Australia | Mar 18 2010
By Chris Shaw
Grain marketing group AWB Limited ((AWB)) yesterday surprised the market with a downgrade to earnings guidance, management indicating pre-tax profit for FY10 would now be in a range of $85-$110 million. This compares to previous guidance of a result (before tax) between $115-$140 million.
As JP Morgan notes, the downgrade in guidance is due to issues in the Domestic Trading business, as all other key operating businesses are trading broadly in line with expectations. The fall in earnings in the Domestic Trading operations is primarily the result of higher global wheat stocks, lower price volatility and lower transactional margins.
The decline in margins is reasonably significant, Macquarie's assumption for AWB's long-term domestic trading margin falling to $5.30 per tonne from $7.30 per tonne previously. This margin pressure reflects domestic traders trying to exit positions in the view of Credit Suisse, pressures the stockbroker expects will remain through the second half of FY10.
To reflect the revised guidance from management, earnings estimates have been reduced across the market, with Macquarie cutting its earnings per share (EPS) forecast by FY10 by 23.3% to 8.8c and its FY11 number by 4.7% to 11.8c.
Citi has lowered its FY10 number by 21% and its FY11 forecast by 3% so its EPS estimates now stand at 9.1c and 12.2c respectively, while consensus EPS forecasts according to the FNArena database stand at 7.8c in FY10 and 11.7c in FY11.
Credit Suisse points out the earnings downgrade from management is not an indication of any change in AWB's position in the domestic market, as volume and book size are in line with previous periods.
Earnings in the commodity trading business are historically volatile and Credit Suisse suggests management has recognized this and wants to reduce exposure through a partial sale.
Such a sale is a strategic need in Citi's view, as the volatility of company earnings are a negative for AWB's overall value. Success in divesting the troubled business would be a catalyst for crystallising value in the stockbroker's view, with an update on such a sale possible at the interim result due in May.
According to Citi, the fact the earnings problems are exclusively in the grain marketing operations means the issues are largely non-structural, as Landmark continues to enjoy improved seasonal conditions and AWB Geneva is performing well.
With the rest of the business is performing as expected, JP Morgan makes no change to its Overweight rating on AWB. JPM suggests this is supported by both fundamental and relative value at current levels, increased confidence with respect to Rural Services earnings and a stronger balance sheet.
Citi also sees value after yesterday's sell-off, which it suggests was an over-reaction given the non-structural nature of the earnings guidance downgrade. Citi retains its Buy rating.
Macquarie, however, has downgraded to a Neutral rating on AWB as while it also likes the Landmark turnaround story, it suggests this is being diluted by the rest of the business.
RBS Australia has similarly downgraded to a Hold rating as it suggests the downgrade is cause for reduced confidence in management and this outweighs the value on offer at present.
As well, RBS notes the business offers little in the way of transparency of earnings at present, all of which adds up to a discount to value persisting in the near-term in its view.
Currently the FNArena database shows AWB is rated as Buy five times and Hold three times, with an average price target of $1.29, down from $1.49 prior to the downgrade in earnings guidance.
Shares in AWB today are slightly higher and as at 12.00pm the stock was up 2.5c at $0.96, which compares to a range over the past year of $0.92 to $1.58. The average price target implies upside of better than 30% from current levels.
