Australia | Jun 23 2014
-Tight focus on cost reductions
-Well placed for economic upturn
-Increased pay-out from FY16
-Lower coal tonnage offset
By Eva Brocklehurst
Rail, terminal and port contractor Asciano ((AIO)) has dug deeper into its cost reduction program and brought forward efficiencies, largely on the back of the integration of PN Rail and PN Coal. The company presented its updated business improvement program at an investor briefing and also took the opportunity to address concerns about any loss of coal volumes, given the downturn in that market.
The company's success just rolls on, in CIMB's view. The broker increases FY15 and FY16 earnings forecasts by 3% and 4% respectively to reflect the improvement in margins gained from enhanced cost cutting. Volumes may be challenged by the downturn in coal prices and sentiment, with risks around additional competition in terminals, but CIMB thinks the market is now sufficiently conservative to enable upside surprise for the stock over the next two years. Efficiencies should leave the company well placed for significant earnings growth when volumes do return.
Citi considers the business is undervalued and retains a Buy rating. So to does BA-Merrill Lynch. However, Merrills still has a query regarding the automation at Swanson Dock, which will be required at some stage and has not been included in capex guidance out to FY16. The broker is also cautious about the extent of the cost assumptions, doubting that 100% of the savings can be held, given the company's margins are well ahead of competitors.
Management has reiterated FY14 guidance for low single digit growth in underlying profit and announced higher one-off costs following an acceleration of the restructuring. Costs in FY14 are expected to be $120-130m, up from the $15-25m range previously announced. The key point brokers gleaned is that management is now confident of delivering on a business improvement target of $300m by FY16 – two years earlier than previously expected. This involves a re-commitment to a 10-15% compound annual growth rate out to FY16. Furthermore, management expects increased cash flow and this should allow for an increase in the dividend pay-out ratio to over 50% by FY16, from 30-40% currently. The company will continue to explore strategic opportunities and partnerships for terminals and logistics.
UBS considers the company's plans are credible. Capex should fall from the current 2.5 times depreciation to 1.0 times by FY16, paving the way for the increased pay-out ratio. UBS also envisages upside potential from monetisation of equity in the ports business, where selling a 50% stake at 10 times earnings could release a net $1.4bn in capital and reduce gearing by 40%. Acquisition of Xstrata's in-house coal operation is also a possibility in the broker's opinion, given miners are wanting to rationalise capital. With around 50% of earnings coming from a domestic cyclical freight business, with high fixed costs, the stock is considered a good play on the Australian economy when it picks up.
Asciano has bought time, in Deutsche Bank's view, as it awaits the underlying economic cycle to return to more normal levels. The broker thinks the improvement program will underpin earnings growth out to at least FY16 before the company needs to see further growth avenues emerge. The broker observes company assurances that coal customers are happy with coal haulage contracts and the service Asciano is providing. To date, the impact of renegotiated contracts has been minimal but the broker reminds the market these contracts are long-dated and there is a risk that returns fall when they are renegotiated.
Macro headwinds are prevailing and challenging the top line in Morgan Stanley's opinion, although value is emerging and the company looks well placed to benefit from an economic recovery. Macquarie also considers revenue opportunities are limited in the near term but thinks the company is rightly focused on reducing the cost base. Still, Macquarie believes the jump in the share price post-update captured the excitement from accelerated cost cutting, noting the probability that if growth stalls in intermodal and ports operations, it leaves Asciano solely relying on cost reductions. The broker calculates the cost reduction program is now 9% of the growth outlook, acquisitions are 1% and there is a residual 1% for organic growth. This limit on growth is a negative, in Macquarie's view, but the re-investment in the asset base appears to be paying off.
In addressing market concerns, Macquarie also notes the company has emphasised the redevelopment of rail terminals in Sydney and Melbourne and does not feel threatened by the Moorebank development. Asciano has negotiated contract extensions with its coal customers and the contracted portfolio has grown by 18 months. This has most likely lowered the average price per tonne, in Macquarie's opinion, but is being offset by using idle capacity, particularly in NSW, to increase the tonnage hauled. The company reiterated an interest in forming a strategic joint venture with a global port operator but there is no financial urgency to do so, and Macquarie does not expect any developments on this front before the Autostrad roll-out is completed in Sydney in late FY15.
Macquarie stands out with the only Neutral rating on the FNArena database. The remaining seven are Buy ratings. The consensus target price is $6.45, suggesting 16.4% upside to the last share price. This compares with a consensus target of $6.30 ahead of the briefing. The targets range from $6.00 (Macquarie) to $7.10 (Deutsche Bank).
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