a 12% increase in sales, attributable to the higher yielding lunch and dinner cruise markets. The broker considers this of major significance, as the turnaround vindicates the company's strategy to move away from in-bound tour groups to free independent travellers.

Meanwhile, as construction work in Gladstone is rolling off, the broker expects declines revenue to be partly offset by continued strength in south-east Queensland. Bell Potter rates the stock Buy, with a target of $4.97. The outlook is underpinned by the company's sole operator status in a number of key markets and exposure to growth in international visitors.

SeaLink has traditionally operated a fleet of 27 ferries in South Australia, NSW, Queensland and the Northern Territory, offering a range of passenger, freight, dining and charter services. The company also owns a paddle wheeler which cruises along the Murray River. The TSM division, which owns 33 vessels, provides passenger and vehicular barge services across south-east Queensland and in Gladstone, and was acquired in 2015. The company acquired Captain Cook Cruises Western Australia in February last year.

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article 3 months old

How Much Growth Can Transurban Deliver?

Toll road builder/operator Transurban has raised FY17 distribution guidance. While brokers acknowledge the strong growth on offer, questions linger regarding the extent of optimism in forecasts.

-Distribution growth strong but likely to be slowing from the 11% experienced since FY09
-Capital release considered a lower quality aspect to the half year result
-Potential sale of West Connex a key catalyst in 2017


By Eva Brocklehurst

The run of strong growth continues at toll road builder/operator Transurban ((TCL)), with the highlight from the first half result being an increase in FY17 distribution guidance to 51.5c from 50.5c. The company remains confident of reaching financial close on the Victorian Western Distributor in late 2017, but notes the timing for funding the transaction is subject to negotiation.

The company has also confirmed its interest in West Connex, with the NSW government currently considering a privatisation process. Transurban confirmed it has not participated in the US Dulles Greenway expressions of interest at this stage but is maintaining a watching brief.

Credit Suisse expects Transurban to deliver over 10% distribution growth in each of the next five years and believes the higher distribution guidance signals management is also confident. The broker downgrades its US express lane estimates, suspecting it had previously over-estimated the revenue growth from the 495 and 95 express lanes. The broker believes the stock is attractive on a forward distribution yield basis and retains a Outperform rating.

Morgans forecasts distribution growth of 8% per annum across FY18-20, implying a slowing of growth versus the 11% experienced since FY09. The broker downgrades to Hold from Add, given the share price strength, but believes investors will continue to be attracted to the company's defensive compound growth and solid investment grade credit rating.

The broker's forecasts conservatively include an $8m capital raising to support the funding of the proposed Western Distributor, despite the CEO warning that a capital raising may not be necessary.

CLSA suspects the market is being overly optimistic in its forecasts and believes proportionate operational earnings (EBITDA) growth will be less than 10% in FY18 and beyond. While management has been good at adding growth through new concessions, the broker worries that West Connex is a "must buy", abetting concerns regarding the price that might be paid. The broker, not one of the eight stockbrokers monitored daily on the FNArena database, has an Underperform rating and $11.10 target.

Traffic performance and margins at CityLink and Hills M2 particularly pleased Deutsche Bank, given there were traffic disruptions during the half. The broker notes no further capital returns or re-financing are expected in the second half, but the company has indicated a further re-financing could occur once North Connex is completed in FY20. The broker suspects further competition could enter the Australian market in any bidding for West Connex, given its size and scale, and these players may be prepared to bid very aggressively.

Strong Cash Flow But Quality Questionable

Free cash flow was boosted by around $170m in a one-off capital release. On an underlying basis, UBS notes cash flow was still up 10%, although accounting for a 6% rise in securities on issue, free cash flow per security was only up 3%. The broker attributes the difference to traffic disruptions and funding costs associated with CityLink and North Connex projects.

The strength of free cash flow impressed Morgans although the quality was questionable, the broker agrees, normalising for the capital release results in around 99% distribution coverage and only 3% growth in underlying cash flow. Around 8.5c per security is calculated to be related to the capital release as a result of the North Western Roads Group (NWRG) achieving North Connex construction milestones. The company has stated this cash goes back to the general funding pool to fund developments.

