Australia | May 20 2014
-Persistent downturn in key sectors
-Advantages in growth strategies
-Leverage to eventual recovery
By Eva Brocklehurst
Capital products and mining consumables provider Bradken ((BKN)) will restructure its manufacturing business to offset earnings declines. The company has downgraded forecasts, albeit moderately, and now expects earnings of $173m in FY14, as opposed to the prior guidance of $180m.
The restructuring is necessary but signals a persistent and deep downturn, in Deutsche Bank's view. The broker finds the outlook highly unpredictable and the company subject to continuing pressure in the mining supply chain. Moreover, gearing is higher than it should be. That said, the company would require a further 25% fall in earnings to breach covenants and the broker acknowledges the dividend could be reduced, if necessary. Deutsche Bank thinks the risk for further downgrades is high and retains a Hold rating.
There are few signs the market is getting better and the restructuring makes sense to Credit Suisse. Bradken plans to reduce operating costs by $27m, mainly by closing high cost facilities and transferring the work to manufacturing bases in Brisbane and China, which currently have surplus capacity. Credit Suisse expects half the cost savings will come from overheads and the balance will be spread between mineral processing and mining products. BA-Merrill Lynch thinks investors have a right to be cautious, given recent misses on earnings and downgrades in the mining services space. For Bradken, the broker thinks a lot of the downside risk is now factored in and FY14 should be the bottom of the earnings cycle. Still, the stock is not expected to perform well while sentiment is subdued and commodity prices continue to decline.
CIMB thinks Bradken is a higher quality play because it is predominantly a product business rather than a contractor, and this means there's not the need for a sizeable order book to execute on an annual basis. Importantly, it is one of only a few mining services business with intellectual property protection in its products. There is also a significant capital base, which acts as a barrier to new players in the market. The broker believes the structural changes will involve some short term pain but are crucial to better position the business. Further cyclical deterioration from a volume perspective is unlikely but CIMB is less certain about the extent of pricing adjustments and the trajectory of key products for which the market structure has changed. Concerns around specific product lines warrant a more cautious view in the near term and the broker retains a Hold rating.
Morgan Stanley has decided to upgrade the rating to Overweight from Equal Weight after the announcement. The broker thinks activity levels have found a base and the restructuring will position Bradken for double digit earnings growth against broadly flat revenue. It will also provide leverage to an eventual recovery. The company has an advantage in its growth strategy via three areas: leveraging increased mining volumes; ability to capture additional margin via extending its position in the value chain; and acquisitions targeted to add scale and scope. Morgan Stanley expects limited top line improvement over the next 12 months but equally there is limited downside. The risk remains with any further downward shift in mining activity.
Moelis has a Hold rating and expects continued revenue and earnings uncertainty, should clients pressure the company on pricing. Hence there are few catalysts for outperforming in the near term. The scale of savings from the restructure is robust but Moelis assumes that not all savings will be retained, with ongoing price weakness in the coal and iron ore sectors to weigh on the stock. JP Morgan is more positive, as demand for core mining consumables holds up and mine production volumes are solid. There are benefits, too, from a global manufacturing platform, product breadth and R&D capability. The broker thinks investors are being compensated for the balance of risks and retains an Overweight rating.
On the FNArena database there are two Buy and five Hold ratings. The consensus target is $4.55, signalling 26.9% upside to the last share price. This compares with a consensus target of $5.15 ahead of the update. Targets range from $3.90 (CIMB) to $5.42 (JP Morgan). The stock has a dividend yield of 7.6% on consensus earnings estimates for FY14 and this rises to 8.0% for FY15.
Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" – Warning this story contains unashamedly positive feedback on the service provided.
