Upper For Downer

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

 – Downer EDI result beats guidance
 – Debt reduction and strong cash flows highlights
 – Legacy issues being dealt with
 – Brokers lift forecasts and price targets
 

By Chris Shaw

Having guided to a full year net profit after tax of $180 million, Downer EDI ((DOW)) delivered a positive surprise to the market by reporting a profit for FY12 of $195 million. The result was an increase of 17% relative to the previous corresponding period.

Macquarie saw some items of outright good news in the result, as Downer's net gearing has fallen by 800-basis points to 28% on a net debt to net debt plus equity (including operating leases) basis. Morgan Stanley agrees, estimating Downer will now have around 23% headroom with respect to financial covenants thanks to its improved debt position, up from 12% headroom previously. 

As well, Macquarie notes operating cash flows have strengthened, to the extent FY13 capex of $400 million can be funded internally. Morgan Stanley expects this improvement in cash flows will remove a key overhang, as the market had some concerns about Downer's ability to refinance around $300 million in debt by the end of the year.

Morgan Stanley notes the result showed some normalising of Downer's previous legacy issues such as the Curragh and Waratah contracts. This suggests management is doing a good job in turning around operations at Downer, to the extent underlying earnings momentum will now start to become more apparent.

Guidance for FY13 reflects this, as management has indicated net profit after tax for FY13 is likely to be around $210 million. As an example, this is around 9% higher than Macquarie had been forecasting for the period.

Downer's updated earnings guidance is also above others in the market, as Deutsche Bank has lifted its FY13 forecast by 9% and Morgan Stanley by 8%. Consensus EPS forecasts for Downer EDI according to the FNArena database now stand at 47c for FY13 and 52.8c for FY14. 

On the back of upward revisions to earnings forecasts brokers have also generally lifted price targets. The consensus target for Downer in the database has risen to $4.36 from $4.32, targets ranging from Credit Suisse at $3.50 to RBS Australia at $5.02.

The database shows Downer EDI is rated as Buy five times and Hold twice, which is unchanged from prior to the earnings result. Valuation and improving earnings momentum are the key drivers of the Buy ratings, with Deutsche Bank pointing out on its numbers Downer is trading on a FY13 earnings multiple of 7.5 times.

JP Morgan's numbers suggest Downer is trading on a 27% discount to its average valuation of $4.76, which appears too low given the solid earnings growth outlook. RBS Australia agrees, taking the view the market is overdoing concerns with respect to the Waratah rail contract and the state of Downer's balance sheet.

The issue for UBS is uncertainty with respect to the timing of both public and private infrastructure investment given the currently challenging operating environment. This uncertainty justifies a Neutral rating in the broker's view, even allowing for the apparent value on offer in Downer at current share price levels.

Goldman Sachs sides with UBS, rating Downer as Neutral on relative valuation grounds. Morgan Stanley is more bullish, seeing scope for Downer to re-rate materially higher as its current earnings multiple closes the gap relative to peers in the market. Morgan Stanley has an Overweight rating on Downer within an Attractive industry view.

 
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