Emeco Needs Momentum

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

-Utilisation rates stagnant
-Debt reduction substantial
-Cash flow yield shows value
 

By Eva Brocklehurst

It's tough for mining services. That's for sure. What's not so sure is when it will get better. Earthmoving contractor Emeco Holdings ((EHL)) has reduced guidance for FY14 earnings to $90-105m. It didn't surprise brokers. Equipment utilisation rates are stagnant, particularly in the gold and thermal coal segments of Australia and Indonesia.

Based on capital expenditure forecasts of $40m in FY14, the scrapping of dividends and $90m in depreciation, the company can reduce its debt in FY14 by a substantial amount, in Macquarie's opinion. That's a major positive. The outlook may be tough and guidance is weaker but Emeco is trading at less than half its Net Tangible Asset (NTA) value, so the broker retains a Neutral recommendation.

The company has guided to a stronger second half with the driver being Canada, where there is strong visibility via contracts. That fleet is expected to be near full utilisation in the third quarter of FY14. It's the Indonesian business that's the main problem. The whole fleet is parked up at present. CIMB has factored in virtually zero revenue from that quarter in FY14. In Australia, tendering activity has improved but material changes in performance are yet to be seen. Around 70% of Emeco's earnings come from domestic rentals, with the remainder split between rentals in Indonesia and North America and the trading business.

The company should generate $95m in free cash in FY14 and on that basis CIMB is content to maintain an Outperform call. What also provides comfort to CIMB is he fact that such cash flow can be generated even in the current environment. Moreover, net debt of $377m represents a decline of $13m in the past six weeks. The company has liquidated $24m in assets so far with a further $18m coming from Indonesia. CIMB notes these assets were sold at a 15% discount to book value but that's significantly better than the 65% discount to NTA implied by the current share price.

CIMB thinks any fears of an equity raising resulting from the guidance downgrade are unfounded, barring any serious deterioration in the operating environment. Emeco is still operating within covenants and should pay down debt quickly. CIMB thinks it unlikely the banks will force the issue on a business which has a swift amortisation profile. Then there's that free cash flow yield of over 60%. The broker senses the stock is an acquisition target. The company's capital intensity in the initial years of any recovery will be minimal. CIMB has imposed a 45% target free cash yield to estimates, which would be an appropriate return for a potential acquirer. Based on this estimate, this implies a market cap for the company of $211m against the current $153m. The downside risks to this scenario are adverse changes to rental division sales, utilisation and margins.

At an earnings-per-share level UBS envisages Emeco to be loss making in FY14-15. Despite the company's comments about "green shoots" appearing in the Australian market – because there's been an increase in customer enquiries – the fundamentals look challenging to the broker and caution remains the word, particularly in the absence of significant contract wins. Emeco has flagged a weighting to the second half in its guidance. CIMB is also sceptical of forecasts for a strong skew for earnings to the second half in the current environment. In this instance the drivers around the improvement, in Canada and somewhat for Indonesia, are either underpinned by customer contract wins or cost savings that are within the company's control. Furthermore, while the Australian situation remains less certain some improvement is expected in the second half.

On the FNArena database Emeco has one Buy rating and five Hold. The price targets range from 21c to 37c and the consensus target of 31c suggests 22.7% upside to the last share price.
 

Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" – Warning this story contains unashamedly positive feedback on the service provided.

Click to view our Glossary of Financial Terms