-Signals more owner-operator mining
-Pressure on mining earnings continues
-But opportunities for acquisitions
-And buy-back potential
 

By Eva Brocklehurst

Downer EDI ((DOW)) may be able to withstand the headwinds when sentiment turns sour but there are few places to hide. The stock received a drubbing after the company announced the contract for overburden removal and pre-stripping at Goonyella Riverside open cut coal mine, Queensland, has been terminated early by the BHP Billiton ((BHP)) Mitsubishi Alliance. Work was originally scheduled for completion in June 2016. Downer indicated the revenue impact on work-in-hand would be $360m, split between FY15 and FY16.

The reaction from brokers took in all angles. To Morgan Stanley the news is a signal the shift to owner-operator mining is beginning. The broker has calculated that with attractive equipment funding options it may be significantly more cost effective for miners to convert to an owner-operator model than to use contract miners. In the broker's survey, 70% of respondents indicated they would consider bringing contract mining in-house, with the remainder having already done so.

UBS estimates that coal mining operations represent 20% of Downer EDI's group earnings and, while the broker's forecasts had already assumed a 22% decline in mining earnings in FY15, they are lowered further to incorporate the loss of Goonyella Riverside. The company may be executing strongly, and oofer opportunities arising from a strengthening balance sheet such as earnings-accretive buy-backs and/or value-accretive acquisitions, but the pressure on mining revenue is mounting. This pressure is coming from miners taking work in-house and also reductions in the scope of works. UBS downgrades to Neutral from Buy.

Credit Suisse takes the same view, downgrading to Underperform from Neutral. In the absence of a material recovery in coal prices the trend to owner-operators is likely to continue more broadly and this implies a greater risk for contract mining earnings, says CS. The broker thinks the remaining BMA contract at Blackwater is likely to meet a similar fate prior to the FY16 renewal date and this loss would make future renegotiations problematic, particularly in the face of a commodity cycle which has passed its peak and excessive divisional returns. Negative earnings momentum means the potential for merger and/or acquisition is likely to be a focus point, in the broker's opinion.

Citi joins the downgraders camp, to Neutral from Buy. The broker thinks the mining industry has further to go with structural cost adjustments and has taken the opportunity to adjust long-range forecasts for Downer EDI's mining division to account for the risks that are inherent in a multi-year down cycle. That's not to say the broker is not positive about the prospects long term, as the company has a robust financial position and will be net cash in FY15. This should provide the means to supplement the growth profile at an opportune time. Still, the broker expects the share price will reflect the mining risks for the time being.

The news did not justify a downgrade, in BA-Merrill Lynch's opinion. The broker retains a Buy rating. Despite the difficult operating conditions in the coal market in Australia, Merrills only envisages minimal further downside risk from Downer's remaining coal exposure. Analysis of the company's order book shows only an additional $120m in contracted revenue - Blackwater - that the broker would assess as being at substantial risk of early termination over the next two years. On the other side of the balance sheet, the company's infrastructure pipeline is growing and Merrills believes this should offset near-term revenue pressure in mining. The broker considers the drop in the share price overdone.

CIMB is of the same opinion, believing the impact of sentiment on the stock is much greater than the actual financial impact. The broker made no cuts to forecasts, having built a buffer of 15 percentage points into revenue forecasts to allow for contract losses or termination. CIMB also observes that Blackwater is the only mine contract left in place with BMA in FY15. While it may sound glib to state the fall in the share price is a buying opportunity, CIMB believes it is just that.

JP Morgan also sticks with an Overweight rating. The company has a diverse order book and that is what matters, says JPM. Other work has recently been won and the broker cites opportunities such as the Adani contract, for which Downer EDI is bidding. Moreover, management has taken steps to stabilise the business and has the capacity to respond positively to the mix of risks and prospects. The broker believes the current discount to its $5.90/share valuation factors in potential near-term risks, without reflecting the stock's competitive advantages. Macquarie also highlights the prospects with Adani and lists some catalysts, such as reasonable FY15 earnings guidance, acquisitions and the buy-back potential.

On FNArena's database Downer EDI has five Buy ratings (compared to seven previously), two Hold (one) and one Sell (none). The consensus target price is $5.43, which compares to $5.87 ahead of the news and signals 15.8% upside to the last share price. The stock offers a 5.0% dividend yield on FY14 forecasts and 5.6% on FY15.
 

