-Question of pay-out ratio arises
-Potential catalysts in upcoming contracts
-Margin pressure intensifies from competition
-Downer better relative to others in sector
 

By Eva Brocklehurst

Downer EDI ((DOW)) is consistent. Macquarie finds the mining services and infrastructure company hard to fault when it comes to maintaining cash flow. When FNArena reviewed the stock six months ago the company was confident that it could offset declining mining revenue from other sources. This has largely worked... so far. Macquarie observes the improved cash flow is a result of better collection systems and processes and fewer legacy problem projects. Hence the company is increasingly under-geared. Macquarie forecasts a near halving of gearing to 9% in FY15. This brings up the subject of capital management and/or acquisitions. The company is reticent about pursuing acquisitions in the current environment so capital management is foremost in brokers' minds.

Macquarie observes there are also plenty of potential catalysts from contracts, with bidding opportunities in Sydney light rail, engineering on the Ichthys project, contract mining and the oil & gas sector in eastern Australia. JP Morgan is also confident in management's ability to respond to the mix of challenges and opportunities, noting the pull back in resources capex took its toll on Downer Australia and on rail but strong execution in both mining and Downer New Zealand compensated as costs were taken out.

BA-Merrill Lynch sums up the results as a beat in mining revenue expectations offsetting a miss in infrastructure. Mining margin was a record 8.8%, delivered by cost control, the cessation of lower-margin contracts and the switch to finance leases from operating leases in some projects. Downer Australia's (infrastructure) revenue declined 18%, materially more than Merrills expected and largely because of major project work rolling off more sharply. Still, the broker notes work in hand has increased for the first time since FY12 and the infrastructure division should return to growth in FY15 and FY16.

The company's improved operations were the highlight for CIMB Securities. The broker thinks the business is improving significantly in the midst of a deteriorating operating environment. Okay, so investors prefer revenue-driven growth to cost-driven growth, but in the current environment the cost cutting is an important tool which CIMB thinks will stand the company in good stead. Downer EDI is the exception to the rule when it comes to owning contractor stocks in the current environment. CIMB expects a 20% return over the next 12 months, driven by some upgrades to earnings expectations, balance sheet improvement and a 5% dividend yield, which becomes fully franked in the next reporting period.

Now for a more negative stance. This comes from Morgan Stanley. The broker agrees that the company is outperforming its peers but thinks investors may be underestimating the underlying risks. The broker notes construction revenue is at multi-year highs and rail under structural pressure. The contract mining industry could be about to follow, in the broker's opinion. This adds up to earnings challenges which drives a risk to forecasts. The risk in mining lies with the scaling back of resources and with mining companies electing to cut costs by bringing work in house. Morgan Stanley estimates this has resulted in $1.2bn of surplus mining equipment in the Australian contract industry. As contract mining contributed 49% of earnings in the first half, the broker thinks the exposure is being underestimated. Moreover, as the engineering and contracting capex activity declines over the next two years, Morgan Stanley thinks the company will find it increasingly difficult to replace the work given intense competition for new contracts and falling bidding margins.

In summary, it's all about relativity. Downer is just a better bet relative to Leighton Holdings ((LEI)), Transfield ((TSE)) and UGL ((UGL)), which are struggling to maintain cash flow. Morgan Stanley has an Underweight rating. On the FNArena database there are seven Buy ratings and one Neutral - Credit Suisse. Credit Suisse comes closest to Morgan Stanley's view in emphasising a tough market, while considering the stock is fair value. The broker believes the earnings base is defensive against the broader sector, based on the progress in cost savings and productivity gains, but there is limited upside amid significant headwinds that have become more apparent from this result. The infrastructure tender market remains highly competitive and there's pressure on margins.

Locomotive maintenance services face severe headwinds as customers defer fleet maintenance and major overhauls. The extent of weakness in this area took Citi by surprise and, while some of the deferred spending is likely to return, the broker notes the timing is uncertain. Citi also questions the sustainability of mining margins and suspects these benefited from abnormally dry weather in the first half. The company expects to maintain mining margins in the second half and thinks these will trend towards 7-8% in the longer term. Citi considers the ramp up of Roy Hill a big contract that will help support mining revenue in FY15.