The broker acknowledges the company does not have access to the free cash flow from the 495 and 95 express lanes, as lenders restrict distribution of the cash flow during the interest capitalisation period. The trapped cash continues to accumulate and will ultimately be available to Transurban. Combining these items, Morgans calculates it reduces the free cash flow to 22.7c per security from 33.3c per security, providing around 91% coverage of the distribution. This is still within the targeted 90-110% pay-out range.

Macquarie also observed the capital release was a lower quality aspect to the result but, importantly, notes Transurban is not including this capital in developing its distribution guidance. Morgan Stanley also believes the company can maintain its free cash flow/distribution coverage ratio at around 100% in FY17, excluding the capital return from NWRG.

Significant Opportunity in West Connex

While debt increased, the company's net debt to EBITDA ratio continues to fall, which highlights for Macquarie the growing capacity in the balance sheet and underpins commentary that material equity may not be needed for current projects. The broker believes any capital raising is likely to be delayed until after the Western Distributor financial close, i.e. the first half of FY18.

This also coincides with a more significant opportunity, West Connex. If only stage one and two are tendered, the bidding will be similar to the QML and Airportlink, in the broker's view, in that it will centre on traffic forecasts. Macquarie believes Transurban would be at an advantage if all three stages and ancillary projects were on offer, as the company could leverage its design optimisation project delivery skills.

UBS also notes the potential sale of West Connex will play out this year and believe this is a critical issue for Transurban, both as a growth opportunity and to protect its Sydney incumbency. UBS considers the stock well supported versus other yield peers because of its strong growth, albeit with some event risk around the Western Distributor and West Connex outcomes.

Citi, too, believes concerns over higher yields are overdone, given average debt maturity of 9.3 years and the benefits to toll pricing from higher inflation. The broker continues to envisage upside for the stock as it delivers on existing growth options and manages existing operations for greater efficiency.

Demographic Trends

Morgan Stanley highlights the risk of a change in the take-up of ride-sharing services on the company's northern Virginian roads, where high-occupancy vehicles are exempt from tolls. The broker takes a look at demographic trends and notes, in Australia's case, the average age of motorists is steadily increasing in line with the general population. Of interest, while driver licence numbers in the 20-29 year-old bracket are growing, there are early signs that licences in the following cohort are falling, particularly in Victoria.

At this stage, the broker speculates that the younger cohort will make more use of taxis and ride-sharing as it enters the workforce and technologies continue to improve. In addition, the broker notes the Australian Taxation Office has issued an alert and flagged a review of certain stapled trust structures. The broker acknowledges, while the company's corporate structure includes multiple such entries, the ATO views the company as a low non-compliance risk. Still, the broker believes these are risks to monitor.

The database shows four Buy ratings and three Hold. The consensus target is $11.72, suggesting 7.7% upside to the last share price. Targets range from $10.05 (Deutsche Bank) to $12.40 (Macquarie, UBS). The distribution yield on FY17 and FY18 forecasts is 4.7% and 5.1% respectively.

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article 3 months old

Brambles: Brokers In The Dark

Brokers can only speculate on the real issues facing Brambles, but believe they may not be structural, suggesting value following the share price tumble.

-US inventory reductions, delayed new business affecting sales, margins and profits
-Sell off now suggesting substantial upside in the stock from current levels
-Questions arise regarding the quality of recent growth in the Americas


By Eva Brocklehurst

As US retailers sharply reduced their inventories late in 2016, Brambles ((BXB)) needed to make a sizeable downward revision to its first half guidance. The lack of clarity on ramifications of the downgrade, in what the market considers is a very stable business, has irked brokers. Also, new customers have taken longer to come on board, while there has been pricing pressure in the recycled pallets business.

Expectations for sales and underlying profit in the first half have been cut and Brambles is now expecting constant currency revenue growth of 5% and operational earnings (EBIT) growth of 3%. As such, the company does not expect to reach prior full year guidance of 7-9% and 9-11% respectively.

The largest impact is in the Pallets Americas segment, where margins are likely to have been reduced. Pallet returns following unexpected de-stocking have meant higher up-front transport and plant costs, without an ability to recognise revenue on returned pallets.