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-Persistent downturn in key sectors
-Advantages in growth strategies
-Leverage to eventual recovery
 

By Eva Brocklehurst

Capital products and mining consumables provider Bradken ((BKN)) will restructure its manufacturing business to offset earnings declines. The company has downgraded forecasts, albeit moderately, and now expects earnings of $173m in FY14, as opposed to the prior guidance of $180m.

The restructuring is necessary but signals a persistent and deep downturn, in Deutsche Bank's view. The broker finds the outlook highly unpredictable and the company subject to continuing pressure in the mining supply chain. Moreover, gearing is higher than it should be. That said, the company would require a further 25% fall in earnings to breach covenants and the broker acknowledges the dividend could be reduced, if necessary. Deutsche Bank thinks the risk for further downgrades is high and retains a Hold rating.

There are few signs the market is getting better and the restructuring makes sense to Credit Suisse. Bradken plans to reduce operating costs by $27m, mainly by closing high cost facilities and transferring the work to manufacturing bases in Brisbane and China, which currently have surplus capacity. Credit Suisse expects half the cost savings will come from overheads and the balance will be spread between mineral processing and mining products. BA-Merrill Lynch thinks investors have a right to be cautious, given recent misses on earnings and downgrades in the mining services space. For Bradken, the broker thinks a lot of the downside risk is now factored in and FY14 should be the bottom of the earnings cycle. Still, the stock is not expected to perform well while sentiment is subdued and commodity prices continue to decline.

CIMB thinks Bradken is a higher quality play because it is predominantly a product business rather than a contractor, and this means there's not the need for a sizeable order book to execute on an annual basis. Importantly, it is one of only a few mining services business with intellectual property protection in its products. There is also a significant capital base, which acts as a barrier to new players in the market. The broker believes the structural changes will involve some short term pain but are crucial to better position the business. Further cyclical deterioration from a volume perspective is unlikely but CIMB is less certain about the extent of pricing adjustments and the trajectory of key products for which the market structure has changed. Concerns around specific product lines warrant a more cautious view in the near term and the broker retains a Hold rating.

Morgan Stanley has decided to upgrade the rating to Overweight from Equal Weight after the announcement. The broker thinks activity levels have found a base and the restructuring will position Bradken for double digit earnings growth against broadly flat revenue. It will also provide leverage to an eventual recovery. The company has an advantage in its growth strategy via three areas: leveraging increased mining volumes; ability to capture additional margin via extending its position in the value chain; and acquisitions targeted to add scale and scope. Morgan Stanley expects limited top line improvement over the next 12 months but equally there is limited downside. The risk remains with any further downward shift in mining activity.

Moelis has a Hold rating and expects continued revenue and earnings uncertainty, should clients pressure the company on pricing. Hence there are few catalysts for outperforming in the near term. The scale of savings from the restructure is robust but Moelis assumes that not all savings will be retained, with ongoing price weakness in the coal and iron ore sectors to weigh on the stock. JP Morgan is more positive, as demand for core mining consumables holds up and mine production volumes are solid. There are benefits, too, from a global manufacturing platform, product breadth and R&D capability. The broker thinks investors are being compensated for the balance of risks and retains an Overweight rating.

On the FNArena database there are two Buy and five Hold ratings. The consensus target is $4.55, signalling 26.9% upside to the last share price. This compares with a consensus target of $5.15 ahead of the update. Targets range from $3.90 (CIMB) to $5.42 (JP Morgan). The stock has a dividend yield of 7.6% on consensus earnings estimates for FY14 and this rises to 8.0% for FY15.
 

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-No major recovery short term
-Substantial discount to market
-Catalyst may be in FY14 results
 

By Eva Brocklehurst

Chemicals and mining services business Orica ((ORI)) confirmed fears with a subdued first half and brokers are resigned to the fact that it will be hard going for a while. The stock is attractive in terms of valuation but many are just not ready to put a Buy recommendation in place.