UBS believes Downer remains compelling value at current multiples and the anticipated balance sheet strength poses upside risk to the dividend pay-out ratio. This is the key re-rating catalyst in the broker's view. UBS assumes the 45% pay-out will rise to 50% in FY15 and to 60% in FY16. Deutsche Bank is disappointed that a capital return is not planned within the next 12 months but thinks the stock has a balance sheet that will see it through the current cycle. Moreover, the company has shown how it can grow with cost reductions. The valuation remains attractive to the broker and a Buy rating is maintained.

The FNArena database reveals a consensus target price of $5.78, suggesting 20.4% upside to the last share price. The dividend yield is 4.9% on FY14 forecasts and 5.7% on FY15. Price targets range from $5.20 (Credit Suisse) to $6.14 (JP Morgan).
 

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-Brokers pull back hard on expectations
-New equity considered most likely
-Takeover possibility looms

By Eva Brocklehurst

Two weeks is a long time in the mining services sector these days. Forge Group ((FGE)) has been diversifying its exposure away from the Western Australian mining services sector but the ill winds that have plagued that sector have come back to haunt the company. Two weeks after downgrading earnings forecasts to $45-50m for FY14, Forge has announced it will now make an earnings loss of $20-25 million. This is the third write-down in two months. Brokers have called Whoa! The construction, electrical and engineering contractor now looks to be in line for some painful medicine, definitely new equity and maybe even a takeover is on the cards.

The company stated it needed to generate cash flow and this is affecting profit margins. While there was no update on debt levels the company did say it had the support of its banker. Nevertheless, the downgrade brings to the forefront another capital raising. Macquarie notes Forge has appointed Euroz to advise on its options - which includes the possibility of a third party interest in the company. Macquarie retains an Underperform rating on the stock and believes new equity is what's required.

The company is undertaking major work on two power stations, Diamantina and West Angelas, which has not been finalised. Work is due to wrap up at the end of FY14. The deterioration in the balance sheet started last November when the company announced a $127m write-down on the West Angeles and Diamantina projects, which forced ANZ Bank ((ANZ)) to step in with additional funding. For some brokers the writing was on the wall in December but the company's recent large contract win, at Roy Hill, appeared to stem the deterioration in terms of confidence. Macquarie has warned that history suggests losses on fixed-price contracts are difficult to estimate until the job is completed.

It was looking good back in September when FNArena reported on Forge after it won the key contract at Roy Hill, worth $1.47bn, in joint venture with Spanish operator, Duro Felguera. The company now signals that joint ventures and projects are being impacted by the threadbare balance sheet. Citi observes the turnaround in fortunes is the result of industry-wide margin pressure, project losses and a focus on cash flow rather than profitability, given recent write-downs. The broker considers the company has poor visibility because of weak reporting systems. Citi also believes the impact of the downgrade means near-term funding capacity is exhausted and another heavily dilutive equity raising is almost a certainty. The company may have a solid $1.5bn order book, positive in terms of forecast revenue, but the inability to convert this to profit is a key risk, in Citi's view.

Citi notes Forge has appointed advisers to field bids for the business but, given the gearing and the damage to the company's reputation, along with eroding valuation, the broker doubts this will provide the panacea shareholders need. The broker does not consider the company is investment grade at present and has downgraded the rating to Sell/High Risk from Neutral/High Risk. The turnaround, just two weeks after confirming guidance, has caused Citi to question the operating systems in place and consider the risk of further material contract losses. Moreover, Citi believes the reputation in the Perth marketplace is tarnished as solvency is now the issue.

Showing how quickly a once enviable position can erode, back in September brokers were even contemplating that, with such a strong order book and improved cash position (June results), the company may be able to increase dividends, or even acquisitions. On the FNArena database there are three covering the stock - with two Sell ratings and one Hold (CIMB). The consensus target price is 49c which signals 36.8% downside to the last share price. This target compares with 71.7c ahead of the latest update.

See also, Forge Graduates To The Big Time on September 3 2013.
 

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-Some relief offered in maintenance work
-Margins still under pressure
-Focus on debt reduction
 

by Eva Brocklehurst

Mining service contractor shares have been subdued for some time and this means expectations are low. Even so, there's still some further risk of downgrades because several of the stocks in the sector have earnings expectations skewed heavily to the second half. Those significantly impacted are UGL ((UGL)), Transfield Services ((TSE)) and WorleyParsons ((WOR)), Macquarie notes. JP Morgan adds Ausdrill ((ASL)) to that list. FY14 is expected to offer some relief to a depressed sector in the flow of work from oil and gas projects and recovery in the maintenance market, as that cannot be deferred indefinitely. The environment is still tough and increased competition for what work is available is expected to pinch margins.