Deutsche Bank downgrades its FY17 estimates for earnings per share by around 8.8%, in line with the trading update. The company's long-term target of reaching a 20% return on invested capital by 2019 requires a much stronger contribution in FY17 compared with what now looks like being achieved.

Management has indicated the issues with inventory de-stocking peaked in December but the broker is concerned the second half is likely to experience a continuation of the trends. Also the company is now indicating that new sales in North America, expected to drive stronger growth in the second half, have now been deferred from the original time frame.

Goldman Sachs points out the lack of detail regarding the revisions means the stock will be subdued until the results briefing and revises its North American growth and cost estimates, reducing its target to $12.41. Goldman, not one of the eight stockbrokers monitored daily on the FNArena database, retains a Buy rating, as the stock now offers around 20% upside from current levels.

The fall in the price suggests the market has taken a more risk averse approach to valuation but the broker believes the additional discounting has been overdone. Ultimately, the impact of the issues could be short lived and a rebound is likely in coming months, although a lack of clarity makes any conclusion difficult.

Downgraded Guidance At Odds With Data

Morgan Stanley finds the downgraded guidance at odds with the positive data on US retail sales. This suggests there are other less defined factors which contributed to the warning and, in turn, raises further valuation and earnings risks. Although the stock is at its lowest price/earnings ratio in the last seven years, the broker maintains an Equal-weight recommendation.

The update raises more questions than answers for the broker as, assuming other regions grew in line with their first quarter run rates, it implies the Americas revenue declined by up to 3% in the second quarter alone. This potentially represents the first negative growth in the broker's data set since 2011.

Management's commentary on subdued demand and inventory de-stocking is also inconsistent with the data, in Morgan Stanley's view, which shows a benign environment for both. The broker notes US retail sales remain above average and continue to trend positively, particularly in key product segments such as food, alcoholic beverages and health-care products.

The broker suspects other factors such as contract re-pricing and market share may have contributed to the weak revenue growth in the first half. Hence, it raises questions around the quality of growth in the Americas recently and the fact this has absorbed a significant portion of the company's growth capital expenditure.

Value Emerging?

Morgan Stanley envisages potential for further downside to the FY17 earnings outlook, maintenance capital expenditure and the FY19 returns target. Nevertheless, and despite the near-term risks, the broker believes value is emerging, particularly if the downgrade is from explainable factors. Until the first half result the broker expects little visibility around new business, pricing and recycling conditions.

Of importance, Macquarie notes that Brambles believes the drop in business wins is not a reflection of failed tenders but rather delayed agreements because of extended decision-making processes.

The broker also believes the impact of de-stocking is short term in nature, particularly in the light of the supportive macro indicators and expectations for a boost in consumer confidence post the US election. Macquarie believes the share price reaction was excessive, given the strength of the company's growth outlook and the stock is a good buying opportunity.

The issue bugging UBS is how long the impact of de-stocking continues, noting the company is waiting to see January numbers before assessing the full year impact. In the meantime, UBS takes the view that it is a one-off step change lower in earnings and extrapolates the impact into the second half ,such that estimates for operating earnings growth are around 2% for the full year, compared with a previous forecast of 8%.

Despite the lingering uncertainty, the broker considers the business model intact, with its high barriers to entry still deserving a premium to the market. UBS upgrades its rating to Buy from Neutral. The broker considers this industrial growth stock has lower than average risk and its reliance on consumer staples and developed markets - with 45% from North America - provides a stable source of growth.

Potential For Further Negative News

Citi, too, is concerned about the lack of clarity, particular when there is another 28 days before there is more detail emanating from the first half results and the indications for the second half are outlined. Nevertheless, the broker does not envisage the issues as being structural and they should correct. As a result, Citi expects the share price reaction will prove to be an over-reaction.

CLSA is less sure and suspects something has gone wrong in the US business quite quickly. The broker acknowledges it was already sceptical regarding management's ability to achieve prior earnings guidance, but believes the increasing deviation between earnings and cash flow over the last two years is something a new CEO/CFO team needs to address after the February results.

The broker, not one of the eight monitored daily on the database, upgrades to Underperform from Sell. Investors are advised to take a medium-term view and be comfortable with the risk for further negative news.

