More Upside For Hills Industries

This story features HILLS LIMITED, and other companies. For more info SHARE ANALYSIS: HIL

-Several recent acquisitions
-Yet balance sheet not stretched
-Funds deployed to higher growth areas
-Yet capital management potential
 

By Eva Brocklehurst

A spate of downgrades to guidance for FY14 and a subdued economic environment meant there was nothing particularly surprising for brokers when Hills Holdings ((HIL)) confirmed a soft outlook. Nevertheless, CIMB called it almost an upgrade, in that the company is one of the few that has stuck to original guidance, albeit now at the lower end of the range. Hills expects FY14 profit to still be in the range of $26-28m, just at the lower end.

Hills plans to become an integrated provider of solutions in telecommunications, technology and health care and recently acquired Audio Products, a supplier of professional audio products in Australia and New Zealand, which is forecast to turn over $26m in FY14. This is the latest in a number of bolt-on acquisitions the company has completed in the second half, including the Auckland-based Intek Security, Questek and Open Platform Systems. The fact the company retains its initial guidance range points to increased stability after significant divestments were made in the last 18 months, in CIMB's view.

The broker considers there is upside risk to such subdued expectations, as Hills retains significant balance sheet capacity. Should this be deployed at historical multiples, there is 20% implied upside for earnings going forward. The economic climate may be subdued, and organic sales growth limited in the short term, but CIMB thinks there is enough in savings flowing through and the stock remains compelling value. Hence, the broker retains an Add rating and $2.10 target.

Despite the share price increase over the past year, amounting to around 80%, Moelis thinks the price/earnings ratio for FY15 estimates of 13 times is undemanding, in view of the operational leverage and ongoing capital management opportunities. The acquisition of Audio Products, combined with the company's existing businesses, will create a leading player in electronics and communications and is indicative of the ongoing re-deployment of capital into higher growth areas. Management has signalled the softer FY14 guidance includes the partial contribution of discontinued businesses including Orrcon and Fielders, with the primary growth driver being further cost cutting benefits.

Moelis anticipates a small net cash position in FY14, after the $80m in net proceeds emanating from the sale of the two steel businesses to BlueScope ((BSL)) back in February, as well as an unused debt facility of $200m. This supports ongoing capital management, including the buy back of shares and sustainable 5% yield. Moelis retains a Buy rating and $2.15 target.

Citi observes, following the acquisition of Audio Products, that the company could spend a further $100m on acquisitions and net debt would only approach 20%. Citi estimates that assuming all $100m was spent on acquisitions at a multiple of four times earnings, this could generate an incremental $35m, representing over 50% of the broker's FY14 earnings forecasts. Such potential upside intrigues Citi. The broker rates Hills as a Buy with a $2.35 target because the divestment of the steel assets is approaching conclusion, which should finalise a re-rating of the business. Moreover, restructuring and transformation should drive further changes, with the positives including a focus on value-adding services as opposed to the prior focus on products.
 

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