Tag Archives: Other Industrials

article 3 months old

Chasing Infrastructure And Utilities For Yield

- Brokers favour Infrastructure and Utilities for yield
- Transurban well liked, Aurizon and Qube also feature
- Goldman Sachs has four rules of thumb for picking yield plays
- UBS likes Origin best


By Andrew Nelson

The "chasing yield" theme carried on in a healthy fashion through April. For the most part, investors chased Infrastructure and Utilities plays, seeing a number of stocks from both spaces outperform the broader market over last month.

This has continued to play out despite declining yields (yields fall as prices rise). A basket of stocks comprised of Transurban ((TCL)), Sydney Airport ((SYD)), DUET ((DUE)), Spark Infrastructure ((SKI)), SP Ausnet ((SPN) and APA ((APA)) have seen yields pull back to 6.2% from 7.5% over the past year, reports BA-Merrill Lynch.

The broker also points out that the best piece of evidence for this sustained level of yield appetite is Envestra ((ENV)) and its share placement last month. The company was hoping to pick up $100m and ended up walking away oversubscribed, pocketing some $130m.

Transurban disappointed at last month’s AGM, revealing the total cost of the M2 project was going to come in $90m, or 16% higher because of scope increases. Despite this seemingly unfavourable news, especially given the current capex-paranoid world, the share price nonetheless pushed higher.

Now what could convince investors in such a capital heavy company to buy more shares when a major project is not running to plan? Simple. All that was needed was the reiteration of the dividend growth story. The broker estimates TCL’s div will post an average of around 9% per year growth for the next five years.

There was some good earnings news to support the dividend story, so yield didn’t carry the load alone. The company also still expects the M2 widening to generate 16% traffic uplift, while March quarter traffic was good enough. CityLink traffic was up 2.6% and a little ahead of Merrills' forecast, while M2 traffic was up 2.5%, although still short of Merrills' 3.5%. All up, the broker expects to see good growth, driven by steady increases in traffic and tolls.

The broker reports most stocks in the sector actually still boast decent growth prospects over the next 3-years. Asciano ((AIO)) is expected to benefit from new grain and coal contracts. There’s a bit less certainty with Aurizon ((AZJ)), as growth needs to be supported by contract re-pricing and capex on regulated networks.

The broker likes Spark Infrastructure and SP Ausnet ((SPN)) amongst the regulated utilities given some fairly attractive multiples, while APA Group is simply too expensive. All up, however, BA-Merrill Lynch expects Transurban, Aurizon and Qube Logistics ((QUB)) to enjoy the strongest 5-year average earnings growth and if you add in Asciano, you’ve got the stocks the broker thinks are offering the best value in the market as well.

Goldman Sachs also had a look at the yield theme playing out in the infrastructure and utilities sector to try to get a handle on the factors that have historically been the best indicators of future risk-adjusted returns. The broker had three key pieces of advice to impart after looking at the numbers from FY00-12.

The first piece of advice is that valuation-based stock selection tends to work. The broker had fourteen data points that it compared and eleven indicated a positive alpha curve over the period. What’s more, many of those metrics that did generate a positive return actually booked compound returns of better than 10% per year.

The next thing the broker noticed was that picking stocks based on distribution yield combined with growth historically generated ever stronger risk-adjusted performance. The broker notes this method yielded compounded average returns of better than 23% a year for the top 25% of stocks and a negative 4% for the bottom quartile of stocks.

The last lesson the broker wanted to impart was that stock selection based on price to discounted cash flow, free cash flow yield and cash return on capital invested tended to generate strong risk adjusted returns.

Across the infrastructure and utilities sector, Goldman Sachs notes Spark Infrastructure and Sydney Airport offer the highest dividend yields. Spark, Australian Infrastructure ((AIX)) and Transurban offer the best forecast dividend per share (DPS) growth on current estimates.

UBS also thinks the utilities make for good choices for yield focused investors, with network utilities offering some of highest yields in the market. The broker notes Origin Energy ((ORG)) and Envestra offer some of the highest total returns.

The broker has broken down the utilities into two groups. The first it calls the high DPS growth average yield basket. These stocks include Origin, Transurban, Envestra and Sydney Airport. The second group has offered what UBS calls a “turbo yield”, while still regularly offering normal DPS growth. These stocks include Spark Infrastructure, SP Ausnet, DUET, Stockland ((SGP)) and CFS Retail ((CFX)).

UBS’ top pick, however, is Origin, which, although the broker points out DUET’S 6.8% yield is also quite attractive and DPS coverage near term is solid compared to peers.
 

