Timing Still Unclear For Turnaround In ALS

This story features ALS LIMITED. For more info SHARE ANALYSIS: ALQ

Expectations for the minerals and life sciences business of ALS Ltd have improved but questions remain regarding the timing of the turnaround.

-Plans to divest oil & gas business and scale up food analytical business
-Little benefit yet seen in the improving geochemistry cycle
-A higher stock rating may attract further corporate interest
 

By Eva Brocklehurst

Analytical laboratory business ALS Ltd ((ALQ)) expects its core minerals division is on an upward trajectory while life sciences, having been affected by several issues, should now turn around. First half net profit of $51.4m was at the lower end of guidance of $50-55m.

Morgans expects the outlook for the minerals business to materially improve in FY18/FY19. The stock is trading at a price/earnings ratio of 20x on the broker's FY18 forecasts, a 60% discount to international peers. The broker believes the leveraging of ongoing improvements in mineral exploration justifies an Add rating on the stock.

The company is looking to divest its oil & gas business, which lost $13.3m in earnings in the half year. ALS expects to continue oil & gas laboratory operations, which are currently making a small loss as they are in the development phase. The FY17 result is expected to still show underlying weakness in resources, but Morgans observes industry data suggests a better environment over the coming 12-24 months.

The broker acknowledges it is difficult to pick the quantum and speed at which fortunes will turn around, but expects investors will be rewarded in the longer term by significantly higher earnings. On face value the stock appears expensive but Morgans continues to believe services businesses should be bought at the bottom of the cycle when they are expensive, as earnings will flow through.

Macquarie also suggests that for cyclical businesses that are coming out of a downturn the turnaround is never as immediate as one would wish. The share price implied great expectations entering into the downturn and guidance remains similar to consensus ahead of the result, so there were no upgrades on which to pin further optimism.

Nevertheless, the company has ended the first half with positive momentum and sample flows continue to accelerate. The broker believes the divestment of the underperforming oil & gas business is a positive as this will increase the company's focus on the core minerals, life sciences and industrials divisions.

That said, it remains unclear as to whether the company will hold onto assets if the divestment process is unsuccessful. The broker envisages the big end of town to be the logical buyer of the oil & gas business, such as Haliburton or Schlumberger.

The company is also in advanced negotiations regarding a number of acquisitions which should be completed by March. This remains consistent with the strategy to scale up the food business. The investment thesis has not changed in terms of the positive leverage to the exploration cycle and the broker considers the oil & gas divestment and sensibly-priced acquisitions are key positive factors.

Macquarie notes there has been no developments since the Bain/Advent takeover approach back in June. The share price is now moved ahead of the $5.30 indicative price and, with a focus on the earnings recovery in the minerals business, provides somewhat of a floor below $6.00, in the broker's opinion.

The results suggest to Morgan Stanley the business remains under pressure and investor perceptions of a rapidly improving geochemistry cycle are offering little benefit as yet. The broker is also concerned about a poor result in the life sciences operation, which is generally considered to be defensive. Life sciences earnings were down 5%. This is also a concern given the company plans to dramatically ramp up acquisitions in this part of the business.

Morgan Stanley is also surprised by the decision to exit the oil & gas business, as the company only acquired it in 2013. The broker believes the shares are factoring in a cyclical recovery which may not be forthcoming and finds the stock is unattractive at this point in time, retaining an Underweight rating.

The outlook commentary was positive and Citi expects management changes in Canada and Latin America should provide support for growth in life sciences. There are also positive signs for geochemistry volumes which were up 30% in the half year. Although positive cyclical indicators are emerging, the broker considers the share price already anticipates a significant recovery, which may take longer than anticipated to realise.

Citi increases net profit forecasts for FY18 and FY19 by 4% and 7% respectively, as a result of incorporating the ALcontrol acquisition and a more positive outlook for minerals. On a broader view the broker notes exploration expenditure appears to have found a bottom as there are early signs that miners are returning to low-cost exploration to shore up longer-term reserves and production profiles.

Credit Suisse's Neutral rating reflects a trade-off between the uncertainty in timing and magnitude of the earnings recovery and further corporate interest in the stock. The broker remains cautiously optimistic, noting uncertainty around oil & gas is being removed and investors are now likely to re-focus on organic and acquisitive growth.

Opportunities in life sciences remain a key driver of growth but, in time, this may be accompanied by a higher stock rating and attract further corporate interest, the broker contends. Credit Suisse also question the timing of the decision to offload the oil & gas business in the context of a broader commodity price rally and a lost option for a higher sale price if conditions improve.

The upside to Ord Minnett's valuation is restricted by a downgrade to margin forecasts and a reduction in the enterprise value/earnings multiple in life sciences. Despite the M&A activity and more bullish forecasts in the minerals business there is still not enough upside for the broker to become more positive and a Hold rating is retained.

FNArena's database shows two Buy ratings, three Hold and two Sell. The consensus target is $5.67, suggesting 8.6% downside to the last share price. This compares with $5.30 ahead of the results. Targets range from $3.27 (Morgan Stanley) to $7.08 (Morgans).
 

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