Macquarie downgraded its recommendation to Neutral from Outperform, noting valuation was undemanding and the stock a quality name but earnings momentum is negative and there are risks regarding the second half. In contrast, Deutsche Bank's Buy rating remains predicated on the fact the stock is trading at a 24% discount to valuation. The broker acknowledges a significant recovery in earnings is not expected in the near term. The stock's discount to the market is justified, in Credit Suisse's view. The broker notes the stock has underperformed the broader market by 15% over the past quarter and end-markets are weak. Credit Suisse suspects the ground support business (Minova) may never generate adequate returns. Credit Suisse expects the stock to remain range bound until there's more clarity on the strategic review.

There's no Sell rating on the FNArena database. The stock has three Buy ratings and five Hold (or equivalent). The consensus target is $23.64, suggesting 13.2% upside to the last share price. The target compares with $24.51 ahead of the results. The dividend yield is 4.6% and 4.7% on FY14 and FY15 estimates respectively.

The company now expects FY14 profit to be "in line or exceed FY13", seemingly less confident of growth than in prior guidance. To Morgan Stanley this is a "soft downgrade". The broker thinks explosives pricing and volume pressure signal forecasts need to be re-based lower. Hence, an Underweight rating. Macquarie observes Orica still assumes a second half recovery in volumes, which should be driven by stronger US and European quarrying and construction. It's the weakness in Australia and Indonesia that's the concern. Orica expects flat volumes in eastern Australian coal, following on from declines in the first half. Macquarie notes this is a change to prior expectations, as explosives prices have been relatively stable for 12 months. The broker cites further risks of production closures the event of more weakness in thermal coal prices.

JP Morgan is also concerned the weakness in Australia and Indonesia, given the company's significant capital investment in these regions. The broker thinks guidance is optimistic, given potential for east coast Australian demand to fall if coal prices weaken further. Moreover there's a potential moderation in Pilbara growth ahead from the weak iron ore prices. JP Morgan also observes that, while Australia/Pacific and North American profit per tonne declined, group profit per tonne actually increased by 5% and finds it difficult to determine how this was achieved.

Goldman Sachs does point out that just under half of the earnings miss was attributable to the downward re-statement of prior years' earnings but, even so, chemicals and mining services are soft. As a result, the broker has reduced FY14-16 earnings estimates by 4.5-5.2%. The stock continues to offer long term value but it's the industry dynamics that worry Goldman. To the broker, key customer end-markets are likely to become worse before they get better. This is reflective of significant cost pressures on the customer base, rather than structural issues. The Neutral rating is retained.

CIMB considers the stock's investment credentials hold up and retains an Add rating. The broker takes heart in the fact there are further costs to be cut, management has announced broader reviews of the footprint, and the chemicals business could be separated. Management said it is exploring all options for the chemicals business. This broker also highlights the re-statement of prior earnings as a factor in the weaker first half result but, overall, acknowledges the volume softness. The catalysts for CIMB are good cash conversion, further reductions in gearing and potential capital management, perhaps as soon as the FY14 results.

BA-Merrill Lynch, too, takes a positive stance. Operationally, Australian earnings dived the most, down 10% in the half because of lower ammonium nitrate demand on the east coast, customer de-stocking and plant shutdowns as well as some one-off restructuring. Some of the fall can be attributed to mining customers deferring overburden removal in response to falling commodity prices and the broker thinks this is a temporary aspect to the results. Markets outside the Australian east coast are expected to recover in the second half. North American earnings were also down 9% in the half, because of cold weather, but this should improve from power plants re-stocking of coal and improved ammonia-gas spreads, according to Merrills.
 

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-Headwinds easing, but by how much?
-Volumes down but earnings per tonne improve
-Key gas supply agreement
 

By Eva Brocklehurst

Orica ((ORI)) has flicked the earnings switch to the second half, announcing a weak first half outcome is likely given weather-related effects in North America and subdued market demand. The company presented the latest scenario at an investor conference and reaffirmed FY14 guidance. Brokers are concerned about the weighting of expectations to the second half, accepting that while the headwinds are dissipating, the extent of a rebound remains to be seen.

Morgan Stanley calculates, assuming a 3% decline for profit in the first half but achieving FY14 expectations, this means a record 39:61 split between first and second half earnings. Hence, the broker is sceptical. Chemicals made up 8% of earnings in FY13 and the company admits the division is under pressure. There's speculation a trade sale may occur but Morgan Stanley does not think such a transaction would have a material impact on either the capital position or valuation. The broker does not resile from an Underweight rating, believing Orica is most exposed to structural change in the regional explosives market and this is likely to pressure returns.

