Australia | Feb 13 2012
– Transfield Services reiterates full year guidance
– Easternwell operations remain problematic
– This business a cause for concern to some brokers
– Others more confident and see value at current levels
By Chris Shaw
Last Friday management at Transfield Services ((TSE)) updated on earnings guidance for FY12 and the market was pleasantly surprised, as full year earnings are still expected to be in a range of $130-$135 million in net profit after tax terms, albeit at the lower end.
For Deutsche Bank, the key point coming out of the earnings update was the core Australian and New Zealand business continues to perform at better than expected levels. The disappointment remains the Easternwell business, where expectations have again been lowered to reflect operational issues in the Minerals operations and some deferred growth capex.
RBS Australia notes the lowering of expectations for Easternwell is the third such change since Transfield has taken ownership. In that time the business has yet to meet any stated earnings targets, which leads RBS to suggest investors should remain cautious with respect to assumptions for the division.
A positive in Deutsche's view is guidance is now based on a stronger Australian dollar rate against the US dollar of 1.06. This means earnings expectations now factor in a slight currency headwind and so are somewhat lower risk.
Based on an expectation for 1H12 earnings of $44 million on a pre-amortisation basis, the implied earnings skew between the first half and the second half for Transfield stands at 34%:66%. While the skew in FY11 was larger, RBS sees this ratio as a concern, especially as Easternwell didn't contribute to earnings in 1H11. There is also potential for FY13 to disappoint in the view of RBS, as the lower than expected run rate at Easternwell means current consensus estimates are too high.
Deutsche Bank is also concerned full year guidance won't be achieved, as the ongoing issues at Easternwell place significant pressure on the Australian and New Zealand divisions. To reflect this, Deutsche is expecting 2H earnings of around $80 million against the $86 million implied by management's guidance.
This has prompted some minor cuts to Deutsche's earnings estimates, its net profit after tax numbers being reduced by 3-6% through FY14. JP Morgan has gone the other way and lifted estimates slightly, to reflect stronger margins from efficiency gains and some cost cutting measures.
Another positive in JP Morgan's view is management now appears to be more disciplined in deploying capital on Easternwell, with the approach now being to only invest when each business is able to deliver on targeted return on investment capital.
This has JP Morgan expecting management will now start delivering on targets for Easternwell. Macquarie is also less concerned for the shorter-term, especially as the announcement of the re-commencement of a buyback implies management has some confidence guidance for the full year is achievable.
Assuming a full 10% buyback is undertaken, Macquarie estimates it would be around 4% accretive in earnings per share terms assuming a price of $2.00 per share. Given the buyback should support the share price and to reflect a higher proportion of annuity style revenues, JP Morgan sees good value in Transfield at current levels.
This has been enough for an upgrade to an Overweight rating from Neutral previously, with JP Morgan also lifting its price target to $3.04 from $2.91.
Macquarie also rates Transfield as Outperform, seeing value given a discount of as much as 28% to the peer group average. This discount appears excessive to Macquarie given near-term earnings worries have been removed.
But Deutsche Bank and RBS disagree, arguing the potential for further earnings disappointment from Easternwell is enough to support a more cautious approach to Transfield. Both brokers rate Transfield as a Hold, as share price outperformance remains unlikely when there is still potential for full year earnings to fall short of what the market expects. In other words, both brokers remain on the lookout for further downgrades to earnings guidance.
Overall, the FNArena database shows Transfield is rated as Buy three times and Hold twice, with a consensus price target of $2.58. This is down from $2.77 prior to the update from management.
Shares in Transfield today are stronger and as at 1.45pm the stock was up 7.5c or more than 3.0% at $2.275. This compares to a range over the past year of $1.755 to $3.76. The current share price implies upside of around 13% relative to the consensus price target in the database.
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