Going A Bit Rough For Adelaide Brighton

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-Earnings growth unlikely in FY13
-Austen quarry has key to price upside
-Challenges for clinker production
-Hostage to housing improvement

By Eva Brocklehurst

Quarry, concrete product and cement producer Adelaide Brighton ((ABC)) used a tour of its Austen quarry, NSW, to let brokers know that the going has been a bit rough. The company is constrained by the wobbly local recovery in housing construction, particularly softness in Victoria, as well as the reduction in mining project expenditure. The Austen quarry is viewed as a key asset that could deliver improved results for the company.

Austen was commissioned in 2007 and was part of Adelaide Brighton's acquisition of Hy-Tec. It produces mainly road base product. The company is confident there is earnings upside of up to $5 million from the quarry, because the location is more favourable relative to peers. Austen is at Hartley, at the western base of the Blue Mountains. Competitor Boral's ((BLD)) Peppertree is twice as far from the key western Sydney market. Macquarie notes that the company's position in the Sydney aggregates market has potential to improve in 2014, as the exhaustion of Boral and Holcim's Penrith Lakes operations mean Austen is no longer at a freight disadvantage.

These companies are sourcing aggregates from further south, at Marulan, in 2014 and will need to  increase prices to cover capital investment and higher transportation costs. This should allow Adelaide Brighton to increase Austen prices and so improve margins. The quarry has spare volume capacity and Macquarie expects, when the market picks up, the company will be ready and able with ample supply. Citi notes the quarry currently sells around 500,000 tonnes of aggregates each year, which is about 50% of its approved volumes and 25% of Adelaide Brighton's annual aggregate sales. The brokers expect a$10/tonne price increase, mooted as a result of the need for competitors to increase prices, should help.

The downside to the site tour was that management advised that FY13 earnings would be similar, or lower than, FY12. The results will be affected by the carbon tax, weakness in Victorian and south east Queensland residential demand and a decline in earnings from joint ventures. Brokers have ratcheted down forecasts as a result. Despite the softness for FY13 the outlook for the following financial year is more sound. Macquarie flags the improvement in the aggregates market, the potential for asset sales and the company's diverse market exposure as positives. The broker notes the company is looking to increase its exposure in aggregates, via greenfield site sourcing and acquisitions, but management is patient, not willing to either aggressively gear up or overpay. So these are prospects that may take time to play out.

Nevertheless, it was the bearish nature of the Victorian and Queensland markets that has underlined BA-Merrill Lynch's fears, and earnings estimates were reduced by 3.8% for FY13. This year Merrills forecasts earnings to be around 1% below FY12. The broker pre-empted management's latest advice and downgraded Adelaide Brighton to Sell earlier this year but hastens to add that this was not a reflection on the company, but rather the economic environment. Earnings trends are indicative of an increasingly challenging Australian cement pricing environment which is placing pressure on margins, in this broker's view. The recommendation is based on the fact that the company sustains the lowest levels of milling utilisation in a decade and over half of this capacity will be supplied via imported clinker – now cheap because of the strong Australian dollar.

Adelaide Brighton is the third largest cement producer in Australia, with around a 25% market share. It also manufactures and distributes lime, ready-mixed concrete and concrete products. Its joint ventures include Independent Cement and Lime in Victoria and Sunstate Cement in Queensland, areas of concern for several brokers and key to the earnings downgrades. For Merrills, despite the current rating, the company offers the most defensive earnings stream in the sector because of its geographic range (Western Australia, South Australia and mining) and its cement and lime products.

It is hoped that the ability to improve pricing in some areas will reduce the company's sensitivity to volumes loss. In this respect, Citi notes lime price negotiations are continuing well and the company is confident of a $5-10 million uplift in earnings from mid 2014. The company is also reducing the WA-based clinker manufacturing kilns and this could also add $5-10m to earnings from FY14/15. Moreover, Citi thinks Adelaide Brighton could make up around $8m with divestment of some of its land bank.

Citi has noted the negatives that could stay around longer term are gas price rises, which could affect earnings by $3-10m before mitigation is likely Nevertheless, Citi has taken a different tack to Merrills, in the light of the more definitive guidance the company provided as well as the positive commentary on lime pricing for FY14 and FY15. The broker retains a Buy recommendation.

Deutsche Bank also finds the glass half full, noting management expects the lime price increase to positively impact earnings from June 2014. Deutsche Bank also sees minimal impact from the recent decline in the gold price, although management has advised volumes may be negatively impacted by up to 10,000 tonnes, 0.9% of total lime volumes, should higher cost gold producers scale back their production and hence lime consumption. Credit Suisse is more inclined to take Merrills' side, liking the under-leveraged balance sheet and better returns compared with peers. It's just that the earnings outlook is so cloudy.

On the FNArena database Adelaide Brighton has two Sell ratings – Merrills and Credit Suisse. There is one Hold rating and five Buys. The consensus target price is $3.52, suggesting 5% upside to the last share price. The price targets range from $3.20 to $3.84. The dividend yield on consensus FY13 earnings forecasts is 5.3% and on FY14 forecasts is 6.0%.
 

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