Macquarie is not overly worried. A weaker first half is not a great surprise given the harsh US winter. Comparatives will become easier in the second half as $24m of the $30m in ground support restructuring costs were incurred in the second half of FY13. The broker acknowledges delivery on expectations is now vital and the profit warning last July lingers long in the market memory. The important features of a second half rebound will be movement in the Australian dollar, the degree of improvement in US coal production and Australian ammonium nitrate demand.

Growth forecasts over FY14 could still be achieved if volumes have simply been affected by seasonality and adverse weather, Citi maintains. The benefits of operating synergies, reduced debt and catching up on lost winter volumes are potentially there but whether the most optimistic of expectations can be achieved is another question, in the broker's view.

While explosives volumes are down year on year the contribution per tonne is higher. Moreover, the company expects volumes to improve the second half. Deutsche Bank takes a positive line from this observation. The broker expects earnings to increase by 15% in FY14, with the depreciation of the Australian dollar and the restructuring of Minova adding 14% alone. Orica has also entered into an agreement with Strike Energy ((STX)) for the supply of an additional l0PJ per annum for 10 years from 2020. The total requirement for Kooragang Island and Yarwun is 17.5PJ, which would be fully covered by the Strike and Esso/BHP Billiton ((BHP)) agreements from 2017 to 2029.

The broker also observes the outlook for the North American market is improving, given appreciation in the gas price, which will improve the competitiveness of coal, while non-residential building was up 2% in the four months to January. Deutsche Bank thinks Orica has scope to improve margins by focusing on operations, manufacturing and capex reductions. Still, there's plenty of downside risks. The broker names uncertain mining sector demand, increasing raw material costs and the ability to pass these on to customers in a timely manner, increased freight and energy costs, increased ammonium nitrate supply in the Asia Pacific and, critically for Orica, the Australian dollar. The broker reminds us that Orica's earnings are highly leveraged to the Australian dollar with every US1c move affecting pre-tax earnings by $7m. The company has hedged 63% of its US dollar exposure at US95c.

What pleased Credit Suisse was that earnings per tonne has improved. The broker thinks manufacturing flexibility should help normalise brief periods of regional oversupply, while the proactive gas strategy could enable Orica to be in the fortunate position where it has excess gas. Credit Suisse still struggles to see ground support breaking even in FY14 and maintains a Neutral rating. CIMB accepts that the FY14 forecasts require a material improvement in second half profitability but, further out, the company could surprise on cost cutting and this would improve leverage to an eventual recovery in underlying markets. This broker contends recent weakness provides an attractive buying opportunity for a quality business and retains an Add rating.

BA-Merrill Lynch believes, despite the downgrade to expectations for the first half, the stock still looks undervalued against longer-term averages and its peer group.There are a number of positive developments, including securing east coast gas and North American ammonium nitrate supply, which keeps Merrills on a Buy recommendation.

Orica scores four Buy ratings and three Hold on the FNArena database. The consensus price target is $25.15, suggesting 17.1% upside to the last share price. The targets range from $23.00 to $29.40. The dividend yield on FY14 forecasts is 4.5% and on FY15 it's 4.8%.
 

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-Opportunity to cross sell services
-Organic growth disappoints
 

By Eva Brocklehurst

Cardno ((CDD)) has secured a major acquisition, opening up new areas of operations. PPI Technology Services is an oil and gas field services consultant based in Houston, Texas. This is the company's largest acquisition to date and brokers believe it offers significant value.

The US$145m acquisition will be funded by US$76m in scrip and US$69m in debt. The company also completed a $50m placement to ensure its gross debt to equity ratios stay below a 40% target. On completion of the transaction Cardno will have $156m in cash and unutilised facilities.

Deutsche Bank notes this acquisition will take the company into areas where it has not previously operated but the timing carries risks, given persistent weakness across a number of the existing businesses. Moreover, a lack of any FY14 earnings guidance is negative as the broker thinks it reflects the challenging operating background. The stock is trading on undemanding multiples but this is warranted, in Deutsche Bank's opinion, until evidence emerges of some improvement in core markets.

