Australia | Jul 18 2012
– Goldman Sachs initiates with Neutral rating on Cardno
– Shift to greater environmental sector exposure a positive
– Organic earnings growth slowing, acquisitions provide an offset
– Valuation an issue following recent share price gains
By Chris Shaw
Cardno ((CDD)) is a global engineering and environmental consulting group, with exposure to most aspects of non-residential construction spending and a growing presence in the international environmental sector thanks to a series of acquisitions in recent years.
Goldman Sachs has initiated coverage on Cardno with a Neutral rating, reflecting the view a capitalised average growth rate for earnings per share (EPS) of 7% through FY14 is not enough to justify a more positive rating given strong share price performance of late.
The earnings growth expected should come from a combination of organic growth and growth through acquisitions. Goldman Sachs is forecasting organic growth of around 3% annually, as the stronger growth of previous years reflected stimulus spending and the impact of this is now fading. As an offset, management has demonstrated an appetite for buying growth given $674 million of acquisitions over the past eight years.
This focus on acquisitions should continue and offers some upside risk to earnings in coming years. On the numbers of Goldman Sachs, $100 million in acquisitions should add around 6-7% to group EPS. The broker estimates for FY13 the balance sheet for Cardno could accommodate $60 million in acquisitions based on a long-term gearing target of 40%.
The acquisitions of recent years have allowed Cardno to shift to a more defensive earnings profile, as exposure to structural growth in the environmental sector has risen. As noted by Goldman Sachs, sales from environmental operations have risen to 41% of Cardno's total sales from less than 10% since FY10, while sales from the Americas have also increased from 30% to 55% over the same period.
As well, Goldman Sachs points out more than 70% of Cardno's work comes from repeat clients, while the fact the group's largest contract is less than 5% of total sales indicates no reliance on one large customer.
In terms of earnings forecasts, Goldman Sachs anticipates EPS for Cardno of 62.5c this year, rising to 65c in FY13. This compares to consensus forecasts according to the FNArena database of 60.7c and 65.5c respectively.
The issue for Goldman Sachs is valuation, as at current levels Cardno is trading on an earnings multiple above that of global peers and at an 11% premium to average multiple for the ASX Small Industrials index. This is elevated compared to historical levels, as Goldman Sachs notes Cardno's five-year average earnings multiple to the Small Industrials is a discount of 16%.
While the current multiple is partly justified by the fact Cardno now offers a more defensive earnings stream, the premium remains excessive in the view of Goldman Sachs. RBS Australia agrees, having this week downgraded Cardno to Hold from Buy.
The change in rating comes on the back of changes to earnings estimates post two more US acquisitions by Cardno and is also a reflection of strong recent share price performance. This has pushed the stock to a level where a Buy rating is no longer justified in the view of RBS.
Not everyone agrees, as the FNArena database shows Cardno is rated as Buy twice and Hold twice. Macquarie and UBS have retained Buy ratings post Cardno's recent US purchases, both seeing scope for further share price upside despite the gains of recent months.
Comparing the consensus price target for Cardno according to the FNArena database of $7.72 to the current share price supports the view valuation upside is somewhat limited at present as the share price is trading around 4.5% above the consensus price target. The consensus target is somewhat distorted though by Credit Suisse's target of $6.07, which has not been updated since January of this year according to information available to FNArena.
Shares in Cardno today are down slightly in a weaker market and as at 11.30am the stock was 1c lower at $8.09. Over the past year the stock has traded in a range of 44.27 to $8.19.
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