Australia | Aug 17 2006
By Chris Shaw
Spotless Group (SPT) has been a poor performer on the Australian stockmarket for some time, as after peaking at a price of near $6.00 last August the stock is now well entrenched below the $5.00 level.
Any prospects for a recovery were not helped by yesterday’s profit result, which while meeting market forecasts was only done so through taking advantage of a lower tax rate, an outcome UBS points out is unlikely to be repeated. At the core of the company’s problems is an increase in its costs of doing business, which is pressuring margins.
UBS notes this margin impact was felt across all divisions as PVC resin, labour and energy costs increased, as did costs associated with the implementation of new contracts. As a result, the broker has cut its margin forecasts in coming years, with its estimate for margins within the Australian Services Operations now sitting at 3.6% in FY07 and 3.7% in FY08, down from 4.1% and 4.3% previously. This has corresponded to a fall in its earnings estimates, with its FY07 forecast down 8.7% to 31c and in FY08 by 9.5% to 34c, which compares to 29c for FY06.
This shows the broker is forecasting only modest earnings growth this year, a view shared by JP Morgan among others given it sees little prospect for a quick recovery in margins. The broker has downgraded its rating to Underperform from Hold as in its view the risk to earnings remains to the downside, though its forecasts are essentially in line with those of UBS.
Macquarie has similarly downgraded its rating to Underperform, though its more negative view is also a reflection of the company’s relatively high level of gearing. In the broker’s view the company’s debt position prevents it from pursuing acquisitions that could bring about some additional earnings growth, so it too suggests any profit growth this year will be modest.
The broker also raises the issue of payouts as it notes the company has been forced to cut the franking level to 60% for the final dividend. It argues shareholders would actually be better served by the company paying a smaller dividend that was fully franked and using the balance to reduce debt levels, as this would speed up the process of repairing the company’s balance sheet and so be a more efficient use of capital.
With such limited growth prospects in store for the next year or so it is no surprise Spotless is not a favourite of the market, the FN Arena database showing it receives three Hold ratings compared to five Underperform recommendations, with an average price target of $4.42.
Thomson One Analytics shows a median price target of $4.79, while it notes the median earnings estimates on the stock are 32c in FY07 and 36c in FY08.
Spotless shares today have fallen despite the stronger overall market, as at 3.15pm the stock was trading 1c lower at $4.44.