FNArena's database has a consensus target of $12.05, suggesting 14.8% upside to the last share price. This compares with a target of $12.94 ahead of the update. There are four Buy and three Hold ratings.

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article 3 months old

Govt Puts Second Airport In Sydney’s Court

The Commonwealth has thrown a curve ball to Sydney Airport, withholding any government funding for the second airport in its notice of intention.

-Sydney Airport required to take on all construction costs and operating risk for the 99-year lease
-Company now finds the proposition a challenging investment
-Prospect now of proceeding just to keep any competitor at bay
-Strong traffic growth continues at Kingsford Smith


By Eva Brocklehurst

Sydney Airport ((SYD)) has been placed in a quandary after the Commonwealth government set out the terms for development of the second Sydney airport at Badgery's Creek in its notice of intention (NOI). The main change to expectations is that there is no federal funding involved in the NOI, placing the investment decision squarely on SYD, which has first right of refusal.

The company is now mulling the investment criteria for the project, such as rate of return, cash flow, growth potential and the impact on its Kingsford Smith Airport. Macquarie calculates that funding a $3.5-4.0bn project without any subsidy over the near term will clearly come at the expense of incremental growth in cash flow, which will be largely capped until 2025.

While an alternative scenario, in which a third party operates the second airport, will ensure short-term cash flow growth expectations remain intact, there are obvious competition concerns which would emerge beyond 2025. Thus, the risk profile for SYD increases over the next 4-9 months that the company has to respond to the NOI. Still, the broker finds it hard to envisage a third party could make the economics work better than SYD.

Aside from this issue, Macquarie notes international passenger growth at Kingsford Smith continues to grow at pace, up 7.5% in November. The main driver has been the increased capacity at the airport and this bodes well for 2017. Load factor trends continue to support further passenger growth.

Current Deal Means Funding Pressure

Morgans is most concerned about the lack of funding and downgrades the stock to Hold from Add. The NOI puts all the risk and funding obligations onto Sydney Airport. The broker had assumed the Commonwealth would offer funding, noting that Infrastructure Australia had indicated a first stage costs of $5bn to develop the airport, although there is no clarity on what cost components were bundled into this estimate.

The government has calculated there would be 1m passengers per annum from opening in 2026, growing to around 10m over the longer term. The timetable contemplates earth moving commencing in late 2018.

Sydney Airport has indicated that the NOI makes the second airport a challenging investment proposition. Morgans agrees, noting there are many instances of failed greenfield, patronage-based infrastructure projects, and cost over-runs and ambitious revenue projections combined with excessive debt funding have been the key factors in such disasters.

The broker also speculates that the government is testing private sector appetite for the project to avoid committing its own capital and in order to cling to its AAA rating. For investors, the risk is one where Sydney Airport proceeds, not on the basis of a value accretive project, but in order to keep a competitor out of its catchment.

Traffic forecasts within the Environmental Impact Statement (EIS) indicated the initial pay mix would be dominated by domestic traffic. This is critical to the early phase economics, Morgans asserts, given domestic passengers are typically low value compared with international. Moreover, airport connectivity will likely be low, as there is no rail link.

The broker also flags the strong passenger growth at Kingsford Smith, with seat capacity growth indications for the first half at 5-6%, suggesting above-trend growth may continue. Morgans does not incorporate a second airport into forecasts but upgrades estimates for 2016-17 to reflect strong passenger growth rates.

Current Proposition Is Simply Unattractive

Deutsche Bank is of the view the company is unlikely to exercise its rights to develop and operate the second airport under the terms of this NOI. The broker has previously calculated that the airport needs $1bn in subsidies or support over the first 10 years to make it commercially viable and de-risk the project.

Changes in the company's language also suggest the investment would now be challenging. At this point, the broker believes value must come in other ways if Sydney Airport is to salvage the project. The most obvious way would be to remove the 80 aircraft per hour cap at Kingsford Smith and also remove regional dedicated slots during peak times.

Unanswered questions for Deutsche Bank include whether another Australian infrastructure investor – the project requires 51% Australian ownership – could invest in such a long-dated project. The broker doubts the government can afford to build the airport itself, given the budgetary pressures. As the deal is long-dated and demand uncertain, with no government support and potential dilution for Sydney Airport's existing distributions, the broker finds it unattractive.

