-Constraints from weak crop, mining
-Long term value in diversity
-Upside from Louisiana ammonia plant
 

By Eva Brocklehurst

Incitec Pivot ((IPL)) may have rallied in the wake of the FY14 results but in coming days a more sober analysis is likely to mean some of those gains are relinquished. This is JP Morgan's observation after the profit result for the explosives and fertiliser business turned out better than many had expected, as did the final dividend. Nevertheless, management's outlook is for a flat explosives market in FY15 and lower earnings from agriculture.

JP Morgan expects a weak outlook for both Dyno Americas and Dyno Asia Pacific will result in eventual downgrades to consensus forecasts. Goldman Sachs, too, considers management's FY15 guidance is cautious, with explosives earnings expected to ease and the contribution from Moranbah's revamp less than the broker expected. Goldman retains a Neutral rating but considers Incitec Pivot one of the most leveraged domestic industrial stocks to a lower Australian dollar and US economic recovery, which should attract investor attention over the ensuing twelve months.

At an operating earnings level, Incitec's FY14 result was up 10% on FY13 and all businesses delivered growth in Australian dollar terms, underpinned by the ramp up at Moranbah, cost cuts and currency translation. Long term value lies in the company's diversity across explosives, fertiliser and ammonia assets but this does not provide enough to support the current share price, in Morgan Stanley's view. Deteriorating explosives market conditions could also be a source of additional downside. The attractiveness of the stock is all relative for the broker - the defensive position at Moranbah offsets deteriorating explosives markets, while the Louisiana ammonia plant is positioned to deliver material earnings growth from FY17. These opportunities are not available for the company's closest peer, Orica ((ORI)), and in that way also, the value is relative.

Morgan Stanley considers the stock is modestly overvalued with efficiencies, fertiliser and FX being the swing factors. The broker retains an Equal-weight rating. Despite rising gas costs the company still offers significant leverage to diammonium phosphate (DAP) and urea prices and would be a beneficiary of any further weakness in the Australian dollar.

Macquarie observes the big ticket items such as Moranbah's revamp and the development of the Louisiana ammonia plant are on track and increasingly important. Louisiana will enable Dyno Americas to be far more cost competitive. Improvements in manufacturing in FY14 also heartened the broker. The outlook for Dyno Americas remains mixed. A number of contracts were renewed in the last twelve months and, while some were retained, geographic cost differentials and higher ammonia sourcing costs put paid to others. Macquarie notes the outlook for DAP prices suggests some recovery is in train, but remains unconvinced prices will move higher immediately. Buyers are reluctant to engage while the market is weakening and this suggests a floor may not yet be reached.

Citi is supportive of the Louisiana ammonia project, despite constrained near-term earnings. Nevertheless, fertiliser markets are pressured by subdued pricing while mining activity globally is suppressed, the broker suggests. The main advantage in the Australian dollar's downturn is in domestic fertiliser reference prices and the translation of foreign earnings, in the broker's view. Still, the crop outlook will constrain performance despite the long-term positives. UBS points out one area of weakness in the results was cash flow, with earnings conversion weak because of the build up in inventory, reflecting a re-basing of working capital going forward.

Guidance was a little softer than UBS expected, but broker believes the stock screens well on relative value and long-term cash generation. Moreover, UBS considers execution risks around plant reliability are diminishing and, with Louisiana offering attractive metrics on spot price assumptions, the stock could be ready for a positive re-rating. Hence, a Buy rating is retained. Morgans is also more buoyant, believing the company offers compelling growth opportunities. While short term operating conditions are challenging and Louisiana's "pay day" is not likely until FY17, when the plant comes on line, the broker maintains a Hold rating.

To Deutsche Bank the trade-off from challenging mining and agricultural markets is the improvement in manufacturing and productivity. Still, the broker is wary of the recent decline in soft commodity prices, particularly as a period of lower fertiliser demand is ahead. The broker reduces earnings forecasts by 3-5% and believes Incitec Pivot will continue to rationalise operations but notes the scope is limited and the impacts one-off in nature.

Ratings on FNArena's database have been consistent for some time. There are two Buy and six Hold ratings for Incitec Pivot. The consensus target is $3.17, signalling 5.7% upside to the last share price. Targets range from $2.80 (Morgan Stanley) to $3.30 (Deutsche Bank).
 

