Emeco Cuts Guidance, Brokers Cut Forecasts

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This story features DOWNER EDI LIMITED, and other companies.
For more info SHARE ANALYSIS: DOW
The company is included in ASX100, ASX200, ASX300 and ALL-ORDS

By Chris Shaw

Strong commodity prices suggests companies supplying services to the sector should be doing well, but downgrades to earnings guidance by Downer EDI ((DOW)) at its recent AGM and by Emeco Holdings ((EHL)) at its AGM yesterday shows exposure to a strongly growing sector is no guarantee of earnings growth.

The issue for Emeco according to UBS is there is no evidence the company’s model of renting heavy equipment to mining operations actually works, especially in overseas markets.

This is reflected in the company’s reasons behind the revised guidance of a flat first-half earnings outlook, as management indicated the international operations and particularly those in the US and Canada are falling short of expectations.

The disappointment is this comes after the company spent more than $300 million on acquisitions and fleet upgrades in FY07, suggesting either the money was not well spent or the model itself is questionable.

On the plus side the broker notes the domestic rental operations, which accounted for around 80% of EBIT (earnings before interest and tax) in 2007, are performing as expected, though growth in earnings is being hampered by infrastructure constraints.

The result is cuts to earnings forecasts across the market, with UBS lowering its estimates by 7% in FY08 and by similar amounts in future years, putting its EPS (earnings per share) forecasts at 13c this year and 14c in FY09.

JP Morgan has reacted in similar fashion and cut its FY08 estimate by 6% to 12.9c and in FY09 by a more substantial 12.5% to 15.1c, while Credit Suisse’s forecasts now stand at 12.7c and 13.7c respectively. Prior to the AGM consensus forecasts were 14c and 15c.

Even allowing for the revised earnings JP Morgan notes the stock offers excellent value, the problem is there is little to suggest this value will be realised anytime soon given the earnings growth issues.

As a result it has retained its Neutral rating, while UBS has downgraded the stock to Neutral from Buy. Credit Suisse has gone the other way and upgraded its recommendation to Outperform from Neutral, but the change is more a reflection of its (stringent) ratings model than a more positive view as it is based on recent relative share price weakness relative to the broader market. Citi has retained its Buy rating given it sees the stock as cheap on fundamentals.

Overall the FNArena database shows Emeco as rated Buy three times, Accumulate once and Hold twice, with an average price target of $1.55, down from $1.72 prior to the AGM.

Shares in Emeco today are weaker in line with the broader market and as at 1.25pm were down 5.5c or 4.5% to $1.18, which compares to a 12-month trading range of $1.17-$2.06.

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