Leighton’s Rocky Road Ahead

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This story features DOWNER EDI LIMITED, and other companies.
For more info SHARE ANALYSIS: DOW
The company is included in ASX100, ASX200, ASX300 and ALL-ORDS

-Margin recovery constrained
-Slow grind on Mid East collections
-Demand still seen weak
-Infrastructure cutbacks won't help
 

By Eva Brocklehurst

Major construction project developer and contractor Leighton Holdings ((LEI)) exceeded most brokers forecasts with its 2012 results. Net profit at $448 million was at the top end of company guidance of $400-450m. Despite the improving balance sheet, brokers still find the company facing a slow grind on collections from the Middle East projects. Margins should benefit from cost cutting and improved risk management but several factors are constraining margin recovery.

On the FNArena database the stock recommendation is tepid – five Hold ratings and two Sell. Citi, which has a Hold rating, finds the operating cash flow of $1.1 billion a highlight as well as gearing, which went down to 35% by the end of the year, from 48%. For Citi, nonetheless, the stock's valuation looks full. JP Morgan finds the lower level of gearing will not only provide flexibility but extra scope to respond to changes in end markets. On the flip side, weaker demand and lower margins imply some risk to near term earnings.

One Sell is CIMB, which considers the stock's current valuation to be reflective of a business that should have progressed further with its transformation. Forecasts are flat and CIMB finds valuation is more a function of the recent appreciation of comparable company and market multiples. CIMB prefers Downer EDI ((DOW)) in the sector as well as Lend Lease ((LLC)). The other Sell rating is Credit Suisse, which sees revenue constrained and earnings growth being primarily driven by cost cutting.

BA-ML suggests Leighton's profit margins should continue to rebound from the lows seen back in 2011 and be on trend by 2013. BA-ML is most concerned about the risk/reward profile but thinks it's more balanced now, noting declining order book/revenue in 2013 from a 2012 base of $21.4bn is being driven primarily by a cyclical downturn in domestic infrastructure end markets. The broker sees upside risks to estimates occurring with further de-gearing and asset sales, while the Habtoor Leighton carrying value and exposure to weaker domestic end markets provides the largest downside risk.

For UBS the primary focus now is on balance sheet, potential asset sales and progress on receivables collection from the Middle East. The broker notes Habtoor Leighton (LEI 45% stake) book value has reduced by 14% during the December half to $298m after incorporating Leighton's share of loss, adverse FX movements and a $20m impairment reflecting a higher discount rate. Leighton is owned $750m across the Doha City Centre, Al Shaqab Equestrian Park and Dubai Airport.

UBS believes sourcing of receivables from legacy projects remains the key to the company recovering its loans, which is likely to be a 3-5 year process. Citi also finds receivables collection dragging out and this increases the risk of material write-down or impairments in FY13-14, although the potential sale of it telco assets this year would alleviate some balance sheet risk. The downside is this could be earnings per share dilutive.

Credit Suisse is  concerned that Leighton is finding it more difficult to be paid for variations on resources work than in its traditional government infrastructure work. With resources projects suffering major cost overruns, the broker questions whether Leighton will suffer margin drag in FY13. Deutsche Bank too is cautious about budgetary constraints on infrastructure spending and the likely pull-back in mining related work in Australia, which would unsettle the company's medium term outlook. 

The FNArena database shows a 12-month target price of $21.22 for Leighton, 9% below the current traded price (after yesterday's big move up).
 

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