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- Macquarie initiates with Outperform
- Four from four Buy ratings
- Revenue growth to supplement cost efficiencies
- Dividends forecast to recommence

By Greg Peel

For this writer, the memory of Spotless Group ((SPO)) will always be one of queuing for half an hour during a footy match to buy a half-frozen meat pie. But that memory, it would seem, is one of a previous incarnation. In 2012, private equity firm Pacific Equity Partners acquired and de-listed a company in decline, which was tenuously stretched across international operations and weighed down with debt.

PEP sold off Spotless’ offshore operations and aggressively cut costs across the remaining domestic (A&NZ) group. The private equity firm drew criticism and disbelief when it sought to re-float the company through an IPO in May this year, with the naysayers unprepared to believe the mess that was the old Spotless could have been turned around in such a short space of time. It seemed as if the critics were just willing the new Spotless to fail.

Which may go some way to explaining why Spotless continues to trade at an average 8% discount to the price/earnings and enterprise value multiples of global peers, as far as Macquarie’s valuation attests -- a point not lost on other brokers. Macquarie yesterday initiated coverage on the new Spotless, setting an Outperform rating. Macquarie joins Citi, UBS and Deutsche Bank among the FNArena database brokers to not only to have restored coverage since Spotless returned, but to have applied a Buy or equivalent recommendation. SPO boasts four from four Buys.

Spotless re-listed in May so the FY14 earnings result released in late August only allowed analysts to check the company’s brief listed performance to date against IPO prospectus forecasts. The result came in marginally ahead of the prospectus and beat all three brokers above who had already initiated coverage.

At the time, UBS noted the “beat” was not just derived from further cost cuts but clearly revenue growth-driven, as the company took advantage of a greater scope of work. It is this “greater scope of work” which has also attracted Macquarie to the story.

Spotless is the leading Australasian provider of facilities management, catering, cleaning and laundry services. The superior scale and breadth of Spotless’ service offerings provides the company with a competitive advantage in the local market, Macquarie suggests. If a corporation or government department were a household, one might consider Spotless the housekeeper, paid to do all those time-consuming and dreary household chores one might be stuck with when there are so many more important things to do. In the twenty-first century, the popular solution is to outsource such obligations.

Indeed, a clear outsourcing trend has emerged downunder, notes Macquarie, particularly in health, education and government services. These three are growing sectors in which spending is being increased, and it makes sense to improve efficiencies by outsourcing certain responsibilities to those who live to handle such matters. Spotless management expects a 9% per annum growth trend over FY13-18 in outsourcing. The resources sector is another area in which cost efficiencies are being aggressively chased, and while Spotless is an immature player in this particular sector, it is rapidly gaining market share from its number three position.

Cost reduction and business improvement in Spotless’ own operations is expected to continue to underpin earnings growth in FY15, Macquarie points out. But the broker does not believe Spotless is “over-earning”. In other words, earnings growth is not expected to come to a screaming halt the day the company runs out of costs to cut or improvements to make. Beyond FY15, Macquarie sees revenue growth as a key earnings driver. Spotless is well-placed to exploit an increasing trend towards integrated and longer term contracts which result in clients becoming more and more “sticky”. It further stands to benefit from an increase in public-private partnership (PPP) arrangements with government departments.

Macquarie expects Spotless can close its valuation gap to global peers by delivering prospectus forecast earnings growth in FY15. Over FY16-17, the broker forecasts 11% per annum earnings growth driven by 6-7% revenue growth and margin improvement.

Macquarie, UBS and Deutsche Bank all forecast “new” Spotless to re-establish dividend payments in FY15 and Deutsche has suggested the possibility of capital returns by FY16. On average, the four FNArena brokers covering SPO are forecasting a dividend yield of 4.5% in FY15 and 5.2% in FY16, for what is basically a “staple” service business.

The consensus target now stands at $2.07 on a very narrow range from the brokers, suggesting 9.7% upside from current pricing.

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-Recovery unlikely inside 12 months
-Life sciences, industrial growth modest
-Price wars keep margins in check
-Structural and internal "issues" to fore
 

By Eva Brocklehurst

Testing and inspection services provider ALS ((ALQ)) has downgraded its first half earnings outlook in the face of soft trends in mineral services revenue. Volatile commodity prices, and economic and political disturbances, continue to affect mining industry volumes coming to the laboratories. Indeed, Macquarie observes global expenditure on exploration has continued to fall in every geography. ALS fears the trend will last into FY16 and is undertaking strategic reviews on operating locations to determine efficiencies.

