-Order ahead of expectations
-Positioned for maintenance work
-Better funding terms this time
 

By Eva Brocklehurst

Ship builder Austal ((ASB)) has scored a win with the US Navy, with the award of two LCS (littoral combat ships) ship building contracts for a value of US$691m. This award finalises the funding of a 10-ship block purchase and the US Navy has added a further option for another in 2016. A plan to extend the LCS program to 32 vessels has been flagged, with 27 already awarded, while the US Navy is reassessing an expansion program for vessels 33 to 52.

The US Navy's budget only funded three LCS this year. Macquarie had suspected Austal would be awarded one ship with long lead items for a second vessel, given its contract is running six months behind competitor Lockheed Martin's contract. Instead, Lockheed was awarded just one vessel for US$362m, with US$79m awarded for long lead items for a second. The broker notes this is the first time the US Navy has had to award an uneven number of ships and been forced to decide between the two builders.

Macquarie suspects Austal could eventually build 15% of the US Navy fleet and the 2016 option for an eleventh LCS is the first tangible sign the program is being extended. The order book now stands at $3.1bn and Austal now has work for its US facility out to 2020. The Joint High Speed Vessel (JHSV) is generating substantial interest both in the US and internationally and Macquarie suggests, should this program and the LCS vessels be extended, there could be substantial work ahead for Austal.

In Macquarie's view, the news signals a strong improvement  in Austal's balance sheet. The broker retains an Outperform rating and $1.96 target. The company's work has put it in a prime position to win service and maintenance contracts as well, and this could build into a material annuity-style business for the company over time.

JP Morgan has an Overweight rating and $1.82 target and believes the decline in the Australian dollar will underwrite the earnings profile over the medium term. This broker also observes there was some risk Austal would not receive full funding for two vessels, with the US government signalling that only three vessels would be funded. The broker cautions that no conclusion can be drawn that the US Navy prefers Austal's variant to its competitor's but Austal has received better terms in this round of funding, with a full benefit for two vessels, while Lockheed has received full funding for one vessel and part funding for the second. JP Morgan assumes the dual purchase program will proceed with both providers.
 

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-Acquisitions, capital options
-Attractive versus Oz peers
-Botany mill ramps up
 

By Eva Brocklehurst

Packaging supplier Orora ((ORA)) impressed brokers with a solid first half result, growing its earnings base despite the lack of support from a subdued market backdrop. Full year guidance was very general, with earnings expected to be "higher than reported on a pro forma basis in FY14". Orora was spun out of the Amcor ((AMC)) group in December 2013.

Macquarie found the results hard to fault. Benefits are forthcoming from the Botany mill ramp-up while margins are ahead of expectations, driven by cost cutting efficiencies in manufacturing as well as market share gains. All the benefits are coming despite a lack of support in the external environment, with demand conditions notably subdued across the company's markets. The broker observes a growing focus on innovation, reflecting a conscious need for sustainable earnings growth as cost cutting benefits run their course.

On the negative side, franked dividends are now more likely to come in FY16 rather than the second half because of the timing of tax payments. The Australian market is still very flat and North America is yet to show tangible improvement. Still, Macquarie envisages 14% compound earnings growth over the next three years, coupled with balance sheet options around acquisitions or capital management. The stock is not cheap but Macquarie believes the valuation is justified by its defensive growth attributes, as it offers leverage to the US economy and a weaker Australian dollar, with solid yield and balance sheet options.

UBS retains a Buy rating and considers the stock attractive when viewed relative to its defensive Australian industrial peers. Given the improved performance of the Botany plant over the past six months and margin enhancement, the broker believes visibility around growth estimates is much clearer. There is scope for acquisitions or capital management and the broker retains a dividend profile pay-out at the upper end of management's 60-70% target range. That said, UBS observes total capital expenditure is still above the historical average, driven by the investment in glass furnace realignment at Gawler, investment in a dairy sack line and a new ERP software system for the North American business.

Confidence in the company has improved and Credit Suisse upgrades to Outperform from Underperform. The broker expects further re-rating because of the stable outlook and yield compression. Rising gas costs will feature in the second half and beyond, while refurbishing of a glass furnace will initially impact profits. Still, glass revenues are expected to benefit from new contracts and Australian data shows wine bottle export volumes have returned to growth.

In terms of gas supply, Credit Suisse observes Orora has an option with Strike Energy ((STX)) for the sale of 45PJ over a 10-year period from 2017 at an attractive fixed rate. While the gas provider is still in the early stages of development, the fixed rate is deemed favourable and Orora could obtain a substantial reduction in gas costs if Strike Energy is successful. Obviously, the broker is not yet factoring in this scenario.