Deutsche Bank is cautious on the outlook but does not expect 2014 to be as negative as 2013, suspecting that most of the marginal and low return projects have now been re-scoped or cancelled. Nevertheless, a better outlook is predicated on cash being generated and expectations for commodity prices being realised. Contract mining was hit in 2013 as work was taken in-house and scope was reduced. While there is potential for further scope reduction and re-tendering, Deutsche Bank does not think this is as significant as in 2013.

Citi has surveyed miner sentiment and found participants still expect a decline in capex over the next 12 months. This has reduced to around 5% and the levels of decline appear to be stabilising. Still, there's no uptrend yet. In fact, 57% of respondents are considering lowering future capex budgets. Added to this is the possibility of a negative pricing environment, with participants expecting equipment prices to be down 2% over the next 12 months. The highest risk here is with mining trucks, haulage systems and tractors/dozers. Pricing risk is also increasing in services, with 86% planning to push back prices in that area. The after-market may grow but at a very low rate, according to the survey.

Coal production could provide the positive surprise in 2014, according to Deutsche Bank. Coal companies have cut back significantly and re-priced contracts. With fewer contract disruptions miners may focus on maximising production volumes to cover fixed costs. This in turn could feed a recovery in maintenance spending. Deutsche Bank expects maintenance contracts for gas projects QCLNG and GLNG to be awarded this year with APLNG following in 2015. There could be some surprises in this area as deferred expenditure resumes and greenfield projects award the work contracts. Conditions for Downer EDI ((DOW)) are tough in terms of locomotive sales but Macquarie is confident this can be offset with accelerated cost cutting and lower interest rates as well as a solid performance from mining and in New Zealand. Macquarie has an Outperform rating on the stock, Deutsche Bank a Buy and JP Morgan is Overweight.

Leighton Holdings ((LEI)) has featured less in news in the last month which, to Macquarie, means near-term write-downs are less likely. Still, gearing is likely to be at the upper end of prior 25-35% guidance and the receivables target is unlikely to be met, as bribery issues have delayed collection. The broker's focus is also on WorleyParsons' ability to achieve full year guidance, given the extent of what's required in the second half split. Macquarie will also be watching Monadelphous' ((MND)) margin decline.

Deutsche Bank expects a lot of attention on debt levels this year, as most companies found they were over-geared when contracts were cancelled and work scope reduced. 2014 will be the year of re-paying debt to better match revenue. Those most at risk for large write-offs for cost variations include Leighton and Monadelphous in the broker's opinion. Macquarie's focus will be on UGL's relatively high gearing and debt as well as any update on the de-merger plans. Attention will also be on Transfield's potential asset sales and the progress of debt reduction. On Deutsche Bank's list of those under pressure to reduce gearing are Ausdrill, Boart Longyear ((BLY)), Leighton, Transfield and UGL.

Deutsche Bank is becoming more positive about the outlook for Australian infrastructure given a large number of projects in the tender phase. Leighton, of those in the contractor sector, has the greatest exposure to this market. Also, the level of resources work still be done remains at elevated levels and investment in the LNG sector should counter some of the decline, although it's not enough to be an offset. Here, Deutsche Bank notes Monadelphous has the largest exposure to the resources capex market. JP Morgan is Underweight Monadelphous and does not expect there will be enough activity in economic infrastructure to offset weak resources and energy capex. In contrast, JP Morgan is Overweight Lend Lease ((LLC)), as the company's strong revenue backlog and development pipeline, with lower exposure to resources, leaves it best placed to manage the current market.
 

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-Acquisitions key to earnings expansion
-Heightened risks with new technology
-High churn potential
 

By Eva Brocklehurst

Newly listed Recall ((REC)) is off and running. The market's first impression of the player in information management, document storage and handling is of a quality business with good returns on capital. Former parent Brambles ((BXB)) hived off the business and listed the stock on ASX earlier this month. A large portion of revenues are recurring and contractual. Still, brokers remain lukewarm on the outlook and acquisitions are considered key to expanding earnings. The four brokers on FNArena's database? that have initiated coverage on the stock since the spin-off have delivered three Hold recommendations and one Sell. Price targets range from $4.07 to $4.53.