The company has revised estimates for first half profits to $64m against guidance of $74m provided at the AGM back in July. Such a result would be 36% below the prior corresponding half. The disappointing guidance is driven by persistent weakness in minerals exploration, which reflects continued reductions in spending by miners. The company's oil & gas segment will sustain lower earnings too, on a combination of low volumes and reduced prices for coal.

Since the AGM, all divisions have experienced a weakening of conditions. The usual seasonal improvement has been less than expected. The balance sheet remains strong and the company is unlikely to resort to raising equity but, in Deutsche Bank's view, its ability to make value-accretive acquisitions has diminished. ALS may have significant leverage to a recovery in minerals exploration spending but the broker suspects it is unlikely to happen inside 12 months. Moreover, Deutsche Bank considers the stock is expensive and, with revenue volatile in the oil & gas sector, ALS could disappoint investors further.

Deutsche Bank retains a Sell rating, as do the other four FNArena database brokers covering the stock. The consensus target price is $6.04, suggesting 3.6% upside to the last share price (which was trounced yesterday). This compares with $6.57 ahead of the downgrade announcement. The dividend yield on FY15 and FY16 forecasts is 5.1% and 5.8% respectively.

ALS is experiencing some growth in the life sciences business and there is a recovery in industrial segments, but JP Morgan observes these are just not growing fast enough to offset resources weakness. Moreover, industry commentary suggests life sciences markets are highly price competitive and this will keep the company's margins in check. Goldman Sachs downgrades earnings forecasts by 18% and 22% for FY15 and FY16 respectively and reduces its target to $5.12 from $6.55. The broker continues to view a 10% discount to the market valuation is appropriate, given earnings are now late cycle and amid forecasts of declining capital returns.

The extent of the downgrade surprised Morgan Stanley. The broker takes some heart in signs that ALS is shifting its business away from minerals exploration and that some of the issues the company is contending with - and why earnings forecasts have been downgraded across the board - reside with execution problems, particularly in oil & gas. The broker believes a component of ALS' oil & gas business must be loss making, which could challenge the $453m in goodwill held against Reservoir Group, acquired in 2013.

The issues in oil & gas were cited as structural changes, which UBS suspects relate to the shift to production from exploration among customers in North America. This has a substantial impact as Reservoir Group derives 60-70% of its revenue from exploration. The company's reference to internal issues in the oil & gas business is assumed to relate to restructuring costs. UBS observes Reservoir Group is a private equity roll-up story and only partial integration was concluded at the point at which ALS acquired the business. UBS remains attracted to the company's industry position as well as its scale and track record, but is also concerned about the lack of visibility surrounding the timing of a turnaround. Moreover, Reservoir Group is principally a coring rather than a traditional laboratory based business and has more risks on that front.

Given the minerals cycle is stabilising, if execution issues are resolved, ALS could be capable of delivering strong growth in FY16. That said Morgan Stanley is mindful that the strength of any rebound will depend on correcting the problems in oil & gas. On the downside, the broker notes there is little visibility on this count and management appears to have been blindsided by the emergence of these issues. There is, therefore, a risk that FY16 earnings could still disappoint.

Macquarie suspects the primary cause of the downgrade to guidance is weaker margins in oil & gas and life sciences. The Reservoir business not only sustained softness from lower expenditure in oil & gas but there were internal cost control problems and inadequate pricing strategies, in Macquarie's view. This resulted in a loss of market share. Competitors in life sciences are also engaged in price wars and ALS has to defend its market share in that realm too. The broker believes ALS has a lot on its plate to get the Reservoir business into shape and there is a tough second half on the way.
 

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- Full bid pulled
- Buyers interested in the parts
- Royalty uncertainty overhangs
 

By Greg Peel

Standards Australia was founded in 1922. SAI Global ((SAI)) was spun out of the organisation in 2003 and floated on the ASX. SAI’s establishment was seeded with a fifteen-year contract with Standards Australia providing the right to sell and publish some 7000 standards under the Australian Standards Publishing Agreement, for which SAI pays a 10% royalty.

That royalty has now become an issue. The original 10% deal was a sweetener to kick off the listed company when a typical standards publishing agreement involves royalty rates of 50% or more. SAI has an option to extend the Agreement for a further five years to 2023, but Standards Australia retains the right to renegotiate the terms of the royalty. Will they expect 30%, 50%, 60%? This is the great unknown.