The slowdown in Australia is consistent with weak conditions and subdued expenditure and that's no surprise to Deutsche Bank. What troubles the broker is US earnings. A decline in that business over the first half was disappointing, given a recovery was underway and the indicators were improving. In defence, Cardno is seeing some pick-up in activity in urban infrastructure and Deutsche Bank thinks the gradual pace of this improvement means it is yet to be reflected in margins and earnings. The broker observes the company has managed its acquisitions well to date and earnings weakness relates to cyclical factors. Hence the share price is reflecting an even risk/reward balance.

Morgans considers PPI of strategic value as it provides the opportunity for Cardno to cross-sell respective capabilities and broaden the client base. PPI has established a 22-year track record, providing offshore drilling and production management, engineering and construction and asset management in North America, Africa and the Asia Pacific region. PPI generated US$133m in revenue and US$21.5m in earnings in 2013. Morgans highlights the significant amount of upstream oil and gas development forecast for Asia Pacific and West Africa in coming years. The company services over 300 clients annually in primary markets in the US and Nigeria.

Goldman Sachs views the acquisition as consistent with a strategy to acquire complimentary services in existing geographies, expecting the acquisition to be 7% earnings accretive. Goldman observes that PPI has a high degree of client concentration, with the largest client representing 21% of revenue for the past four years. The top four clients account for around 55% of revenue. Following the acquisition Cardno will generate 25% of its revenue from the oil, gas and energy market versus 14% in the first half of FY14. The company expects the merger to be 2c and 5c per share accretive in FY14 and FY15 respectively.

The price tag of US$145m is not cheap but it is reasonable, in Macquarie's view. Macquarie considers it a good strategic acquisition, but believes the company should not lose sight of the principal challenge to lift organic growth rates and generate value from prior acquisitions. JP Morgan, too, observes such a large acquisition can take time to digest. Given organic revenue declines in the first half and difficult operating conditions the broker retains a Neutral stance.

The company has a neutral profile on the FNArena database, with four Hold ratings and a range of price targets between $6.42 and $6.85. The consensus target is $6.68, suggesting 5.4% upside to the last price. The dividend yield on FY14 and FY15 estimates is 5.9% and 6.1% respectively.
 

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-Uncertainty over supply networks
-Pressure on market share in SA?
 

By Eva Brocklehurst

A single contract supply agreement in the cement industry will be terminated at the end of this year. The announcement has sparked speculation over a complex chain reaction among cement suppliers which is difficult to quantify. For the moment, Adelaide Brighton's ((ABC)) major cement customer in South Australia and Western Australia, Cement Australia, is not expected to extend the current SA supply agreement beyond the end of 2014. Instead, Cement Australia intends to expand facilities in Osbourne, South Australia, and bring in its own volumes.

Currently, Cement Australia brings 500,000 tonnes from Railton, Tasmania, to Sydney. The demand in Sydney can now be met from the grinding facility expansion at Port Kembla - where Cement Australia has recently taken delivery of the first clinkers. Cement Australia plans to move some of the previous supply that was going from Railton to Sydney, to Adelaide. The logistics of moving some of the Tasmanian supply to Victoria are also featuring in broker considerations regarding the chain reaction in the cement industry.

Cement Australia's plans are expected to have a material impact on Adelaide Brighton's 2016 earnings. The company expects a loss of the 120,000t currently delivered on that contract to reduce 2016 earnings by $15m. Morgan Stanley observes that flow-through pricing in the SA market could be negative, should Cement Australia choose to import more than the required volumes into that market. Having said that, the broker notes that Adelaide Brighton has a cost advantage in the South Australian market and is well placed to defend market share.

The broker is not sure of the import volume restrictions in Melbourne but estimates Cement Australia's volumes could increase in that port by up to 260,000t, putting further pressure on pricing. Then, again, Adelaide Brighton may seek to use the expansion of import facilities in Newcastle, NSW, to put pressure on the market in both Victoria and NSW, in terms of margins. Morgan Stanley still perceives Adelaide Brighton's pay-out ratio over three years of 120% is possible. Nevertheless, the broker is cautious and presumes a 90% ratio. On that basis the 2015 yield is still attractive. The broker thinks the stock price reaction now more than accounts for earnings risk and retains an Overweight rating.