FNArena's database has two Buy ratings, four Hold and one Sell (Credit Suisse, yet to report on the NOI). The consensus target is $6.78, suggesting 9.8% upside to the last share price. Targets range from $6.00 (Credit Suisse) to $7.45 (Macquarie). The dividend yield on 2016 and 2017 estimates is 5.0% and 5.4% respectively.

Disclosure: The writer has shares in Sydney Airport.

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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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article 3 months old

Qube Facing Complex Outlook

The outlook for Qube Holdings is gaining complexity, with the recent contract loss for its Patrick division, while substantial, not considered significant in the longer term.

-Despite contract loss management is expected to improve service levels at Patrick
-Macquarie believes value is now emerging in the stock
-Morgan Stanley suspects logistics weakness could be more broad based


By Eva Brocklehurst

The Patrick division of Qube Holdings ((QUB)) has lost its contract with the Asia Australia consortium, which Macquarie calculates to represent 225,000 containers annually. The loss of the contract may not be material for the group in FY17 but represents a material loss to Patrick.

The loss of the contract reflects the uncertainty over the ownership and a lack of direction that has plagued Patrick over the last 12 months, Citi contends, flagging operational improvements at competitor DP World and aggressive pricing from Hutchison.

The broker suggests management at Patrick needs to make changes to operations over the next few months to improve service levels to shipping customers, in order to better its prospects of increasing market share.

Citi estimates market share loss for Patrick is 3.5%. The impact is less for FY17 as the current contract is expected to run to the end of October. Pricing pressure is expected to increase and revenue per lift to decline by an average of 2.1% over the next three years. Nevertheless, Citi is confident management can increase efficiencies and improve service levels.

The broker's investment view is not fundamentally changed by the loss of the contract and the size of the Moorebank, Sydney, development is expected to provide attractive economics that will accelerate the modal shift to rail. The Moorebank intermodal will include a large freight hub and a rail shuttle to Port Botany.

Macquarie believes Qube Holdings is facing a mixed outlook, but growth should return once the effects of the cessation of contracts in ports & bulks and the re-negotiation of the Atlas Iron ((AGO)) contract are cycled. The broker envisages longer term upside from Moorebank.

FY17 logistics growth should be driven by the stabilisation of existing volumes and new business. Since its financial results the stock has drifted down 14% and the broker believes this negates further downside risk, with value now emerging. While not currently expecting earnings-per-share (EPS) growth, the broker takes the opportunity to upgrade to Outperform from Neutral.

Diesel fuel data suggests there are volume challenges which are widespread and growing with Morgan Stanley using monthly sales figures as a a rough proxy for industrial demand in logistics and bulks. The broker finds the data sober news.

Diesel volumes fell 7% in July 2016 and the three-month rolling basis also suggests a decline (4%), indicating this is more than a one off. Morgan Stanley analyses other data in the container business, which affects 65% of Qube's business either directly or indirectly, and finds the weakness could be more broad based than previously appreciated.

The broker considers there are better entry points ahead for the stock and continues to like the options around strategic assets such as Moorebank, with the first half result offering the first opportunity to assess the severity of the unwinding of volumes and prices.

Earlier this month UBS upgraded the stock to Buy from Neutral, noting Qube Holdings has a simple strategy but the financial journey is complex. The broker does not expect Moorebank to make a meaningful contribution to earnings until FY20, suggesting that while the stock's price/earnings ratio of 24x for the next two years appears stretched this will descend to 17x in FY21.

UBS continues to like the company's strategy of leveraging infrastructure-like assets in the import-export freight chain but does not expect EPS will recover to FY15 levels over the next two years, reflecting the step down in mining-related earnings and dilution from the investment in Patrick and Moorebank.

Consensus expectations appear to be 10% above the broker's forecasts for the next few years and UBS interprets this as a lack of understanding of the financial implications of the Patrick and Moorebank investments. There is the possibility the company may do better if it wins contracts in operating divisions, or makes accretive acquisitions, but the broker suggests the market is taking a subdued view of near-term earnings.

