Australia | Mar 28 2012
– UGL has underperformed over the past 12 months
– A recovery in earnings growth should reverse this trend
– Goldman Sachs reiterates a Buy rating
By Chris Shaw
A lack of earnings growth and some uncertainty with respect to the recent DTZ acquisition has contributed to UGL Ltd ((UGL)) underperforming the market over the past 12 months. As noted by Goldman Sachs, UGL generated earnings growth of around 9% in FY11 and is on course for growth of about 5% this year, well below others in the engineering and contracting sector.
The stockbroker predicts double-digit earnings growth will return from FY13 onwards, helped in part by some signs of improvement at DTZ. This is important, as the DTZ acquisition increased UGL's exposure to property services. This created some confusion in the market as to whether UGL was an engineering services provider or a property services company.
The combination of a better growth outlook and improvements at DTZ leads Goldman Sachs to suggest now is the time to reconsider the stock.
Driving the anticipated improvement in earnings should be further growth in the underlying business and a turnaround at DTZ, with margins expected to improve in coming periods. Assuming such an improvement, the business should contribute EBITA (earnings before interest, tax and amortisation) of $20-$25 million in FY13, which is meaningful from a group earnings perspective.
There are potentially some additional shorter-term catalysts for UGL. A frigate maintenance contract has already been won and is a positive for sentiment, while Goldman Sachs notes the group is tendering for some structural, mechanical and piping contracts with BHP Billiton ((BHP)) in Western Australia and appears well placed to possibly win one of these contracts.
Goldman Sachs is forecasting earnings growth in FY13 of 15% and in FY14 of 13%. In earnings per share (EPS) terms this translates to 120.5c in FY13 and 136.2c in FY14, up from a forecast 90.5c this year. By way of comparison, consensus EPS forecasts for UGL according to the FNArena database stand at 103.8c in FY12 and 116.5c in FY13.
On the forecasts of Goldman Sachs, UGL is trading on a FY13 earnings multiple of 10.5 times at current levels. This appears attractive assuming earnings growth does return to double-digit levels in that year.
During its recent underperformance UGL appears to have been used as a funding stock for other investments in the sector with better short-term earnings potential. Goldman Sachs sees scope for this trend to reverse in coming months as the market begins to price in the improved earnings growth outlook from FY13.
Post a review Goldman Sachs has retained its price target on UGL of $15.50, which compares to a consensus price target according to FNArena's database of $14.31. Targets in the database range from RBS Australia at $13.02 to Citi at $15.26.
Given an expected 12-month total return from UGL of around 28%, Goldman Sachs continues to rate the stock as a Buy. Most in the database agree, as UGL is rated as Buy five times compared to two Hold ratings.
Credit Suisse is one of the brokers with a Buy on UGL, having upgraded from a Neutral rating earlier this month. The upgrade followed a sector review that generated some positive earnings revisions and was enough for the broker to list UGL as its preferred sector exposure.
Shares in UGL today are higher and as at 10.50am the stock was up 2c at $12.70. This compares to a range over the past year of $10.95 to $16.48. The current share price implies upside of around 13% relative to the consensus price target in the FNArena database.
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