Royal Wolf Supported By Diverse Market

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-More leasing income, higher margins
-Growing scale offsets subdued backdrop
 

By Eva Brocklehurst

Royal Wolf ((RWH)) is a leader in containers, controlling an estimated 35% of the Australasian market. Brokers note the competitive advantage that comes from a large distribution network and breadth of product. The containers are used in storage, freight and as mobile buildings.

Bell Potter has initiated coverage on the stock with a Buy rating and $3.75 price target. The broker considers the main source of the company's income will increasingly be revenue from container leasing, as opposed to container sales, and container leasing delivers three times more in gross margin. Bell Potter also likes the competitive advantage in distribution, with a network of 27 service centres across Australia and New Zealand. Moreover, the large capital investment required acts as a deterrent to new entrants to the market.

Deutsche Bank recently downgraded its recommendation on the stock to Hold from Buy. Driving that downgrade was a subdued first quarter result. Sales revenue was up but the higher margin sales in the portable storage segment declined as a result of  the difficult economic backdrop. Furthermore, no transportable camps were delivered in the first quarter. Deutsche Bank thinks the company is trading at a premium to the market and, while the business is solid, it's now fairly valued because of the weakness in underlying conditions.

Bell Potter does not expect Royal Wolf's debt levels to stay as high as they are currently. The company is carrying higher inventory because of partial delivery on the Aurizon ((AZJ)) contract, as well as from seasonal inflow for the peak demand period which lies ahead. The broker also heeded the company's observation that there has been some sign of a recovery in demand in October. The delivery of five transportable camps in the second quarter and seasonal demand is expected to lift utilisation and performance.

Portable storage is the company's largest segment, while portable buildings is the fastest growing segment. Bell Potter observes that, while the portable container-based buildings market does not have much competition, Royal Wolf faces strong competition in modular buildings and demountables. The third segment, freight containers, is a smaller market for the company, as Australia is a net importer and China a cheap producer of containers and a large exporter.

Where the broker thinks Royal Wolf will continue to make its presence felt is in the growing scale of the distribution network. This allows the company to effectively manage inventory, with customers having easy access to service needs. Also, a large network provides a procurement advantage and scale in marketing. Despite this, the market is still not saturated, in Bell Potter's view. The company envisages a potential to add 3-4 customer service centres per year. It's not all about plain old containers, either. The company has a good history of innovation. The patented hoardings product is the only solution of its type, to the broker's knowledge, in Australia and New Zealand.

The stock is expected to deliver top line growth that's less volatile and more predictable as leasing grows. Bell Potter acknowledges the exposure to the resources sector but thinks the company can still grow earnings through the cycle by innovation and increased leasing. Moreover, 49% of revenue comes from transport, general public, retail and manufacturing. There is potential for bolt-on acquisitions which should underpin the company's market position.

On the FNArena database there are four brokers covering the stock with two Buy ratings and two Hold. The consensus price target is $3.40, suggesting 2.8% upside to the last share price. Most brokers believe the stock is an attractive investment, with resilient earnings from the diversity of sectors to which it caters. Deutsche Bank notes the majority of Australian transport companies trade at a premium to the market but, given the fact Royal Wolf is smaller and has lower liquidity, a valuation on a market multiple is appropriate. The broker does not think valuing at a discount to the market is appropriate, because of the diversified end-market exposure, large network and continuing increases in the revenue base.
 

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