There are some negatives dragging on profitability in FY16-18, which limit the ability for earnings to recover, but the winding down of four major contracts in ports & bulks (UBS made this note ahead of the latest contract loss from Patrick) also signal a permanent step down in the broker's opinion.

FNArena's database shows three Buy ratings and three Hold for Qube. The consensus target is $2.65, suggesting 14.6% upside to the last share price. Targets range from $2.40 to $2.90.

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article 3 months old

Prospects Mount For Special Dividend From Air NZ

-Trans Tasman JV likely unaffected
-Probable sale of remainder in time
-Timing of any capital return uncertain


By Eva Brocklehurst

Brokers have responded positively to Air New Zealand's ((AIZ)) intention to sell down its stake in Virgin Australia ((VAH)) and retain a marginal holding.

The airline will sell 810m shares to a Chinese conglomerate, Nanshan Group, to realise around $268m, conditional on Chinese regulatory approvals. The sale price indicates 33c per share and an 18% premium to the last closing price of Virgin Australia stock. Air NZ will retain a residual holding of around 2.5%.

Deutsche Bank welcomes the deal, having expected a sell-down was a likely alternative to a complete exit. The residual could eventually be sold, possibly even on market given the small size. The sale is understood to occur after Virgin Australia's $159m equity placement to HNA Aviation, which is also pending Chinese approval.

Macquarie notes Air NZ will consider its options for the remaining holding and HNA, having recently acquired a 13% stake in Virgin Australia, has expressed an intention to go to 19.99% over time.

Divestment should reduce Air NZ's gearing levels, which at 53.8% in the first half was near the top of its 45-55% target range. Deutsche Bank expects gearing should fall to the lower half of the range. The company still has $2.3bn in new aircraft capital expenditure to be undertaken until FY19 and a deteriorating operating landscape, so the broker suspects a cautious approach will be taken to capital management, despite the capacity for a special dividend.

From an accounting perspective, the broker expects material mark-to-market losses on disposal of the stake, given an estimate of the first half carrying value of NZ$400m. The main near-term risk to Air NZ's stake was a discounted equity raising, with either Air NZ contributing further capital or being diluted.

Hence, Deutsche Bank considers this sale at a premium to the market price is a good outcome. The outcome suggests a takeover bid for Virgin Australia may now not be forthcoming given several potential blocking stakes.

Nanshan has its own emerging airline, Qingdao, and will have a holding in Virgin Australia as a result of the deal at just under 20%. It follows Virgin Australia's new strategic alliance with HNA Aviation, and both parties have stated an intention to support the outcome of the upcoming capital structure review. UBS believes the joint venture between Air NZ and Virgin Australia on the trans Tasman route will be unaffected by the likely change to Virgin Australia's share base.

The broker expects net proceeds of the sale are likely to be returned to shareholders via a special dividend but the timing is difficult to ascertain, although this could occur before the end of August. Net proceeds are expected to be around NZ25c a share. The broker also expects its shareholder loan to Virgin Australia, around $131m, to be re-paid.

UBS calculates fair value for the Air NZ stock at around NZ$2.60 a share, excluding any potential capital return. A Neutral rating is retained to reflect the valuation support, offset by heightened short-term earnings uncertainty that is created by greater competition on the long haul, and rising fuel costs.

The main consideration for the use of the capital is balance sheet strength, Macquarie contends. A modern fleet and the resultant lower capex requirements – the company expects maintenance capex around NZ$250m by FY19 versus the NZ$1bn in expenditure occurring at present - should underpin cash flow. This can be used to lower debt and provide some flexibility to counter changes in the operating environment, the broker surmises.

Air NZ has the ability to pay a special dividend while Macquarie also estimates a buy-back for the full proceeds would be around 10% accretive to FY17 earnings estimates. The stock's de-rating now makes the company more attractive on a valuation basis but the broker expects the market to be driven by sentiment, and operating statistics will be scrutinised to obtain an indication of yields for FY17.

The potential for a capital return is likely to be weighed against both the balance sheet capacity and the banked capex in later years, as well as the macro headwinds from rising fuel costs. Based on FY16-20 forecasts and FY11-15 actuals, Macquarie estimates an average return on invested capital at around 15%, in line with the airline's long-term aspirations.