There is potential for both client growth and acquisitions in the market, as it's very fragmented. The company estimates there is 65% of the potential storage market that is yet to be tapped. Recall's position regarding this opportunity is strong, but there are challenges. Deutsche Bank notes that FY13 revenue declined because of lower customer transactions and lower paper prices. Paper prices? The company is affected because of the revenue it draws from the sale of recycled paper. JP Morgan also flags this issue, estimating that 4% of group revenue is derived from sales of shredded paper and there has been a 15% decline in realised prices over the last four months. A decline in new paper prices represents less demand on recycled paper.

The company has also made its debut with higher business development expenses on the balance sheet, following the unsuccessful attempt by Brambles to sell the business in 2012. Deutsche Bank expects growth will occur in FY14 but longer term thinks the company has to ensure it has a big presence in the digital storage space to offset any decline in physical storage volumes.

JP Morgan also thinks the physical storage industry is characterised by low growth and that's something the company has to address. The speed at which customers are switching to digital storage is unknown and this is the reason why JP Morgan does not wish to value the stock aggressively, retaining an Underweight rating. Moreover, the broker thinks translated earnings will be negatively affected by a strengthening US dollar. In pro-forma FY13, 40% of earnings was generated from the Australian business.

The two key revenue drivers - transaction services and organic box volumes - are facing structural difficulties, according to BA-Merrill Lynch. Recall should still benefit from acquisitions and gains from a market that's far from saturated when it comes to choosing independent information storage but, until such is certain, the broker is conservative about revenues and forecasts 2% constant currency growth. As records storage contracts typically last 13-15 years, and storage of certain documents is underpinned by regulatory requirements, a portion of the company's activity may be regarded in terms of an annuity. That's the safer side of the business.

What stands out for most brokers is the uncertainty regarding new technology. The company has three divisions: document management services, secure destruction services and data protection services. Besides the risk of converting clients to digital storage and increased scanning of documents there's the advent of cloud-based storage - which Recall does not offer. This could impact both Recall's records management and destruction businesses, in Merrills' view.

Furthermore, there is a risk that electronic signatures are adopted amongst core financial institution clients. Recall has a physical server storage service but the broker thinks this is of a limited scale. The legislative requirements for records storage provides some stability but this may be eroded if electronic signatures become more widely adopted. At present, the scanning risk is currently limited by the high cost to scan - $90 per box - compared with $3 per box for storage. Merrills also notes that, should the company attempt to build a cloud service, then it could suffer from poor returns, consistent with the experience of global peer, Iron Mountain.

The balance sheet has the capacity to sustain incremental acquisitions which could unlock material logistical synergies, in Macquarie's opinion. The broker expects the document storage industry to benefit from plenty of risk averse and disorganised customers. The unsuccessful sale process and the eventual de-merger lost the company some market share and Macquarie believes management needs to focus on regaining this share. The broker anticipates there will be some register turnover in coming months as investors re-evaluate the stock but, given the price on listing - it closed at $4.50 on the first day, the stock appears to have quickly found fair value.

On this score, Merrills also thinks there's a risk that both offshore and local institutions will have to sell down. The company's market capitalisation is only $1.4 billion or thereabouts and may be outside the mandate of offshore funds that are currently shareholders in Brambles. Brambles describes its registry composition as including 40% offshore institutions. Hence, in Merrills' view, the foreign segment looks most at risk of churn. While Recall will likely enter the ASX100 list automatically, given Brambles is an incumbent, at the next quarterly rebalancing of the index in March it may be dropped. If that becomes the case, Merrills thinks local institutions may also have to sell and it could take time for smaller cap managers to soak up this liquidity. The broker observes that offshore investors hold Brambles for the CHEP business, which has high barriers to entry, long-term growth options and high returns to attract them.

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-More leasing income, higher margins
-Growing scale offsets subdued backdrop
 

By Eva Brocklehurst

Royal Wolf ((RWH)) is a leader in containers, controlling an estimated 35% of the Australasian market. Brokers note the competitive advantage that comes from a large distribution network and breadth of product. The containers are used in storage, freight and as mobile buildings.