It is also the reason private equity has backed off. In May, a consortium consisting of Private Equity Partners and KKR made an indicative bid for SAI Global at $5.10-5.25 per share, representing a 19-23% premium to the traded price of the day. After a lengthy period of assessment, PEP/KKR has decided against pursuing a bid for the full company. The consortium has cited royalty uncertainty after 2018 as its concern.

SAI’s share price, which shot up to match the bid price back in May, last week tumbled back to the point at which it was previously trading, around $4.20.

Also, SAI has announced that while it has received no full-company offer, it has received various offers from parties interested in acquiring the different businesses within the company. SAI may have begun as a standards “bearer” but today it is a highly diverse and disparate organisation.

The company’s Information Services division distributes standards and other technical information and has developed intellectual property consisting of database and workflow solutions. It offers information brokerage to banks, conveyancers and mortgage outsourcers. The Compliance Services division offers advice on governance, risk and regulatory compliance solutions including everything from newsfeed compliance to learning systems, audit support and whistle-blower management. The Assurance Services division provides assessment and conformity systems pertaining to local and international standards with particular emphasis on food quality and safety.

And that is just a very brief summation.

The bottom line is that aside from private equity looking to acquire and “flip” the conglomerate with a re-listing, SAI has no real peers that would be interested in anything other than the particular division with which it is aligned. Brokers are also concerned about the tax implications for shareholders and the value impact on remaining divisions were one or more businesses to be carved off for sale. And while the issue remains of just what royalty Standards Australia might require from 2018, Standards Australia has thrown a further spanner in the works by suggesting it might even buy back the Publishing Licence Agreement in 2023.

Notwithstanding, all this has been occurring as SAI searches for a new CEO after sacking the last one, while the company is managing the migration of clients onto its new Compliance technology platform, and while a shift to electronic conveyancing threatens an impact on earnings.

Never a dull moment in the standards business.

The issue for brokers is that SAI clearly offers value, but as to how that value is extracted and just what assessment analysts can use to put a number to that value is not at all clear. The great unknown is just what royalty SAI will be paying after 2018 and indeed whether it will still have a standards business in 2023, and whether the sum of the parts provides an equivalent value to the whole.

What we do know is that the PEP/KKR bid at $5.10-5.25 is off the table. The private equiteers have declared no further interest. Media reports suggest they are still sniffing around the various bits, and SAI management confirms other potentially interested parties are too. Beyond that, it’s all a bit cloudy.

Those brokers reassessing their recommendations to date have cut back the previous takeover premiums within their valuations to reflect the fact that while SAI no longer appears “in play” as a whole, it is still in play as a break-up. On that basis, some brokers have reverted to a sum-of-the-parts valuation while others have settled on discounted cash flow, dependent on a royalty assumption beyond 2018. Goldman Sachs has assumed 30%, Deutsche Bank 50% and Morgan Stanley has factored in potential to 60%. A risk factor, that SAI will lose its licence agreement after 2023, is then applied.

Deutsche Bank has cut its twelve month share price target to $4.75 from $5.18, JP Morgan to $4.40 from $5.18, Goldman Sachs to $4.34 from $5.23, and Morgan Stanley to $4.40 from $5.00. All four brokers retain Hold or equivalent ratings. Within FNArena’s database, other brokers are still assessing developments and as such the current ratings spread and consensus target price are invalid.

Morgan Stanley sums up the feeling: “There is clearly a lot of value to be unlocked from SAI, in our view; however, we see a long hard road to value realisation as a publicly listed company”.
 

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-Cash flow, debt remain issues
-Progress made on margins
-Dept of Immigration key contract
 

By Eva Brocklehurst

Transfield Services ((TSE)) may have improved its performance during FY14 but the result has received mixed reviews. A number of issues remain to be worked through and broker opinions depend on just how confident analysts are in a light at the end of the tunnel.

CIMB worries about the need to normalise a number of factors on the balance sheet to arrive at the achievements the company indicates it has made. In particular, the difference between statutory and management-derived cash flow figuring requires a number of adjustments. The broker is always uncomfortable with having to make adjustments to the cash performance in this sector as cash flow is important to understanding true performance. Moreover, the significance of the contract with the Department of Immigration cannot be underestimated. Even outside of the issue of operating cash flow, or the level of debt, the broker considers the stock is too expensive. CIMB is concerned too that the bulk of FY15 growth is emanating from a single contract.

