Programmed Paints A Tough Outlook Picture

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By Chris Shaw

Following a weak start to FY11, property maintenance and outsourcing group Programmed Maintenance ((PRG)) last week downgraded full year earnings guidance with net profit after tax now expected to come in at around $28.8 million. This would be growth of around 10% compared to last year and would be a result 18% lower than the market's previous consensus forecast.

As Deutsche Bank notes, the main area of weakness in the business has been in the property services division, where clients have been reducing maintenance and deferring the renewal of painting contracts.

According to JP Morgan these delays are likely to drag down margins longer-term, as Programmed appears to be cutting its prices to sustain activity levels. A revised, lower cost model is an option being considered by management and without such a reorganisation the broker suggests the erosion in margins may become a structural issue as restoring them is likely to be a difficult process.

As Deutsche Bank adds, evidence of increased competition in the painting services sector means not only margins but market share will come under pressure going forward. This leads the broker to suggest Programmed is unlikely to ever see a return to the peak margins and earnings the painting business enjoyed in FY08.

To reflect the new guidance, earnings estimates across the market have been cut heavily with Deutsche lowering its FY11 estimate by 26% and its FY12 forecast by 19%. It now expects earnings per share (EPS) of 24c in FY11 and 32c in FY12.

Others in the market have been just as harsh, Citi cutting its EPS forecasts by 23% and 21% respectively to 25c and 32.3c, while Macquarie has lowered its numbers by 30% and 26% to 22.2c and 26.8c respectively. Consensus EPS forecasts according to the FNArena database now stand at 25.8c and 33.3c.

The upturn in earnings expected in FY12 reflects the start up of work related to the Gorgon project, which will boost work levels in the Marine division. But even here there appear some risks, Deutsche Bank suggesting there is potential for delays in the Allseas contract that largely kicks in from FY12.

This, plus the fact the latest downgrade may reflect a cyclical change in the nature of contracts in the maintenance division, means even after the latest downgrades to earnings there is still downside risk associated with outlook for Programmed.

In the view of Deutsche Bank, investors are therefore unlikely to ascribe full value to Programmed until there is evidence of a recovery in the earnings outlook. Citi agrees, pointing out any change to the company's service offering could potentially take 18 months or more from pitch to implementation.

This uncertainty is likely to see investors treat the stock with caution in Citi's view, especially as other growth options aside from the Marine business appear limited at present.

To reflect the new earnings outlook for Programmed brokers have also lowered rankings for the stock, with Macquarie, Citi, JP Morgan and Deutsche Bank all downgrading to Neutral ratings from Buys previously.

JP Morgan goes as far as to say the decision by customers to reduce their spending on maintenance activities means there are now some fundamental concerns with respect to the future of the business. Citi is not as negative, seeing value at current levels but not expecting it to be realised until such time as investors regain confidence in Programmed's outlook.

The downgrades to ratings mean Programmed is now rated as Buy four times and Hold five times, with an average price target of $2.79, down from $3.61 previously. Shares in Programmed Maintenance today are higher and as at 1.45pm the stock was up 11c at $2.01.

This compares to a trading range over the past year of $1.90 to $4.86 and suggests upside of better than 28% to the average price target according to FNArena's database.

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