What is more certain is that a lower Australian dollar and the quality of the paper coming out of Botany means the forest/Kraft pulp market in North America should find a ready substitute in the local product. Concerns around the performance of the Botany liner board mill were always overdone, in Citi's view. Citi observes the mill is on track to meet its FY15 target of 360,000 tonnes and further export sales to the US are likely. The first half performance should go a long way to easing concerns, in the broker's opinion. Deutsche Bank was also upbeat. Cash flow was in line with expectations and the balance sheet much improved. Deutsche Bank retains a Hold rating as the stock is trading at a 9.0% premium to the broker's valuation.

Morgans was pleased with the company's ability to take advantage of growth opportunities and the reiteration of an intention to deploy cash via acquisitions or capital management. While the stock is considered fully valued at current levels, cash deployment could mitigate uncertainty associated with future initiatives. Importantly, this could also provide a more sustainable basis of earnings growth. In the current uncertain environment the company's relatively stable growth outlook should support the investment proposition, in the broker's view.

FNArena's database reveals Orora has three Buy ratings and four Hold. The consensus target is $2.16, suggesting 4.4% downside to the last share price. This target compares to $1.94 ahead of the results. Targets range from $1.81 to $2.50.
 

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-Cash conversion strong
-Pay-out ratio increased
-Costs rise with competition
-Needs time to bed down Jobstreet
 

By Eva Brocklehurst

Online employment classifieds and education business, Seek ((SEK)), missed profit forecasts in its first half result, despite delivering solid growth at the top line and increasing the dividend pay-out ratio. The market was clearly disappointed and the share price reacted negatively. While there were both pleasing and not-so-pleasing aspects to the numbers, several brokers wonder whether the market has set its expectations too high.

JP Morgan observes that while the company re-affirmed FY15 guidance and increased the payout ratio, the market is grappling with the amount of reinvestment being undertaken in the employment division, as well as the increased competition in Seek Learning and the new Seek Asia combination. The pay-out range was increased to 50-60% from 50% previously, reflecting strong free cash flow and a strong balance sheet. Management hastened to allay concerns this did not reflect a lesser desire to invest, either by capital expenditure or acquisitions, nor a lack of investment opportunity.

Guidance implies expectations for FY15 profit may be hard to achieve, in Morgan Stanley's observation. The result missed the broker's forecasts because of higher operating costs in the domestic business. The company has suggested underlying profit in the second half should be modestly higher than the first half, but the broker observes consensus expectations are looking for 29% growth in the second half, substantially more than the 9.0% achieved in the first half.

Credit Suisse also highlights the step-up in the domestic cost base, which emanates from investment in the company's placement strategy and a more competitive environment. Upside remains difficult to quantify, although investment in the business should support longer-term revenue growth. The broker believes the stock is fully priced and retains an Underperform rating. UBS now implies 10% underlying growth for the second half in its estimates. Despite the attractive asset base, placement and international learning opportunities this broker also believes the stock is expensive. A third of Seek's growth is driven by its Chinese employment site, Zhaopin. UBS is inclined to sell Seek and buy the Chinese stock.

Morgans claims the market is unnecessarily spooked by the implications for the second half. The company has a long tradition of being conservative in its forecasts. The second half should be supported by a full six month contribution from the merged Jobstreet business - which will be more than double the size of the former standalone business JobsDB - and the rolling impact of the prior year's price rises. Moreover, volumes are growing domestically and the second half is traditionally stronger for education. Worries about a lack of margin growth are also misplaced, in the broker's opinion.

Morgans also flags cash conversion, which remains excellent despite the heavy IT spending. Moreover, Zhaopin overcame intense competition and slowing economy to grow revenue by 27% in local currency terms in the first half and Morgans points to leading indicators on that front which suggest growth should continue at a solid rate.

Citi observes market expectations may elevated but execution risk is also increasing. The risk to earnings forecasts is to the downside, given the high expectations and premium valuation. Hence, Citi retains a Sell rating. Further cost inflation across the domestic employment and Seek Learning businesses into FY16 is expected. That said, the broker believes the assets are well positioned for growth. 

The damp squib in the results was the higher level of expenditure being directed towards placement products, in Macquarie's view. The broker does not doubt expenditure and costs are higher but also points to the strong underlying trends, and believes it is too early to judge the outcomes of the company's initiatives. Macquarie retains an Outperform rating, noting Seek is expecting to create material value in Asia over a number of years following the Jobstreet acquisition, while driving new revenue streams in placements and expanding its learning platforms.

FNArena's database has a spread of views with three Buy, two Hold and three Sell ratings. The consensus target is $16.98, suggesting 1.5% downside to the last share price. Targets range from $13.70 (UBS) to $19.97 (Morgans). 
 

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