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article 3 months old

Downer On A Firm Road

-Progress on reducing risk, fixing problems
-Limited exposure to mining capex downturn
-Biggest opportunity in Qld, NSW road work
-Potential for acquisitions
 

By Eva Brocklehurst

Downer EDI ((DOW)) has impressed brokers with progress on improving risk management, fixing problems with project execution and solidifying the balance sheet. The engineering services provider updated brokers in a briefing recently and reaffirmed FY13 earnings guidance of $370 million. Most tweaked earnings expectations to the downside for FY13 and FY14, citing the challenging conditions in contract mining and lack of certainty in infrastructure markets. Despite the current climate, brokers were confident that Downer was one of the best placed contractors, with limited exposure to the impending decline in large-scale mining and energy capital expenditure while in line for the opportunities in government outsourcing.

The company has re-established its investment grade status for BA-Merrill Lynch and is now the broker's top pick in the sector. Merrills thinks combining the Australian and New Zealand infrastructure business units should allow for more cross-selling opportunities and efficiencies in a division that has historically underperformed peers. For Merrills the risks now lie with contract mining and freight rail. These are are the most exposed to a reduction in bulk capital expenditure and cost reduction strategies. Management has revealed a diminishing contract mining tender book and lower sales for locomotives, which is consistent with the broker's view.

Despite the downturn, management believes the contract mining business is strong. The order book still has in excess of $6 billion and an expected earnings margin of 7-8%. Brokers see this as the benefit of three years of a strategy to be more diverse in exposure while remaining cost competitive. Citi notes Downer has had no contract terminations, other than Peabody which was at end of life, and the renegotiation of the BHP Billiton ((BHP))/Mitsubishi alliance contracts are expected to be completed shortly. Revenue growth in FY14 is expected to be challenging but the broker flags the fact Downer is tendering for contracts worth $400m per annum, which supports a return to growth in FY15 earnings forecasts.

Management believes the biggest near term opportunity is the Queensland and NSW road work. Combined, this represents around $35 million per annum in potential revenue. Contracts are to start being awarded in 2014. Citi highlighted the growth potential in road maintenance, viewing it as a $2 billion per annum revenue opportunity if NSW and Queensland increase outsourcing in line with Victoria and Western Australia. Merrills has flagged the benefit, discussed by management, of operating asphalt recycling. Producing recycled asphalt is cheaper than using virgin material. Taking a cost perspective, 50% of road maintenance cost is asphalt and Downer captures 10% of cost savings by using a recycling plant. As well, Downer will receive green grants on building a recycling plant, reducing capital costs. This should give the company a competitive advantage over incumbent peers.

JP Morgan observed management is considering acquisitions, given the financial position the company is now in. This won't come easy, as the focus is on securing financial as well as competitive advantage. Management is intent on broadening capability rather than bulking up in core markets. Moreover, the company wants to avoid buying bad contracts and remarked on the low level of transparency in the accounts of potential targets.

JP Morgan flags the opportunity and desire to grow offshore revenue to 20% of group revenue, although management acknowledges entry into Asia is difficult. Goldman Sachs, noting CEO Grant Fenn said there were capability gaps he'd lie to fill, thinks the company could be considering increasing the geographic footprint internationally, as well as more scale in industrial maintenance. Macquarie found this bit interesting as well, seeing potential in expansion of the tyre management business from Latin America/Africa.

Credit Suisse came away more positive and upgraded the rating on the stock to Buy from Hold. The broker found the hard work over several years has paid off, although concedes there are no new major contracts to act as catalysts. Nevertheless, Credit Suisse believes Downer is now one of the better positioned in the contracting area and has limited exposure to the pending decline in large-scale resources and energy capex. Additionally, it is now among the largest asset maintenance companies in Australia, with over 70% of revenue from recurring activities. Rail and infrastructure legacy issue have been rectified and the broker now finds the company has a compelling valuation as a de-risked business with a 5% dividend yield.

FNArena's database reveals seven Buy recommendations and one Hold (Macquarie). Macquarie replaced Credit Suisse's former Hold position on the database, downgrading the stock to Hold from Buy. While acknowledging the company is navigating the current environment well, Macquarie finds FY14 a bit uncertain. The broker is forecasting a 2.2% revenue decline in FY14, resulting in a flatter earnings profile, and believes upside to FY13 guidance is unlikely. Macquarie believes Downer has a number of near-term contract opportunities, such as electrical work on Wheatstone and Ichthys, NBN work and $1.5bn in mining work under bid but most of this is likely to be of benefit in FY15 rather than FY14.

