Australia | Feb 15 2010
By Chris Shaw
Last Friday Leighton Holdings ((LEI)) delivered interim earnings of $289 million, a result slightly above market consensus thanks largely to the company generating stronger margins than most analysts had expected.
Revenues for the period were flat in year-on-year terms and there were no large one-offs in the result, while strength in the Australian operations were offset by weaker performance from the Indian and Middle East operations. Overall, Bank of America Merrill Lynch, to name but one commentator, viewed it as a solid performance.
JP Morgan points out the minor increase to full year guidance post the result to more than $600 million from around $600 million previously suggests management expects the stronger margins generated in the first half should continue through the second half, though JPM also notes the timing of contract awards remains subdued.
This suggests a more meaningful earnings recovery is more likely to be deferred until FY11 at the earliest, in JP Morgan's view, which brings the valuation equation into play as the stock is at a 15-20% premium to the All Industrials index but the earnings outlook means investors are likely to question whether this growth premium is justified, especially as significant near-term earnings upgrades are unlikely.
Disappointing, according to RBS Australia, were the lack of any meaningful upgrade to full year earnings guidance and work-in-hand levels, especially as RBS notes the market has grown accustomed to upside surprises from Leighton management.
The other issue RBS Australia sees is while Leighton has a number of growth options, the fact capex is running at a level below depreciation means there are some questions as to how these growth options will be funded. RBS suggests investors will want to see more clarity on this issue.
Citi sees margins as another issue as while margin expansion in the half year was driven by materials cost deflation, likely due to falling commodity prices and the benefits from many contracts being on fixed price terms, this trend is unlikely to be repeated going forward.
As well, Citi's view on work-in-hand is the result of $38.4 billion was soft given previous indications of around $40 billion and given the trend has been broadly flat for the past four quarters this is scope for investors to begin to question how Leighton will deliver growth in this measure going forward.
Management currently expects to be able to deliver this growth as it has previously indicated a target to grow earnings by 50% in five years, which implies earnings per share (EPS) of around 300c in FY15. This compares to Citi's forecasts of 205c for FY10 and 225c for FY11.
Citi's numbers compare to JP Morgan's EPS estimates of 207.5c and 223.6c, Bank of America Merrill Lynch at 208c and 242c and consensus estimates according to the FNArena database of 207.7c for FY10 and 231.5c for FY11.
Valuation for the stock becomes a question for Citi as even allowing for EPS of 300c in FY15 the stockbroker estimates Leighton would be on an earnings multiple of 12-13 times for that year, meaning it is not particularly cheap at current levels in its view.
Citi rates the stock as a Sell but is on its own with this view, the FNArena database showing Leighton Holdings is also rated as Buy three times and Hold six times. UBS upgraded post the result to Neutral from Sell given a lift in price target to $37.00 from $26.50 previously, but as with Citi UBS suggests value is tight at current levels.
In contrast, Deutsche Bank takes the view the current premium on Leighton shares is not excessive given the outlook remains for double digit earnings growth through FY13, the working capital position is strong and returns on capital continue to lead the industry. Given this Deutsche sticks with its Buy rating with a price target of $42.65.
This compares to an average price target for Leighton according to the FNArena database of $38.77, up from $36.81 prior to the interim result. Shares in Leighton Holdings today are stronger and as at 12.25pm the stock was up 80c at $38.09, which compares to a range over the past year of $17.69 to $41.70.
