Treasure Chest | Aug 13 2014
-Potential upside not reflected
-Primed for infrastructure projects
-Was DTZ priced well?
By Eva Brocklehurst
UGL ((UGL)) has significantly improved its balance sheet with the sale of the DTZ property services business. The stock is now a pure-play in engineering and construction. Moelis observes UGL is now net cash, a vast improvement from the 36% gearing levels of the first half and the first time the company has been net cash since FY05. The broker believes this was the major concern the market held regarding the stock. Now around $613m will be available for distribution, based on a gearing level of 15% in FY15. Effective capital management will bring significant upside, in the broker's view. Furthermore, Moelis does not believe the current share price is reflecting this situation.
Moelis has run the ruler over a number of scenarios and finds they all provide valuations above the current price. Capital management could come from a cash dividend, a share buy-back or reinvestment/acquisitions. In the case of a cash dividend an aggregation of the discounted cash flow (DCF) valuation on the existing engineering business and cash per share as a special dividend implies a valuation of $7.96. With a share buy-back, this enhances underlying valuation per share and provides significant premium to investors. At an average price of $7.25 a buy-back would represent a superior initiative compared with a special dividend. The broker values a likely share buy-back at $8.69.
The third scenario, acquisitions, values the stock at $8.11. Moelis suspects that reinvestment or acquisitions would be delayed and a full year of earnings from such initiatives would only be realised in FY16 at the earliest. Moreover, identifying quality assets may be challenging in the near term. In a similar vein, given current market conditions, reinvestment in the engineering sector may not offer a near-term incentive.
The broker has applied an equal weighting to all three scenarios and establishes a target of $8.25 with a Buy recommendation, for a total return of around 23%. The earnings forecasts have been revised to reflect the sale and the proceeds netted off against intangibles. Moreover, the broker expects the cycle will bottom out in the next six to twelve months and the influx of government infrastructure projects should support further earnings growth. This timing is a key investment consideration, in Moelis' view. Engineering providers which have a greater weighting to infrastructure over mining are the most primed for these projects.
FNArena's database reveals Deutsche Bank and BA-Merrill Lynch also have Buy ratings with targets of $8.37 and $7.70 respectively. Deutsche Bank has flagged the NSW government's proposed North-West Rail Link, in which UGL is a preferred provider for rolling stock, signalling, tunnel and control systems, as a significant contract which could enhance earnings by up to 6% between FY16 and FY20. The database has two Hold ratings and four Sell. CIMB finds it difficult to envisage the standalone business will deliver on expectations and rates the stock Reduce. Macquarie too, with an Underperform rating, attributes some value to the improved balance sheet but believes the price received did not justify the sale of DTZ. UBS and JP Morgan also had reservations regarding the addition of value from the sale and make up the remainder of the Sell ratings.
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