Cardno Opens Up Opportunity With Acquisition

This story features CARDNO LIMITED. For more info SHARE ANALYSIS: CDD

-Opportunity to cross sell services
-Organic growth disappoints
 

By Eva Brocklehurst

Cardno ((CDD)) has secured a major acquisition, opening up new areas of operations. PPI Technology Services is an oil and gas field services consultant based in Houston, Texas. This is the company's largest acquisition to date and brokers believe it offers significant value.

The US$145m acquisition will be funded by US$76m in scrip and US$69m in debt. The company also completed a $50m placement to ensure its gross debt to equity ratios stay below a 40% target. On completion of the transaction Cardno will have $156m in cash and unutilised facilities.

Deutsche Bank notes this acquisition will take the company into areas where it has not previously operated but the timing carries risks, given persistent weakness across a number of the existing businesses. Moreover, a lack of any FY14 earnings guidance is negative as the broker thinks it reflects the challenging operating background. The stock is trading on undemanding multiples but this is warranted, in Deutsche Bank's opinion, until evidence emerges of some improvement in core markets.

The slowdown in Australia is consistent with weak conditions and subdued expenditure and that's no surprise to Deutsche Bank. What troubles the broker is US earnings. A decline in that business over the first half was disappointing, given a recovery was underway and the indicators were improving. In defence, Cardno is seeing some pick-up in activity in urban infrastructure and Deutsche Bank thinks the gradual pace of this improvement means it is yet to be reflected in margins and earnings. The broker observes the company has managed its acquisitions well to date and earnings weakness relates to cyclical factors. Hence the share price is reflecting an even risk/reward balance.

Morgans considers PPI of strategic value as it provides the opportunity for Cardno to cross-sell respective capabilities and broaden the client base. PPI has established a 22-year track record, providing offshore drilling and production management, engineering and construction and asset management in North America, Africa and the Asia Pacific region. PPI generated US$133m in revenue and US$21.5m in earnings in 2013. Morgans highlights the significant amount of upstream oil and gas development forecast for Asia Pacific and West Africa in coming years. The company services over 300 clients annually in primary markets in the US and Nigeria.

Goldman Sachs views the acquisition as consistent with a strategy to acquire complimentary services in existing geographies, expecting the acquisition to be 7% earnings accretive. Goldman observes that PPI has a high degree of client concentration, with the largest client representing 21% of revenue for the past four years. The top four clients account for around 55% of revenue. Following the acquisition Cardno will generate 25% of its revenue from the oil, gas and energy market versus 14% in the first half of FY14. The company expects the merger to be 2c and 5c per share accretive in FY14 and FY15 respectively.

The price tag of US$145m is not cheap but it is reasonable, in Macquarie's view. Macquarie considers it a good strategic acquisition, but believes the company should not lose sight of the principal challenge to lift organic growth rates and generate value from prior acquisitions. JP Morgan, too, observes such a large acquisition can take time to digest. Given organic revenue declines in the first half and difficult operating conditions the broker retains a Neutral stance.

The company has a neutral profile on the FNArena database, with four Hold ratings and a range of price targets between $6.42 and $6.85. The consensus target is $6.68, suggesting 5.4% upside to the last price. The dividend yield on FY14 and FY15 estimates is 5.9% and 6.1% respectively.
 

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