Air New Zealand has three Hold ratings on FNArena's database.

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article 3 months old

Virgin Australia Outlook Becomes More Uncertain

-Reduces FY16 profit guidance
-Aggregate 2.0% industry supply cut
-Demand weakness likely short term

By Eva Brocklehurst

Virgin Australia ((VAH)) will reduce its carrying capacity in the June quarter, making a similar response to competitor Qantas ((QAN)) in the face of weaker consumer demand.

The company's pre-tax loss in the March quarter of $18.6m was greater than brokers expected and guidance for FY16 pre-tax profit of $30-60m is also materially lower than forecasts. UBS lowers its forecasts to $45m by reducing aircraft utilisation and unit revenue as well as updating FX and fuel assumptions. The broker's FY17 estimates drop by 40%.

The broker observes the business remains highly leveraged to the uncertain outlook in demand, with every 1.0% change in unit revenue driving a $40m change in pre-tax profit.

The company's remarks on the state of consumer demand echo recent commentary from Qantas. Both carriers are making reductions in capacity in the domestic market, which UBS estimates will amount to a 2.0% cut to industry capacity in the June quarter. This should help correct the supply/demand imbalance.

A capital structure review is still underway at the airline, following a weak performance in the December half year. This, together with Air New Zealand ((AIZ)) signalling an intention to divest its 26% stake, suggests to UBS a range of scenarios will be contemplated as to future management control and the current 16% free float. Pressure also continues on management to improve profitability and reduce gearing.

The capacity cuts are a rational response to weak short-term demand, Macquarie maintains. Demand is also hampered by pre-election uncertainty and the resources downturn. The broker is encouraged by the decision, as it reflect the airline's intention to preserve profitability rather than scramble for market share gains.

Virgin Australia will cut final quarter average seat kilometres (ASKs) by 5.1%. Traffic statistics were solid enough in the March quarter although yields were low and the broker highlights the performance was affected by the comparable revenue benefits from the Cricket World Cup in 2015, and Easter occurring at a separate time to the school holidays this year.

Macquarie expects domestic capacity control will stabilise load factors and stimulate a recovery in yields. The broker also notes this is a positive development for Qantas as it signals that the current weakness is not carrier specific.

Deutsche Bank believes the update implies the fourth quarter will also be loss making and, while reducing its target by 19c to 44c, maintains a Buy rating, given the upside from the current share price. Still, the broker accepts that risks are increasing as oil prices continue to rally and consumer demand falls.

There are one Buy and five Hold ratings on FNArena's database. The consensus target is 41c, suggesting 30.2% upside to the last share price. This compares with 51c ahead of the update. Targets range from 31c to 50c.

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article 3 months old

Qantas To Lose More Altitude

By Michael Gable 

The Dow Jones index topped the 18,000 mark overnight for the first time since July, which is a clear sign giving the local market some direction; something that has been lacking recently in light of the Australian Dollar and oil price both having rollercoaster rides, US earnings still progressing (more than 90 companies are scheduled to report results this week) and local banking stocks still under political pressure (notwithstanding the rally in the major banks over the last week).

News that we are heading into an election on 2 July, as well as the upcoming federal budget on 3 May, have greater implications for businesses and the consumer, than for the stock market. Consumers do not like uncertainty; and a relatively long election campaign is generally not good for business spending as companies tend to defer making big decisions.

In today’s report we look at Qantas Airways ((QAN)).

A few months ago, we warned about the rising wedge forming on QAN. It dragged out longer than expected but yesterday sees confirmation of the downside break out of the wedge. This implies that QAN will head down to the base of the wedge which is near $3.

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

Outlook Cloudy But Aurizon’s Dividend A Key Attraction

-Likely to miss targets, volumes 
-Most customers meeting contract terms
-Can dividend and buy-back be maintained?

By Eva Brocklehurst

Brokers hold a mix of views about the outlook for Aurizon Holdings ((AZJ)) but irrespective of whether haulage volumes hold up over the rest of FY16, a buy-back and firm dividend should sugar coat the full year results.

The company's operating targets are likely to prove difficult in the current environment but brokers are more positive about Aurizon because of its cash backing.

