Macmahon Cuts Guidance, Other Contractors To Follow?

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By Chris Shaw

With the global financial crisis forcing cutbacks in expenditure on both infrastructure and mining projects it has been a tough 12 months or so for contractors, especially those exposed to mining contract work. Macmahon Holdings ((MAH)) is one such company finding the going more difficult, the company yesterday revising down full year earnings guidance.

Two months ago the company had indicated profit for FY09 would be in the order of $40 million but yesterday management indicated the figure was now more likely to be in the range of $15-$20 million. RBS Australia suggests the decline is due to a combination of the cancellation of another mining contract, poor weather impacting on operations, the impact of redundancies and restructuring costs as the group trims its workforce by as much as 20%, and a slower ramp-up rate for new projects.

The broker notes revenues for the company for the full year are expected to be essentially unchanged on previous guidance and this means the fall in earnings reflects a slump in margins, with the broker estimating pre-tax margins have declined from better than 5% in FY08 to around 1.4% this year.

As margins have fallen so too has cash flow and the broker notes this is putting some pressure on the group’s balance sheet, with gearing as measured by net debt to equity rising to around 39% now from as little as 12% previously. At the same time, interest cover has fallen to a ratio of around three times.

The brighter spot in the broker’s view is FY10 at present is looking a reasonable year given 75% of forecast revenues are currently contracted, with construction work representing around two-thirds of this level. It is this section that offers the most growth potential in the broker’s view given a renewed emphasis on infrastructure projects, while mining services are expected to remain under pressure and deliver around 25% lower earnings next year.

Post the update from management the broker has cut its earnings estimates accourdingly, putting its earnings per share (EPS) forecasts at 3.2c this year and 5.3c in FY10. UBS has similarly cut its numbers and is now forecasting EPS of 3c and 5c, the broker also noting the increase in gearing and seeing it as a sign of a jump in working capital levels. The other point the broker makes is the operating conditions for the company are now far more volatile, which suggests reduced confidence in the company’s earnings outlook.

Post today’s changes to estimates the FNArena database shows consensus EPS numbers of 3.1c and 5.1c respectively for FY09 and FY10, the magnitude of the cuts reflected by the fact Macquarie has lowered its numbers by 53% this year and 18% next year.

Lower earnings mean lower price targets and Macquarie has dropped its target to $0.30 from $0.62, UBS to $0.33 from $0.60 and RBS Australia to $0.30 from $0.45. The latter was the only broker to downgrade its rating on the back of the update, dropping to a Neutral recommendation from Buy previously. This leaves the stock rated as Hold three times and Reduce once according to the FNArena database, while the average target of $0.31 is down from $0.557 previously.

Given Macmahon’s revised earnings outlook Citi points out the risk to earnings for both Leighton Holdings ((LEI)) and Downer EDI ((DOW)) has increased as the cuts to mining projects being announced make reductions to volumes, margins or outright contract losses more likely. The broker rates the former as a Sell and the latter as a Buy while the FNArena database shows Leighton scoring two Buys, two Holds, one Reduce and four Sells and Downer EDI registering three Buys and six Holds.

Shares in Macmahon today are slightly higher and as at 11.20am the stock was up 2c at $0.34, which compares to a trading range over the past year of $0.285 to $1.925. Leighton is currently 34c higher at $19.94, while Downer EDI is trading up 19c at $5.05.

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