More Upside Potential For Emeco

This story features EMECO HOLDINGS LIMITED. For more info SHARE ANALYSIS: EHL

By Chris Shaw

Heavy equipment and earth-moving supplier Emeco Holdings ((EHL)) last Friday advised the market it expected to report an interim profit of between $27-$29 million, guidance broadly in line with market expectations.

RBS Australia notes the guidance from management implies a utilisation rate of about 89% at present, up from 86% in August and 78% in the second half of FY10. Conditions are currently strong across all of Emeco's markets and the stockbroker expects this trend will continue through 2012.

What has impressed RBS Australia is the strong start to the year for Emeco. The stockbroker notes the achievement has come despite a number of headwinds, including adverse weather conditions, a stronger Australian dollar and some large fleets coming to contract ends.

Contract renewal rates don't appear a major danger in the view of UBS, as it notes following expiry the bulk of these contracts have been resolved. There will continue to be the opportunity for new contracts as well, as UBS points out the Australian coal market is in the early stages of material capacity increases.

At present around 81 million tonnes of mine capacity is under construction, which should progressively add 25-30% to export volumes and so offer scope for Emeco to expand its operations in the Australian market.

For Credit Suisse, the update not only reduces any earnings uncertainty for Emeco but also represents the new management team delivering on another of its promises, as operational focus returns to core operations in Australia, Canada and Indonesia.

This renewed focus is, according to Morgan Stanley, reflected in management's decision to move the business towards higher-return assets. The outlook commentary provided confirms the initial stages of executing this strategy have been a success in the broker's view.

While ongoing strength in the Australian dollar represents a threat to earnings Credit Suisse sees this as being at least partially offset by Emeco's ability to purchase US dollar denominated equipment at lower prices.

Given management continues to deliver on its promises, Credit Suisse expects the market's focus will revert to sustainable business earnings and Emeco's leverage to improving resource volumes. This suggests to Credit Suisse there is still value in the stock, especially given a solid earnings growth outlook in coming years.

On Credit Suisse's forecasts Emeco's earnings per share (EPS) should grow from the 6.5c achieved in FY10 to 9.7c in FY11, 12c in FY12 and 13.1c in FY13. RBS Australia is a little more conservative with its EPS forecasts of 9.2c this year, 10.5c in FY12 and 11.5c in FY13, while consensus EPS estimates according to the FNArena database stand at 9.6c in FY11 and 11c in FY12.

As RBS Australia lifted its earnings forecasts on the back of the earnings guidance update, the broker's price target has also increased, to $1.05 from $0.87. The consensus price target according to the FNArena database now stands at $0.94, up from $0.91 previously. RBS Australia and Credit Suisse are the high marks with respect to price targets at $1.05 each, while Deutsche Bank and BA Merrill Lynch have targets of closer to $0.80.

The FNArena database shows Emeco is rated as Buy three times and Hold twice, with no changes to ratings post the earnings update. Morgan Stanley is not part of the database but rates Emeco as Overweight within an In-Line rating for the Australian emerging companies sector.

The Buy argument according to RBS Australia is even when allowing for recent share price gains, Emeco is trading on a FY11 earnings multiple of less than 10 times. This is viewed as undemanding given Emeco has a superior fleet mix to peers and should enjoy the benefits of strong outlooks in its key markets.

Credit Suisse agrees, noting on its numbers Emeco is trading on an earnings multiple for FY11 of 10.6 times, which is well below the average multiple for small cap industrials on the Australian market of around 13.2 times.

Shares in Emeco today are stronger and as at 11.30am the stock was up 4c at $0.99. This compares to a range over the past year of $0.45 to $1.10 but implies downside of around 5% to the consensus price target in FNArena's database. Note that both BA-ML and Deutsche Bank have yet to update their views and calculations post the company's latest market update.

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