Australia | Aug 09 2006
By Chris Shaw
Go ahead and add Downer EDI (DOW) to the list of companies where the share price has been slammed as a result of falling short of earnings estimates, after management yesterday updated earnings guidance.
While underlying earnings will be in line with guidance at around $138m, the decision to write-down as much as $200m from a number of contracts but in particular one with Iluka (ILU) means what had expected to be a solid profit result will instead be a loss of around $25m for FY06.
The market is far from impressed, with brokers falling over themselves in the rush to cut forecasts for coming years and downgrade recommendations. Credit Suisse has been one of the more aggressive, downgrading the stock to Underperform from Outperform and lowering its price target to $6.90 from $9.20, though even this looks optimistic given the share price pasting the stock is receiving in today’s trading.
In the broker’s view the write-downs are in some ways a justification, as it notes the market has consistently applied a discount to the company’s earnings given the large discrepancy between reported earnings and gross cashflows.
Following management’s update the broker has cut its FY07 profit forecast by 15.1% to $153.1m and in FY08 by 9.6% to $180.3m, which equates to earnings per share of 47.8c and 55.5c respectively.
ABN Amro has been less harsh in maintaining its Hold rating, but it too has cut its target price to $6.70 from $9.03. The broker suggests the major implication of the write-downs is a higher interest expense and a negative impact on cashflows, so it too has lowered its earnings estimates to $155m in FY07 and to $168.5m in FY08, down 11% and 13%. This equates to earnings per share forecasts of 48.9c and 52.3c respectively.
Additionally, it notes along with the write-downs the company has announced a management reshuffle, which it suggests is an indication there remain further issues the company must address before the market again can take confidence in earnings guidance.
UBS takes a similar view, suggesting there are two issues for the market with respect to the write-downs at Iluka in particular. The first is the rapid increase in the size of the overrun, which in its view raises concerns about the company’s future prospects in the contracting sector as well as the overall capabilities of the group.
It also suggests there may now be questions about how well the market was informed at the time of the most recent capital raising in April, when shares were placed at $8.40. Any further action by those taking shares in that placement would be an additional negative for the group at a time when the market’s confidence in management is quite low. With this in mind the broker has also turned negative on the stock, cutting its rating to Reduce 2 from Neutral 2.
Overall, the FN Arena database shows among the leading brokers and equity researchers the stock is now rated as Hold four times, with two Underperform or Sell ratings and one Buy recommendation, though it is worth noting only four of the seven brokers to cover the stock have today updated their expectations based on yesterday’s market update, so further changes are likely.
The database shows an average target of $7.23, which compares to a median price target according to Thomson One Analytics of $8.86. Median earnings per share estimates according to Thomson are 57c in FY07 and 63c in FY08.
While Credit Suisse suggested the stock could trade as low as $6.00 per share in the aftermath of the downgrade the market’s reaction has been much harsher, as at 11am the stock was trading at $5.05, down $2.36 or more than 30%.