In contrast, Credit Suisse does not believe the valuation is demanding, given material business and balance sheet de-risking, and raises its rating to Neutral from Underperform. Management is making progress in dealing with unprofitable contracts, improving margins through a reduction in overheads, which Credit Suisse applauds. In FY15 the company will have benefit of a full contribution from the Immigration contract, and six months of an expanded Defence Department contract as well as a ramp up in NBN volumes. Credit Suisse acknowledges the concerns regarding the concentration of business with Immigration but does not expect this will be a major problem in the near term. The broker upgrades forecasts by 20% and 36% for FY15 and FY16 respectively, with the drivers being an improved earnings outlook and 17% reduction in depreciation.

The company has done well to push through cost reductions but JP Morgan is of a similar view to CIMB, believing the share price is not reflecting the challenges in end markets or the risks relating to gearing. On the positive side, the company does have good visibility on near-term earnings and could achieve margin improvement on ramping up of contracts, but there are limits to further material savings in Australasia. All up, high gearing dampens the broker's enthusiasm amidst the prospect of further headwinds from competitive end markets. Investors are not being fairly compensated for the downside risk, in the broker's view. JP Morgan downgrades to Underweight from Neutral.

Infrastructure outperformed Macquarie's expectations but this was offset by disappointment in the Americas and higher than expected corporate costs. The company's interests in the US delivered weak outcomes which included delayed work from key clients and problems with work flow. Transfield also exited the Chilean operation at a cost of $3.7m.The company has shifted more of its contract base to fixed fee and schedule of rates, which is a good step in Macquarie's view. The broker also likes the 46% win rate on new contracts as well as the 72% renewal rate.

Exposure to outsourcing in infrastructure management remains the key attraction in the stock for Macquarie. The more Transfield deals with its operational issues and stretched balance sheet the more the broker likes it. The company also exhibited a greater degree of confidence in the outlook, with competitive capability seemingly enhanced, given the indications in recent contracts. Add improving margins to the mix and Macquarie is happy to retain an Outperform rating.

 On FNArena's database Transfield has on Buy, three Hold and two Sell ratings. The consensus target is $1.47, suggesting 13.2% downside to the last share price and compares with $1.09 ahead of the results. Targets range from $1.13 to $2.03.
 

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-May walk on Dynapack
-Acquisition discipline
-Losing rigid share in Australia?
 

By Eva Brocklehurst

Packaging company Pact Group ((PGH)) delivered on guidance issued at its IPO last December but there were two more important factors which pleased brokers - debt reduction and cash conversion. This underpins management's credibility, despite any weakness emanating from the challenging macroeconomic environment. Moreover, the suggestion that acquisition of Dynapack, which is under consideration, may not meet financial criteria was also welcomed, signalling management is prepared to be disciplined regarding acquisitions.

UBS welcomes the possibility Pact may walk away from Dynapack, having concluded that paying more than eight times earnings for that company would be dilutive to value. Pact's option on Dynapack is due to expire in December. Guidance for FY15 does imply a weaker outlook in Australia but that is offset by better margins in the international business. UBS likes the stock, expecting 7% growth in FY15. Pact has relative valuation appeal, as it is trading at a 20% discount to a basket of defensive industrials and has a strong yield. The broker believes there is scope to leverage the balance sheet with acquisition-led growth going forward. Using Pact's targeted 20% hurdle rate, acquisitions would provide 4% annual accretion to the broker's existing forecasts.

The share price has rallied strongly since July and Credit Suisse downgrades to Neutral from Outperform on that basis. Top line momentum was below expectations but Credit Suisse remains positively disposed to the stock. The business is diversified and evidence of sustainable top line growth could take the group forward to the next milestone. The broker also hails the discipline shown regarding the Dynapack acquisition, which may allay concerns regarding the influence of Pact's chairman, who owns 50% of Dynapack.

Credit Suisse observes the company's aspirations to become a $5bn, five region, company in five years time does not mean investors should be put off by fears Pact may try to swallow large acquisitions. The company has demonstrated a commitment to accretive returns and the broker assumes no big packaging asset would be sold at a multiple that is low enough for Pact to maintain its targets. This is most probable, considering Pact has little in the way of material synergies outside of Australasia, while low interest rates have inflated packaging asset valuations. On reflection, the broker considers Pact is more likely to be acquired, or merged into a larger company.

