Downer Shakes Off Railroad Blues

This story features DOWNER EDI LIMITED. For more info SHARE ANALYSIS: DOW

 – Downer's investor day commentary well received
 – Legacy issues appear behind the company
 – Management can now focus on growth
 – Brokers upgrade ratings on valuation grounds
 

By Chris Shaw

Engineering company Downer EDI ((DOW)) held an investor day yesterday and brokers left the update generally happy with the outlook for the company following a reiteration of earnings guidance from management. Full year EBIT (earnings before interest and tax) of $340 million is expected, while (NPAT) net profit after tax of $180 million is expected.

In terms of divisional updates, Macquarie notes the mining division commentary was broadly positive with respect to performance on major projects. The blasting and tyre management businesses are also seen as under-appreciated and offering strong growth potential, while Macquarie also sees opportunities for further work to be won in areas such as thermal coal and Fortescue's ((FMG)) Christmas Creek 2 project, this given Downer is the Christmas Creek 1 contractor.

The news on the Waratah project was also good, Macquarie noting trains in service are performing well at present and there have been signs of quality improvements in general. Delivery of further train sets remain in accordance with the existing timetable.

A further positive for Deutsche Bank is Downer now appears to have control of what have been ongoing legacy issues such as with the Waratah project and various engineering contracts, meaning management is now better placed to focus attention on growth opportunities.

But the news was not all positive, as Credit Suisse notes the update also stressed industry conditions are subdued at present across many of Downer's markets. Projects in the coal and iron ore space are being delayed as resource clients adopt a more cautious approach, meaning volumes are below desired levels in some areas of the business.

To counter this Downer is looking to increase exposure to recurring maintenance work, which Credit Suisse notes will be achieved by leveraging current pockets of expertise. Management has indicated this model will require partnerships to bring additional skills and expertise to the offering, so is likely to take some time to boost earnings.

Deutsche Bank agrees any growth from such an approach will take some time to deliver benefits, so nothing is factored into the broker's earnings forecasts to reflect the longer-term potential. Post the investor day update Deutsche's earnings per share (EPS) forecasts stand at 40c for FY12 and 42c for FY13. This compares to consensus EPS estimates according to the FNArena database of 41.2c this year and 45.2c in FY13. 

While revisions to earnings estimates have been modest post the update there has been movement in terms of ratings for Downer EDI. Macquarie, JP Morgan and Deutsche Bank have all lifted ratings for the stock to Buy from Hold, while Credit Suisse has upgraded Downer to Neutral from Underperform.

Valuation has been a key driver of the upgrades, Deutsche noting based on its target price for Downer of $4.17, down from $4.36 previously, the implied 12-month forward earnings multiple of 9.9 times would be a 23% discount to the market.

Macquarie also sees improved value on offer in Downer following recent share price weakness and so upgrades to Outperform. The broker estimates the stock at current levels is trading at a 31% discount to the market, which is greater than its long-term discount of about 19%.

While Credit Suisse also sees improved value given recent share price falls the broker wants to see further confidence in execution of the Waratah contract and greater clarity on cuts to mining capex before turning more positive.

Factoring in the changes, the FNArena database shows Downer EDI is now rated as Buy five times and Hold twice. The consensus price target according to the database is $4.43, largely unchanged from prior to the investor day.

Shares in Downer EDI today are stronger in a better overall market and as at 11.00am the stock was up 12c at $3.59, which compares to a range over the past year of $2.71 to $4.16. The current share price implies upside of more than 24% relative to the consensus price target in the FNArena database. 

 
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