BA-Merrill Lynch also thinks margin pressure may ensue in South Australia. Cement Australia could also target the remainder of Adelaide Brighton's business there. The broker thinks Adelaide Brighton's earnings have been flat for four years now and the relative growth comparison to other stocks in the sector, combined with the premium to valuation at which the stock is trading, forms the basis of an Underperform rating.

Uncertainty prevails and other players may be affected as well. According to Macquarie, game theory will dominate the cement industry. The broker observes the stated impact of a $15m reduction to earnings in 2016 is made under a very defined set of market outcomes. This includes the loss of 120,000t of SA supply, that Cement Australia takes no more than its current volumes into the state, and that Adelaide Brighton does not try to mitigate the loss by raising the volumes it sends to other regions. The broker notes Boral ((BLD)) has been selling 150,000t of NSW cement to Cement Australia and, with Boral committing to run its Berrima plant at full capacity, this would suggest a substantial volume of cement is now looking for other markets. Macquarie has reduced earnings forecasts by the stated amount, but will evaluate the impact further depending on how the strategic positioning plays out.

UBS observes Cement Australia already took 50% of its Western Australia contract away from Adelaide Brighton in 2010, at a cost of $10m pre-tax. The broker believes Adelaide Brighton will try to ship its over-capacity in South Australia to other markets and this could lead to price competition, benefitting independent concrete producers in NSW and Queensland. Adelaide Brighton could even contemplate shipping cement to Auckland, New Zealand, where Holcim - one of the partners in Cement Australia - is considering building new import clinker grinding facilities. The balance sheet is under-geared, in UBS' view, but the broker has removed the 3c special dividends forecast for 2014 and 2015, while reducing 2016 dividend by 0.5c.

JP Morgan thinks this is the opening salvo in a re-positioning of the southern Australian marketplace and Adelaide Brighton is the first "victim" of the soon-to-be commissioned Port Kembla grinding mill. The new SA facility could be built by the end of this year but Adelaide Brighton expects it more likely next year. As South Australia is one of Adelaide Brighton's highest margin markets, JP Morgan wonders whether Cement Australia will try to take market share in South Australia, or Victoria, from Adelaide Brighton to fill the excess capacity coming from Railton.

As Cement Australia owns the land and a port at Osbourne, Deutsche Bank thinks the construction of the facilities is relatively inexpensive and straight forward and could feasibly be completed at the end of this year. Hence, the broker reduces 2015 profit assumptions by 15%. Further contract losses may be possible but Deutsche Bank does not think Cement Australia will look to import more cement into Western Australia as it lacks the necessary land and port facilities, or a cement grinding facility for that matter.

The market has over-reacted. That's CIMB's take. The broker suspects that Adelaide Brighton may have alternatives for mitigating the impact of the contract loss. The timing of the new facilities to be constructed by Cement Australia is uncertain and the $15m profit decline forecast for 2016 is a "worst case" scenario, in the broker's view, which assumes all volume currently associated - around 120,000t - is lost. As the stock is now fairly valued CIMB has upgraded the rating to Hold from Reduce.

There are two Buy ratings, four Hold and one Sell on the FNArena database. The consensus target is $3.87, suggesting 3.1% upside to the last share price. This target compares with $4.03 ahead of the announcement. The dividend yield on 2014 earnings forecasts is 5.9% and on 2015 it's 6.0%. Price targets range from $3.50 (Merrills) to $4.25 (Credit Suisse).
 

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-Potential credit rating downgrade
-Hochtief wants more board seats
-Uncertainty for minor shareholders
 

By Eva Brocklehurst

The bid by major shareholder, Hochtief, to acquire more of Leighton Holdings ((LEI)) has been greeted with a mixture of concern and opportunism by brokers. The final intention may be unclear but what brokers are concerned about is the reduced liquidity in Leighton stock that would come with such a large holding, if the bid succeeds, and a likely downgrade in Leighton's credit rating.

Hochtief has offered to acquire three out of eight shares not owned, for $22.15 plus interim dividend of 60c. This would take its stake in Leighton to 74.23% from 58.77%. Hochtief wants greater board representation, irrespective of the outcome of the offer, and a broad-based review of the operating model.