While believing there was always limited risk to prospectus forecasts, CIMB also considers the FY14 results characterise management's cautious approach to acquisitions. CIMB suspects this will broaden the pool of potential investors and narrow the discount relative to fundamental valuation. The broker acknowledges related party arrangements remain a part of the business, and an acquisition of Dynapack would likely require an equity issue, but remains confident that management can effectively manage these risks.

Management has highlighted the recent greenfield investment in Indonesia provides organic growth opportunities. Credit Suisse is seeking more information on the size of this revenue opportunity before factoring it into forecasts. Pact expects its Indonesian factory will yield revenue in FY16. Credit Suisse models 0.5% organic growth in Australia and 2.5% for the international segment. FY15 should be underpinned by the integration of Cinqplast, Pact China and Sulo.

Australian FY14 contributions were affected by the loss of a milk bottle contract and subdued sales in the agricultural segment. Pact also recently upgraded its thin-walled tub manufacturing, adding new volume. Credit Suisse seeks some clarity on what may be holding back Pact's rigid plastics volume growth in Australia. The broker has some suspicions that Visy, a well capitalised competitor, is adding rigid plastics capacity and may have won some market share. It appears volume went backward in New Zealand as well. Credit Suisse expected the company would have captured revenue growth from price increases that were undertaken to recover resin costs.

Macquarie believes the stock is cheap but has made a solid start in building a track record as a listed company. Pact is trading at a 19% discount to Orora ((ORA)), a listed domestic competitor. Macquarie observes Orora has stronger near-term earnings growth but Pact has higher returns and margins.

FNArena's database has four Buy ratings and one Hold. The consensus target is $4.29, suggesting 12.9% upside to the last share price. The dividend yield on FY15 and FY16 forecasts is 5.4% and 6.0% respectively.
 

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-Subdued earnings near term
-Acquisitions likely catalyst
-Question of prior asset valuations
 

By Eva Brocklehurst

Tough conditions persist for Transpacific Industries ((TPI)). The company may have overshot broker estimates for FY14 at the headline but the composition of the results suggest weakness. The result was helped by the New Zealand business, which is now sold, and lower interest and tax. The main positive was the early resumption of dividends. The main negatives were a significant impairment charge and adjustment to remediation provisions.

CIMB likes the longer-term outlook and backs the attempts to turn around the business through top line growth, efficiencies and the redeployment of capital. It just takes time. Nevertheless, the broker cannot find the valuation appealing at current levels and downgrades to Hold from Add. The company has made a $189m extra provision for revised valuation of landfill remediation costs and total provisioning now sits at $347m. The company expects closure of landfills in Victoria and NSW over the next few years.

The glass is now half full, in Deutsche Bank's view. The company has improved its balance sheet significantly, having divested non-core assets, and management can now focus on revenue and operating efficiencies. While awaiting strategic initiatives to get going, the broker retains a Buy rating.

Credit Suisse was unimpressed with the quality of the result and downgrades forecasts for FY15-17 by around 20%. The recently appointed CEO, Robert Boucher, has indicated his strategy on sales, market share and price will take 18-24 months to implement. Until then, subdued conditions and the required investment will weigh on earnings. Management is actively pursuing landfill acquisitions and, with the company carrying significant head room on debt, these could drive earnings accretion, in Credit Suisse's view. There is limited upside in the short term as acquisitions remain the likely positive catalyst. The broker sticks with a Neutral rating.

The primary reason behind retaining a Buy rating is the belief that management can execute on its strategy, in UBS' opinion. Recent market share losses and limited landfill capacity in NSW and Victoria mean a number of short term challenges. The broker counsels investors to add the cash liability on remediation that will total $175m over the next five years to enterprise value calculations going forward. Trading conditions are expected to remain consistent with FY14 and the broker has reduced revenue estimates by 5% and earnings margin estimates by 131 basis points.

The provision for rectification and remediation is absolutely necessary, UBS asserts, as, while the short term cash impact is larger than expected, it is a better outcome than an environmental disaster. The broker considers the company is in excellent shape, as evidenced by the decision to pay a final dividend and introduce a policy of paying regular dividends of 50-75% of underlying profit going forward.

