Qube Facing Complex Outlook

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The outlook for Qube Holdings is gaining complexity, with the recent contract loss for its Patrick division, while substantial, not considered significant in the longer term.

-Despite contract loss management is expected to improve service levels at Patrick
-Macquarie believes value is now emerging in the stock
-Morgan Stanley suspects logistics weakness could be more broad based
 

By Eva Brocklehurst

The Patrick division of Qube Holdings ((QUB)) has lost its contract with the Asia Australia consortium, which Macquarie calculates to represent 225,000 containers annually. The loss of the contract may not be material for the group in FY17 but represents a material loss to Patrick.

The loss of the contract reflects the uncertainty over the ownership and a lack of direction that has plagued Patrick over the last 12 months, Citi contends, flagging operational improvements at competitor DP World and aggressive pricing from Hutchison.

The broker suggests management at Patrick needs to make changes to operations over the next few months to improve service levels to shipping customers, in order to better its prospects of increasing market share.

Citi estimates market share loss for Patrick is 3.5%. The impact is less for FY17 as the current contract is expected to run to the end of October. Pricing pressure is expected to increase and revenue per lift to decline by an average of 2.1% over the next three years. Nevertheless, Citi is confident management can increase efficiencies and improve service levels.

The broker's investment view is not fundamentally changed by the loss of the contract and the size of the Moorebank, Sydney, development is expected to provide attractive economics that will accelerate the modal shift to rail. The Moorebank intermodal will include a large freight hub and a rail shuttle to Port Botany.

Macquarie believes Qube Holdings is facing a mixed outlook, but growth should return once the effects of the cessation of contracts in ports & bulks and the re-negotiation of the Atlas Iron ((AGO)) contract are cycled. The broker envisages longer term upside from Moorebank.

FY17 logistics growth should be driven by the stabilisation of existing volumes and new business. Since its financial results the stock has drifted down 14% and the broker believes this negates further downside risk, with value now emerging. While not currently expecting earnings-per-share (EPS) growth, the broker takes the opportunity to upgrade to Outperform from Neutral.

Diesel fuel data suggests there are volume challenges which are widespread and growing with Morgan Stanley using monthly sales figures as a a rough proxy for industrial demand in logistics and bulks. The broker finds the data sober news.

Diesel volumes fell 7% in July 2016 and the three-month rolling basis also suggests a decline (4%), indicating this is more than a one off. Morgan Stanley analyses other data in the container business, which affects 65% of Qube's business either directly or indirectly, and finds the weakness could be more broad based than previously appreciated.

The broker considers there are better entry points ahead for the stock and continues to like the options around strategic assets such as Moorebank, with the first half result offering the first opportunity to assess the severity of the unwinding of volumes and prices.

Earlier this month UBS upgraded the stock to Buy from Neutral, noting Qube Holdings has a simple strategy but the financial journey is complex. The broker does not expect Moorebank to make a meaningful contribution to earnings until FY20, suggesting that while the stock's price/earnings ratio of 24x for the next two years appears stretched this will descend to 17x in FY21.

UBS continues to like the company's strategy of leveraging infrastructure-like assets in the import-export freight chain but does not expect EPS will recover to FY15 levels over the next two years, reflecting the step down in mining-related earnings and dilution from the investment in Patrick and Moorebank.

Consensus expectations appear to be 10% above the broker's forecasts for the next few years and UBS interprets this as a lack of understanding of the financial implications of the Patrick and Moorebank investments. There is the possibility the company may do better if it wins contracts in operating divisions, or makes accretive acquisitions, but the broker suggests the market is taking a subdued view of near-term earnings.

There are some negatives dragging on profitability in FY16-18, which limit the ability for earnings to recover, but the winding down of four major contracts in ports & bulks (UBS made this note ahead of the latest contract loss from Patrick) also signal a permanent step down in the broker's opinion.

FNArena's database shows three Buy ratings and three Hold for Qube. The consensus target is $2.65, suggesting 14.6% upside to the last share price. Targets range from $2.40 to $2.90.
 

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