Small Caps | Aug 11 2016
Royal Wolf is showing signs of a turnaround as it benefits from diversifying exposure away from the oil & gas sector.
-Increasing stability in earnings and scope for growth
-Revenue uplift in FY16 driven by low margin container sales to freight sector
-Focus on re-deploying or selling $23.5m in idle assets
By Eva Brocklehurst
Royal Wolf Holdings ((RWH)) has worked hard to diversify its service contract exposure and brokers acknowledge the effort after the FY16 earnings report revealed increasing stability in the second half. The company is broadening its offering to the industrial, construction and infrastructure sectors and away from the mining sector. Around 90% of its mining camps have been decommissioned.
Lower depreciation and interest expenses provided a boost to earnings although, as expected, the negative impact of reduced resources camp activity meant earnings were well down on the prior year. Revenue was up 11.1%, with most of the uplift driven by low margin container sales to the freight sector.
The company's balance sheet and cash flow were both stronger than Credit Suisse expected. Despite the remaining challenges in the operating environment, Credit Suisse upgrades to Outperform from Neutral. The broker observes the business is no longer materially exposed to oil & gas and earnings are likely to be more stable going forward.
The broker believes the company now has a plausible path to growth and valuation is undemanding. The pace of re-deploying idle assets has been slow but Credit Suisse observes the outlook implies an improvement and New Zealand, in terms of re-building and heightened activity in Auckland, signals growth ahead in FY17.
Royal Wolf is expected to make further recoveries from the Titan Energy receivers, having gained $2.5m in FY16, but the broker warns this does not represent recurring earnings. While there some potential risks to forecasts and the growth profile is modest, Credit Suisse welcomes the emerging areas of growth and believes the company is at the very least close to the low point in earnings.
The failure of Titan Energy was undoubtedly a negative, Ord Minnett concurs, but as the company’s ongoing exposure to the resources sector and single customers has reduced significantly, the broker believes the risk/reward are more definitely to the upside. Moreover, the company has a pool of assets that is very difficult to replicate in the Australian market.
The outlook is uncertain and some market share growth will be required as well as earnings growth into FY17, Deutsche Bank maintains. The main positive is the cash flow. The ability to re-deploy or sell surplus assets minimises capex requirements and also allows debt to be paid. Deutsche Bank expects FY17 capex requirements will remain subdued and a further reduction in debt around $12m will be incurred.
Given the fragmented nature of the industry, Deutsche Bank believes the business has scope for expansion. Nevertheless, the broker is cautious about potential incremental returns stemming from a focus on growing lease revenue through sector diversification.
Deutsche Bank notes there is $23.5min idle mining camp accommodation assets on the books and the company is pursuing opportunities to re-deploy or sell into other geographies, such as re-locating assets to the east coast from Western Australia.
Macquarie observes the sale, or re-deployment of the $23.5m in excess assets, is proving challenging. Sales would mean around $3m uplift to profit pre-tax and a reduction in gearing and thus be a key catalyst for the stock.
Macquarie also upgrades, to Outperform from Neutral, believing the company has almost cycled through its foray into the CSG sector. The market is expected to take time to regain confidence in the return to earnings growth that is forecast in FY17. Given the lack of liquidity the broker believes this is an opportunity to revisit the stock.
Macquarie expects General Finance Corp to maintain its 50% holding in the stock, despite speculation that the company, along with private equity, is exploring options in regard to Royal Wolf. Royal Wolf’s equity value is now less than half what it was in US dollar terms at the time of listing.
General Finance’s stretched balance sheet makes an acquisition less likely, in Macquarie’s view, while divestment of Royal Wolf would actually increase leverage, making this option even less likely.
There are four Buy ratings on FNArena’s database with a consensus target of $1.53, suggesting 15.1% upside to the last share price. This compares with $1.44 ahead of the results. The dividend yield on FY17 and FY18 forecasts is 4.5% and 5.0% respectively.
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