The asset base may be more realistic now but, given the risk around future capital allocation and positioning in the waste management value chain, JP Morgan takes a cautious view and retains a Neutral rating. The broker is concerned that, given the lack of quality, strategically-located landfill assets available, the transaction multiple the company is likely to pay may be difficult to justify.The company has increased remediation provisioning beyond expectations. Furthermore, given the extent of impairment adjustments, JP Morgan suspects earnings from these assets were historically overstated by both Transpacific and previous owners. The broker believes a reduction in the provisioning in future years could be a meaningful driver of earnings.

On the FNArena database there are three Buy and three Hold ratings. Consensus target is $1.07, suggesting 19.3% upside to the last share price, and compares with $1.24 ahead of the results. Targets range from $1.00 (CIMB) to $1.18 (Macquarie).
 

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-Strong cost control, cash flow
-Scope for restructuring benefits
-Recovery still shaky
-Plans to diversify
 

By Eva Brocklehurst

Conditions for Bradken ((BKN)) appear to be stabilising and there is a glimmer of hope for a turnaround stemming from the order book. Restructuring is delivering promised savings and improving the company's competitive position. Still, brokers diverge on how much upside to factor into the outlook. To Deutsche Bank the likelihood of a meaningful recovery is low. Conditions are patchy and the mining sector is subject to continuing pressure. Beyond any re-stocking the broker expects longer term structural and competitive issues will weigh on this capital goods and mining consumables business.

This does not bother JP Morgan. The broker liked the FY14 results, finding evidence of strong cost control and an improved business mix. The other key feature was good cash flow, allowing a higher dividend to be paid and a reduction in net debt. This is expected to continue. Demand for core mining consumables remains firm while mine production volumes are solid. The broker believes investors are being compensated for the balance of risks and retains an Overweight rating.

BA-Merrill Lynch errs on the side of caution, suspecting that margins are unlikely to grow further. The evidence is mounting that the bottom of the mining capital cycle may be at hand and Merrills estimates that the cumulative order intake was 7% higher in the second half. Despite an improvement in gross profit margin to 33.3%, the broker thinks this is as good as it gets. Yes, there is some upside but not enough to warrant changing a Neutral recommendation, in the broker's opinion.

Macquarie, too, envisages a bottom in the cycle is at a hand. Order books have been slow to recover and remain tilted towards maintenance, as capital expenditure programs are constrained among key customers. The broker believes the downside risk is limited now while management commentary points to a more expansionary and acquisitive outlook. The company has intentions to diversify end-market exposure, geographically and by industry. All up, this provides enough confidence for Macquarie to upgrade to Outperform from Neutral.

The positives add up for Goldman Sachs too. The broker believes Bradken is better placed than others in the sector to withstand weak conditions in mining, given the focus on consumables that are exposed to growth in mining production volumes.

Credit Suisse accepts the company is improving its business, with scope for restructuring benefits over and above those already announced, while the balance sheet is on a de-leveraging trajectory. However, the broker believes the valuation is already taking account of this. Earnings may have levelled out but capital products look set to remain weak. Mineral processing is firm and there is strength in the energy market. Credit Suisse is not enthused and moves to Neutral from Outperform given recent stock price outperformance. UBS also sticks with a cautious view, not sure when the capital cycle in mining will turn but conceding there is upside risk as the stock is trading at a low price/earnings multiple.

Orders are bumping along the bottom and this is not good evidence of a cyclical recovery, in Morgan Stanley's view. What enhances the outlook for this broker is that there is growth outside of the cycle. Restructuring initiatives and lower gearing mean the business can grow independently of the cyclical turnaround. The broker believes the company's growth strategy is intact with volume coming from from mining production, and there is scope for additional margin and acquisitions. The broker points out the company is confident in the potential for both fast pay-back on cost reduction initiatives and synergistic acquisitions in the coming year.

CIMB is happy that revenue trends have not deteriorated further and there is momentum in the order book. The broker believes expectations for FY15 are reasonable and is increasingly confident the cost savings can be retained. The broker notes this stock has consistently been regarded as a defensive and high quality player in a sector that has big challenges. Concerns over the balance sheet are now reduced, not that CIMB was overly worried on this score. The broker cites evidence that, for the past two down cycles, Bradken has proven it can organically de-leverage in a falling market. The broker considers the valuation argument is now compelling, upgrading to Add from Hold.

Summing up the views, FNArena's database has three Buy and four Hold ratings. The consensus target is $4.99, suggesting 3.0% upside to the last share price, and compares with $4.31 ahead of the result release. Dividend yield on FY15 and FY16 forecasts is 5.9% and 6.6% respectively.

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