Bell Potter has initiated coverage on the stock with a Buy rating and $3.75 price target. The broker considers the main source of the company's income will increasingly be revenue from container leasing, as opposed to container sales, and container leasing delivers three times more in gross margin. Bell Potter also likes the competitive advantage in distribution, with a network of 27 service centres across Australia and New Zealand. Moreover, the large capital investment required acts as a deterrent to new entrants to the market.

Deutsche Bank recently downgraded its recommendation on the stock to Hold from Buy. Driving that downgrade was a subdued first quarter result. Sales revenue was up but the higher margin sales in the portable storage segment declined as a result of  the difficult economic backdrop. Furthermore, no transportable camps were delivered in the first quarter. Deutsche Bank thinks the company is trading at a premium to the market and, while the business is solid, it's now fairly valued because of the weakness in underlying conditions.

Bell Potter does not expect Royal Wolf's debt levels to stay as high as they are currently. The company is carrying higher inventory because of partial delivery on the Aurizon ((AZJ)) contract, as well as from seasonal inflow for the peak demand period which lies ahead. The broker also heeded the company's observation that there has been some sign of a recovery in demand in October. The delivery of five transportable camps in the second quarter and seasonal demand is expected to lift utilisation and performance.

Portable storage is the company's largest segment, while portable buildings is the fastest growing segment. Bell Potter observes that, while the portable container-based buildings market does not have much competition, Royal Wolf faces strong competition in modular buildings and demountables. The third segment, freight containers, is a smaller market for the company, as Australia is a net importer and China a cheap producer of containers and a large exporter.

Where the broker thinks Royal Wolf will continue to make its presence felt is in the growing scale of the distribution network. This allows the company to effectively manage inventory, with customers having easy access to service needs. Also, a large network provides a procurement advantage and scale in marketing. Despite this, the market is still not saturated, in Bell Potter's view. The company envisages a potential to add 3-4 customer service centres per year. It's not all about plain old containers, either. The company has a good history of innovation. The patented hoardings product is the only solution of its type, to the broker's knowledge, in Australia and New Zealand.

The stock is expected to deliver top line growth that's less volatile and more predictable as leasing grows. Bell Potter acknowledges the exposure to the resources sector but thinks the company can still grow earnings through the cycle by innovation and increased leasing. Moreover, 49% of revenue comes from transport, general public, retail and manufacturing. There is potential for bolt-on acquisitions which should underpin the company's market position.

On the FNArena database there are four brokers covering the stock with two Buy ratings and two Hold. The consensus price target is $3.40, suggesting 2.8% upside to the last share price. Most brokers believe the stock is an attractive investment, with resilient earnings from the diversity of sectors to which it caters. Deutsche Bank notes the majority of Australian transport companies trade at a premium to the market but, given the fact Royal Wolf is smaller and has lower liquidity, a valuation on a market multiple is appropriate. The broker does not think valuing at a discount to the market is appropriate, because of the diversified end-market exposure, large network and continuing increases in the revenue base.
 

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-Mixed aspects to outlook
-Good cash flow, lower debt
-Enterprise bargaining risk
-Scope for dividend increases
 

By Eva Brocklehurst

Programmed Maintenance Services ((PRG)), a company that provides facilities management, maintenance and a construction workforce, produced a first half result that was not too hot, not too cold, but was it just right? Broker opinions mostly diverged around what to emphasise most in the outlook, but tended to be on the positive side.

Citi and UBS thought the outlook quite modest and factored into the price already, so decided to downgrade to Neutral from Buy. Macquarie thought the outlook very solid, so upgraded to Outperform from Neutral.

The first half did show a change in emphasis compared with FY13. Whereas the preceding year was characterised by weakness on the east coast that outweighed the booming west, the start to FY14 appears to be the opposite. Contract completions in WA meant that the focus was on east coast where growth in property and infrastructure led the way. The second half is expected to be better, as there is a high levels of work-in-hand and the Wheatstone and Ichthys LNG contracts will come on line.

So why did Citi and UBS downgrade? Now that all the three divisions have been restructured, Programmed is a more balanced and more capital efficient company and Citi thinks the stock is fairly priced. Moreover, FY14 is expected to be subdued, with flat demand for new staff and reduced government expenditure. This will be offset somewhat by outsourcing opportunities and the contracts in the oil and gas sector. UBS also highlights the restructuring that has delivered improving returns. Nevertheless, the broker considers the market has priced this in as the stock is up 58% so far in 2013. This prefaces a downgrade to a Neutral rating.