Chief among broker concerns is the stock's credit rating. S&P currently rates the stock a BBB-minus/A-3 with a stable outlook. Moody's rates it Baa2 with a stable outlook, and has placed this on review after the announcement. Both agencies have said in the past credit ratings could be lowered if there was unexpected control being implemented by Hochtief or its parent, ACS, or if the board's independence was compromised. CLSA thinks a downgrade will ensue, triggered by a change in board control or Hochtief owning over 70% of Leighton. A rating downgrade would cost Leighton $15-20m per annum in additional fees and interest. Performance bonds would become more difficult to source as well. Macquarie considers the intended review from Moody's reflects the uncertainty regarding the future financial and business profile of Leighton and that Hochtief and ACS have lower credit quality compared with Leighton.

Macquarie decided the time was ripe to downgrade the stock - to Underperform from Neutral. The partial offer has realised value in the short term but there is considerable uncertainty regarding $5 billion in Leighton's receivables an the Gorgon jetty and Iraq issues. Leighton, while staying listed, will also not be included in an index at less than 30% free float. Credit Suisse already had an Underperform rating and the bid does not change that view. Credit Suisse reminds all that increased control by Hochtief won't alter the headwinds the industry faces. The broker does not expect Australian infrastructure work to offset the anticipated outcome in Australian resources activity. Additionally, there are issues around the recovery of payments in Iraq and the Indonesian court dispute.

Morgan Stanley's fundamental view on the stock is also unchanged by the offer, with Leighton characterised by significant challenges. The bid represents considerable upside to Morgan Stanley's valuation and the broker will assess the offer once the board has responded. CLSA does not expect a full bid to ensue, given that 75% is a redemption trigger for Leighton's debt. Nor are any sweeteners expected. The broker acknowledges there are index risks but, as Hochtief won't be buying on market, this is likely to have less influence on the stock than a credit downgrade. CLSA thinks the share price is factoring in too many positives and downgrades to Underperform.

While Hochtief does not want to mount a full takeover at this stage it's possible this is a precursor. BA-Merrill Lynch thinks it is a way to creep up the register, which is currently restricted to 3% every six months. CIMB has advised shareholders to get in while the going's good - move ahead of the formal bid and sell into the market while the share price is at a premium to the bid price. The broker warns non-acceptances to the bid offer cannot be recaptured by others wishing to raise their stake.

Deutsche Bank thinks the offer is appealing, relative to fundamental valuation, given Leighton's risks. The broker also expects the offer to receive government approvals. What concerns Deutsche Bank, besides the potential credit downgrade, is the desire by Hochtief to increase its board representation, which the broker views is another departure from governance principles, which ACS indicated back in 2010, it would not alter. The governance principles were about NOT increasing Hochtief's shareholding beyond 55%, which it did last year, the right to appoint up to four of 12 board seats, maintaining the structure of the group, supporting management and the independence of the chairman. Hochtief currently holds three of 10 board seats. Deutsche Bank would not be surprised if, as Hochtief has already departed from two of the principles, it abandons the others.

CLSA thinks board control is the likely motivator for ACS, and a proportional bid the way to achieve this. The broker wonders what ACS cannot achieve with the current board - cutting the dividend? This broker also finds it unsettling that Hochtief's CEO has been anointed for the ACS CEO role.

Moreover, what about the future treatment of minority shareholders? Deutsche Bank lists possible cash flow moving upstream towards Hochtief, and ACS, as well as potential for value-destructive asset sales and an on-market buy-back increasing Hochtief's ownership further. Another concern is changes to the operating company structure which may reduce revenues - but also lower bid costs. There is potential for full takeover and Deutsche Bank estimates that this would increase Hochtief's gearing to 52%, and ACS' gearing to 59% - within ACS' historical range, so it does have financial capacity. The broker delves further and notes ACS has, historically, not paid a significant premium to minority shareholders. Macquarie thinks the minority interests may endure for some time and, while the current share price is already factoring in the prospect of a further bid, it's not necessarily discounting the time it may take.

On the FNArena database there are no Buy ratings. There are three Hold and four Sell. The consensus target is $19.95, suggesting 10.9% downside to the last share price, and compares with $16.77 ahead of the bid announcement. Targets range from $16.60 to $22.75. The dividend yield on FY14 forecasts is 4.6% and on FY15, 4.7%.
 

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