Australia | Feb 28 2013
By Andrew Nelson
Tuesday’s interim result from Seven Group Holdings ((SVW)) provided yet another significant outperformance of market expectations, although brokers are lining up to point out there’s plenty more upside than just strong and consistent earnings. Although, a big earnings beat is still a pretty good place from which to start.
As far as analysts at CIMB are concerned, the real highlight of the day was the significant working capital release. After factoring in the company’s now considerable listed-asset portfolio, the business now sits atop a very effective net cash position. Operating cash was almost six times the broker’s expectation and saw the company finish the half with a net debt of just $830m, which equates to gearing of 23%. The improvement is quite significant when compared to last year’s 40% at the end FY12.
WesTrac Australia was a standout, with the broker noting that margins are holding up well despite the strong growth experienced in its lower margin Equipment Sales business. Given guidance was pretty much unchanged, the broker sees this as a good indicator of the increased predictability and defensiveness of WesTrac earnings in what for others is a difficult, post peak capex environment.
Guidance is pointing to a weaker 2H given Equipment Sales are expected to have reached what is a very high peak, but CIMB is little concerned at this point, noting the market is already looking at FY14. The broker expects WesTrac Equipment Sales will pullback by around 30%, but this should be at least somewhat if not completely offset by ongoing growth in higher margin Product Support revenue. All up, the broker only sees a 5% decline in FY14 operating earnings for WesTrac.
BA-Merrill Lynch had a similar reaction to the result, very keen on the WesTrac performance and thus upgrading FY13-14 forecast earnings by 23% and 17%. Otherwise, BA-ML’s hit list reads the same as CIMB’s: top line and margin outperformance from WesTrac and the ongoing deleveraging via strong cash flows and asset sales. In fact, the broker says when taking into account the value of a liquid listed portfolio, which sits at around $804m, the business is pretty much un-geared at current levels.
Macquarie is of a similar opinion, while JP Morgan also sees increasing upside coming from WesTrac China, noting some signs the operation seems to be on early track to recovery. The broker is confident about the underlying drivers of demand for Chinese heavy equipment and expects the operation to become an increasingly important earnings driver over the medium term.
Valuation appeal also plays a big part in the attraction, CIMB noting that despite the recent strength in the share price, the stock still trades at a better than 30% discount to offshore Caterpillar dealer peers and a 17% discount the broker’s sum of the parts valuation.
And when you add in a balance sheet that is deleveraging at pace, the ongoing work to simplifying corporate structure and what is a defensive and resilient earnings base, CIMB and all the other brokers in the FNArena database, bar one, believe these sorts of discounts are unwarranted. Thus, the stock is just one Hold call away from straight Buys in the database, trading at 14.1% discount to the consensus price target.
Deutsche Bank is the broker sitting at Hold and unsurprisingly, the broker also has the lowest price target and thus the least appreciation for the valuation story. The broker liked the WesTrac performance, the stronger balance sheet and the better than expected FY guidance. Upgraded guidance comes despite the cautionary note that has been sounded. In fact, DB lifted its FY13 net profit forecasts by 13% and FY14 by 5%.
With the broker positive on all of the elements everyone else is positive on, where does the Hold call come from? Simple: the broker sees a few things that worry it more than the others. First, there’s the threat of a sustained global commodity market downturn; it’s not expected, but far stranger things have happened and they way things look know, it’s at least not hard to imagine. Next, the company’s prospects are tied, to some extent, to a Caterpillar dealership agreement that needs to be maintained and a controlling shareholder that needs to be kept happy.
So despite Deutsche Bank’s price target jumping from $7.80 to $11.45 post the result, it isn’t enough to change the broker’s view that the risk-reward profile is balanced.
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