To Macquarie, the valuation is undemanding. Hence, the upgrade. The company has around 40% of earnings from the oil and gas business and a strong balance sheet so there's scope to perform well. Moreover, net debt is now down to 10.1% relatively to equity and this, in the broker's view, allowed for the 20% increase to the interim dividend to 6c. Property and infrastructure earnings were up strongly and the KLM business returned to profit. The workforce earnings grew despite a fall in revenue and Macquarie thinks this business should benefit as the domestic economy improves. The main risk to the outlook is the marine enterprise bargaining negotiations, as a prolonged dispute has potential to disrupt earnings.

CIMB also thinks the stock looks cheap relative to the market, despite trading above the consistent 6-year average. The broker thinks the stock is well positioned to benefit from the recovering domestic economy but the enterprise bargaining issue is a key risk. The broker points to the fact these work stoppages were a major driver of marine earnings falling from the second half of FY10 to the first half of FY11. The broker is conservative with regard to the growth prospects for resources. The company may have guided to a stronger second half, driven primarily by increased offshore work, but the potential threat from industrial action hampers this view. Once this can be discounted then the outlook is solid.

The reversal in the earnings trend was evident to JP Morgan but the broker thinks Programmed requires a recovery in general economic conditions before it can gain momentum. This is considered unlikely in the near term. The property and infrastructure and the workforce divisions require a shift in business confidence, and an increase in labour hire and maintenance programs. Then there's the risk with the enterprise bargaining that's currently in train. The broker is confident a higher level of earnings can be maintained in resources over the medium term but this is now reflected in forecasts.

Credit Suisse also sees some blue sky emerging, despite the weakness in onshore mining demand. This increased confidence is based on the property and infrastructure division with suggestions an end to the deferring of maintenance is occurring. Moreover, the company is capitalising on the oil and gas opportunities, witness Gorgon, Wheatstone and Ichthys contracts. That said, this broker also believes that the risks remain elevated because outer-year earnings growth is dependent on a macro-led recovery and there's limited visibility on when this will happen. Management is projecting an overall result in FY14 that's similar to FY13.

Several brokers, while keeping their ratings tepid, raised price targets substantially after the result to capture the higher market multiples in evidence. Deutsche Bank was one, noting the stock is now trading on FY14 price/earnings of 10.5 times and a strong yield, making it attractive. The broker notes Programmed is paying down debt at a faster rate than had been expected and dividends are increasing. Free cash flow is expected to stay strong and provide the scope for increases to the dividend, debt reductions or acquisitions, or all of these. It adds up to a Buy rating in the broker's opinion.

On the FNArena database there are two Buy ratings, five Hold and no Sell. The consensus target is $3.13, suggesting 4.6% upside to the last share price. This compares with $2.57 ahead of the results. Targets range from $2.90 to $3.50. The dividend yield on FY14 forecasts is 5.4% and 5.8% on FY15.
 

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-Pressure on margins and earnings
-Leverage to cyclical improvement
-Less volatility, upside from diversity
-Question of when turnaround happens
 

By Eva Brocklehurst

Analytical laboratory service provider, ALS ((ALQ)), is feeling the pinch from all quarters. Earnings and margins are being affected, by reduced sample flows, increased costs, competitive pressures, delays and cancellations and the general downturn in the resources business. Brokers are subdued in their expectations for the company, mainly because the future is so uncertain with regard to any turnaround in the resources industry.

Citi is a little more buoyant than many others on the FNArena database, retaining a Neutral rating in the wake of the first half results. The company proffered no guidance for FY14 because of the lack of visibility. New businesses have yet to show their worth and, therefore, there's no immediate offset to the core minerals business. The one positive item that Citi snatched at was that geochemical sample volumes, while down 30% on the prior corresponding half, are showing signs of stabilising. Nevertheless, competition is expected to continue pressuring margins, although Citi does not see material falls in either volume or margin from current levels. The stock offers significantly more leverage to any cyclical improvement compared with its peers and at some point Citi believes this will justify a smaller discount.