While the profitability of customers has fallen, Macquarie observes Aurizon's contractual position should be strong enough to maintain revenue stability. Cockatoo Coal, in voluntary administration, is the only customer currently in contract negotiations. Aurizon has signalled that no other customers, besides Queensland Nickel which recently entered into voluntary administration, are running behind terms.

The company's transformation savings, instead of driving growth, are limiting the downward pressure on the revenue line, Macquarie observes. Even in a worst case scenario, where coal and iron ore earnings dive, capital expenditure can be cut further to ensure cash is retained.

Hence, while the structural challenges continue for the business, Macquarie believes the share price has more than captured this downside. The broker upgrades its rating to Outperform from Neutral.

Earnings were in line with the guidance provided in December, while the margin declined to 22.9% driven by lower revenue over the first half. Gearing rose to 35.4% but the interim dividend of 11.3c, 70% franked, was better than many expected.

Capex guidance for FY16 of $650-700m is a reduction of $50-100m on prior forecasts. Capex remains above Macquarie's prior estimates and, while the broker welcomes the reduction, this suggests the company could do more into FY17 if needed.

FY16 guidance is $845-885m, which assumes stable iron ore and freight volumes. The company does not expect to meet its FY16 operating ratio target (a measure of operating expenses as a percentage of revenue) of 73%, and suspects it will be a challenge to achieve 71.5% in FY17. The target of 70% for FY18 is retained.

Morgans lacks conviction in the stock, unable to envisage the company weathering the challenging operating environment completely unscathed. The broker retains a Hold rating until end-product market dynamics improve. Deutsche Bank, too, is sceptical of the targets and guidance and maintains a Hold rating, but acknowledges the company is financially sound and capex will fall, so it can continue to return money to shareholders.

Goldman Sachs expects earnings will increase in the second half, reflecting the absence of costs incurred in the first half. Cost initiatives are expected to support margin expansion despite soft revenue growth. Free cash flow should also increase over FY16-18, as the company moderates its capex profile.

Hence, Goldman Sachs expects gearing will remain stable and the company can continue with its buy-back and deliver a payout ratio at over 90% of earnings. The broker, not one of the eight monitored daily on FNArena's database, has a Hold rating and $4.15 target.

UBS does not find signs of any financial impact from the pressure on contract pricing, as yet. Revenue weakness is confined to some volume slippage and the passing through of lower performance fees and fuel prices.

The company has signalled that 68% of volumes come from investment grade miners and only 26% are neutral or loss making at current prices. There is no material contract expiry until 2021. Still, the broker notes this does not sway perceptions that pressure in contract pricing will ensue. While there is obvious risk from coal and iron ore haulage contracts, UBS points to the 50% of earnings that come from the regulated track network, which provides some stability.

UBS also points to the stock's high yield, with around $200-250m likely deployed to complete the current buy-back over the next few months. The broker does not believe earnings will grow beyond 2018 in the current commodities environment and acknowledges these concerns are likely to overshadow any bottom-up analysis in the absence of a valuation catalyst.

Morgan Stanley also points out that the subdued reception given to the results signals a significant lack of confidence in the risk profile. Sentiment will take time to improve, the broker asserts, despite an attractive and definable dividend.

Concerns which overshadow the results, Morgan Stanley suggests, include scope for the second half to be weak. Management's updated guidance now suggests earnings will be weaker than the first half rather than “in line” as per the December update.

There are also suggestions that the company cannot maintain the buy-back as well as deliver a 100% dividend pay-out ratio. Assuming only organic cash for distributions, Morgan Stanley calculates the dividend can be 95% cash covered form FY17 at a yield of 7.4%.

Citi suspects management will be hard pressed to achieve its targets but insists the yield on offer is attractive and investors ignoring this in favour of the earnings outlook are passing up an opportunity, albeit one for which they may need to be patient. Citi upgrades to Buy from Neutral.

FNArena's database shows four Buy ratings and four Hold. The consensus target is $4.29, suggesting 18.4% upside to the last share price. This compares with $4.78 ahead of the results. The dividend yield on FY16 and FY17 forecasts is 6.8% and 7.3% respectively.

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