Weak Conditions Dull Outlook For Qube

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-Weak FY15-16 likely to pressure shares
-But could provide entry point
-Moorebank development potential ahead
-But not featuring until FY18
 

By Eva Brocklehurst

Qube Holdings ((QUB)) has unveiled the potential of the Moorebank intermodal Terminal development but given a soft near-term earnings outlook, not all broker reviews are positive. In tandem with the company’s warning that earnings are reduced due to the expiry of resource contracts, the federal government has given its approval for the Moorebank project, a major transport and logistics hub to be developed in south western Sydney.

In addition to earnings from running trains into the Moorebank terminal, Qube will derive earnings from ownership of the site and fees from being the construction manager. The company will also buy out Aurizon Holding’s ((AZJ)) property development rights as each tenant is signed up and deliver cross-docking and services to customers. Aurizon is the 33% partner to Qube in the Moorebank project. The total project cost is estimated at $1.5bn over 10 years with a government share of $370m towards development including funding the rail connection with the southern Sydney freight line.

Brokers have emerged from a detailed briefing on Moorebank with divergent views. Qube Holdings has a consensus target on FNArena’s database of $2.84. It suggests 13.6% upside to the last share price. Targets range from $2.25 (Deutsche Bank) to $3.35 (Credit Suisse). There are five Buy ratings, two Hold and one Sell.

Morgans was pleased the agreement on Moorebank with the government was finally reached and expects around $40m could be generated in earnings by FY20. Otherwise, reduced earnings from the ports & bulk division in the near term is a negative. Having already cut FY16 forecasts by 5.0% because of the cessation of contracts, the broker’s FY15 estimates are reduced by a further 6.5%, as the company cites flagging volumes and price pressures. Still, Morgans believes markets were factoring in views which were too optimistic on FY16 and these needed to be revised down. The broker remains of the view the company has the potential to build a high quality transport company and retains an Add rating.

The Moorebank development is actually a property play, UBS maintains, with only 30% of the fully developed earnings coming from logistics activities. The broker expects the warehousing and logistics connections will attract volume to the terminal and be important in differentiating the intermodal offering. The broker expects incremental earnings contributions from FY19 and incremental cash flow from FY21. At this stage the broker does not incorporate the project’s financials into mainstream forecasts but presents preliminary modeling on a standalone basis and retains a Neutral rating. Moreover, the stock is trading at a significant premium to market average multiples which the broker believes captures much of the upside potential.

Morgan Stanley was impressed with the details on Moorebank but until the tenancy is settled, expects the share price direction will come from the base business. Given this is subdued, the stock is likely to suffer in the near term but the broker believes any weakness could provide an attractive entry point. The positives in the detail include a rent free period to accelerate the rail economics and lower up-front capital expenditure. Qube will also receive the full economic benefit from warehousing and the broker believes the project could be worth $1bn in the end. Still, Morgan Stanley acknowledges risks around tenancy, greenfield development and developer margins.

Outstanding issues remain, Macquarie agrees, citing clarity on warehouse funding and timing. Still, the broker retains an Outperform rating, believing the market will start to factor in the heightened prospects now the project has been approved and discussions with tenants and developers can begin.

One difficulty Citi has with the Moorebank development is how savings will be delivered to customers. There will be differing price ranges and management expects supply chain savings of 20-25%. Citi suspects this will be targeted at key exporters and importers, and savings will stem from conversion to a faster cross-dock operation. The company’s capital commitment is easily covered by cash and existing debt. Given the long-term ownership of the property Citi envisages potential in developing and leasing a portion of the warehouse capacity. Management is forecasting a post-tax return of more than 12-15% and Citi believes, if development rights were sold, this could be even more attractive.

Deutsche Bank is more pessimistic about the short term, suspecting earnings would not improve going into FY16 because of the cessation of the Arrium ((ARI)) contract and the restructure of the Atlas Iron ((AGO)) contract, while the opportunity from the Moorebank development is well into the future. The broker understands the strategy to reduce supply chain costs and the longer-term potential for Moorebank to change industry dynamics.

Nevertheless, in the here and now, the broker’s FY15 earnings estimates are reduced by 16% and the rating is downgraded to Sell from Hold. Deutsche Bank estimates iron ore represents 23% of port & bulk segment revenue in FY15 and further volume weakness will continue. On most measures, in comparison to peers Aurizon and Asciano ((AIO)), Qube is viewed less favourably.

Credit Suisse expects the promise from Moorebank could be in evidence by FY18. Credit Suisse also downgrades estimates by 16% on the back of the expiry of resource contracts coupled with the loss of margin on the Atlas Iron contract, as well as lower expected rental from Moorebank while the property is developed. In a similar vein to Morgan Stanley, the broker accepts, longer term, there could be attractive upside and entry points could be available in the near term.

Despite the company’s iron ore exposure, now the earnings downgrade has been factored in, the broker has come to the conclusion upside for Moorebank outweighs the risk. Credit Suisse believes Qube has unfettered pricing power and can capture a large portion of the efficiency gains in the import/export container supply chain. Hence, rating is upgraded to Outperform from Underperform.
 

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