Operationally, the contribution from oil and gas was strong but overshadowed by minerals and coal weakness. Credit Suisse is of the view the company is managing the downturn effectively and making progress in diversifying away from minerals exploration. Management did signal the market was challenging in minerals exploration and there was a slowdown in environmental services activity in the northern hemisphere. Oil and gas may be operating at peak season in the fourth quarter in North America but Credit Suisse suspects it will be overshadowed by the headwind in the mining-exposed business in the short term.

UBS is attracted to the company's position and scale in the industry but can't move from a Sell recommendation until there's visibility around the timing of a turnaround in minerals. The Reservoir coring business, which accounts for almost half Reservoir's revenues, has been quiet. This has mainly been from postponements and cancellations. This niggles at UBS, although management does not believe the trend is entrenched. UBS expects the current trends will continue through the remainder of FY14 on the back of cut-backs to minerals exploration and greenfield projects by the major miners while juniors are struggling to access capital and fund exploration.

Morgan Stanley takes a different tack. The broker believes ALS is on the verge of a period of significant earnings growth. The drivers of this will be the presence in oil and gas, expansion of life sciences - particularly food - as well as potential growth in asset care. The broker thinks the profile of the company is changing and neither minerals nor coal is contributing to this new outlook. Furthermore, the discount to global peers - around 20-25% - should narrow as investors appreciate the more defensive and diversified nature of forecast growth rates. The diversification strategy has become more noticeable to Morgan Stanley as geochemistry revenues went through a rapid change of fortune from cyclical peak to trough in just over 12 months. As a result, the second element of the company's FY17 strategic revenue target - one third minerals, one third life sciences and one third other divisions - is already in place, in the broker's view.

It's not happening quickly enough for JP Morgan. A lack of organic revenue growth, increased competition and restrictions in life sciences and weakness in minerals exploration means Underperform in the broker's opinion. The new Reservoir business in coring fell short of expectations because of weak demand in coal mining. The broker thinks the decision to not provide FY14 guidance emphasises the challenges facing the group. JP Morgan prefers the production exposed mining services companies. Deutsche Bank continues to rate the stock as Sell, given the high level of uncertainty and the belief that margins are unlikely to expand until activity levels improve.The fourth quarter is the off season for minerals exploration and there is reduced environmental activity in the northern hemisphere but it is the peak for North American oil an gas drilling. The lack of guidance suggests to Deutsche Bank that management is unsure about whether oil and gas activity will offset weakness in minerals and environmental services.

The life sciences testing and inspection service margin was squeezed as South American earnings underperformed because, as Macquarie points out, integration and cultural changes took longer than expected. The broker expects margins will stay soft in the second half, given the seasonality of the business. The energy segment was the only one where there was no decline in overall margins. In this case, the coal business suffered from lower volume and price pressure. Macquarie expects the energy segment will have steady margins over the next few years as the oil business ramps up and coal stabilises. Power generation work - higher margin - is expected to get a lift in the second half and gradually pick up in FY15 as these deferred projects are re-started.

Macquarie is waiting for the turnaround, as well as monitoring the Reservoir acquisition. The stock looks fully priced in a domestic context but cheap relative to global peers. Still, the recommendation is Underperform until the extent of the pick up in oil and gas is more quantifiable. BA-Merrill Lynch retains an Underperform rating too but expects the portfolio should become more balanced as energy and life sciences acquisitions are absorbed. This diversification should produce lower cyclicality in earnings but it's not enough for the broker to throw caution to the winds just yet. 

Merrills questions just whether the seasonal strength in oil and gas is enough. The broker emphasises that the minerals division will still represent 40% of earnings in FY14 and this is heavily weighted towards exploration, particularly gold. If gold prices of US$1,200/oz were to be sustained this unpleasant scenario signals to the commodities team that 37% of operating mines would be uneconomic. Moreover, if, as the commodities team suggests, further downside risk exists for oil, coal and copper in the event of a US Fed tapering, then the company's earnings in the minerals and energy sector are likely to be pressured beyond FY14.

The FNArena database tells the story. There is one Hold and six Sell ratings. The consensus target is $8.15, suggesting 7.5% downside to the last share price. The targets range from $7.00 (UBS) to $9.75 (Citi). The dividend yield on consensus earnings for FY14 and FY15 is 4.2% and 4.7% respectively.
 

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