The consensus target price is $5.77, suggesting 23.9% upside from the last share price. The dividend yield based on consensus FY13 forecasts is 4.8% and rises to 5.3% for FY14.

See also, Downer Reveals Value In Diversification on April 9 2013.
 

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article 3 months old

Orica Clears The Way For Better Growth

-First half better than expected
-Brokers see long-term value
-Barriers to entry an advantage
-Cash flow improves
 

By Eva Brocklehurst

Diversified chemicals company Orica ((ORI)) pleased the market with a solid half year result, better than many had feared. Also, management indicated a trough was likely for the Minova business, which has been the cause of much angst among brokers.

Citi remains the most cautious, and the one with a Hold rating on the FNArena database. The broker found the $90 million benefit from the normal operation of Kooragang Island a key growth driver. Sodium cyanide and emulsion sales helped to some extent. Minova was weaker than the broker expected, and Bontang plant costs also impacted. Orica is confident that margin improvement will drive growth but Citi is not so sure, expecting ammonium nitrate pricing pressures could be the next hurdle. The broker remains wary of the deteriorating mine production outlook and cost conscious miners and sees limited upside in volumes and price. Citi has cut Minova earnings forecasts for the year by 20%.

Goldman Sachs believes taht while investing in mining services companies may be counter-intuitive at present, the company offers a more resilient earnings path than the market price is currently giving it credit for. The stock is one of the few in the basic industrials segment that the broker thinks represents good long-term value. CIMB also thinks the stock is a core portfolio holding and welcomed the greater clarity which came with the result. CIMB believes the company offers a strong market position, protected by real barriers to entry which provide a sustainable competitive advantage. The stock is trading at a material discount to its typical range relative to market and CIMB expects the latest result should enable a re-rating.

Credit Suisse finds the potential to achieve 12 years of profitable growth in FY13 is highly commendable, given recent adverse conditions and weak end-markets. This broker also sees the market leadership of Orica tightening as the barriers to entry are raised. Productivity and efficiency benefits may become harder to realise but Credit Suisse does not under-estimate the reinvigorated management team.

Strategically, the greatest operational risk is balancing of Asia Pacific ammonium nitrate supply and demand. Credit Suisse thinks balance should be maintained with imports being displaced, although unless underlying demand accelerates in FY14 there could be marginal oversupply. This implies that Kooragang Island expansion is unlikely in the foreseeable future. Credit Suisse thinks this should free up significant capital. The broker finds it hard to get excited about Chemnet and Chlor alkali businesses and believes, with no mining services exposure, ownership under Orica could be tested medium term. This is particularly so given the number of competitors that are owned by private equity. There's no compelling need to offload these businesses but Credit Suisse would not rule out Orica moving towards 100% mining services over coming years.

UBS made few changes to earnings forecasts. Lower operating earnings from Minova and chemicals is largely offset by lower net interest costs. What did surprise the broker was cash flow. Underlying operating cash flow improved significantly on the prior year. As a result net debt was better than expected and, with a better interest rate environment helped drive lower interest costs. UBS also sees little need for the Kooragang Island project through to 2020 and continues to exclude it from capex forecasts. The broker finds there is scope for raising the pay-out ratio, currently 55%, and other capital management initiatives in FY14.

Macquarie hailed the healthy cash flow, noting first half results had disappointed in recent years but this time the cash flow was ahead of forecasts. The explosive business remains resilient and the company is seen benefiting from a shift into emulsion products. The broker remarked on the company's push to increase on-site product and services supply against product only. New contracts show an increase in the mix of on-site product and services to 70% of sales against 39% six months ago. Supplying product only has reduced to 26% from 61%. Emulsion sales rose to 62% of revenue compared with the December half's 57%. Emulsion was used mainly in wet environments but is now more widespread. The ammonium nitrate solution is combined with emulsifier to make it more flexible in application, more energy efficient and with less fumes. It is higher margin but there is productivity benefit which justifies this higher price, in Macquarie's view.

What was particularly negative? European results. Europe's earnings were down 55% on the prior corresponding half, driving much of the weak Minova business as Europe faced a colder-than-usual winter with declines in explosives volumes/margins in Western Europe and Scandinavia. Minova was also affected by weakness in North America. Minova remains the key to upside for Macquarie, for the earnings are considered high risk. The broker accepts that, if there is indeed a troughing in the business, this would be a positive driver of the share price.

The stock has seven Buy ratings on the FNArena database and one Hold. There is no Sell rating. The consensus target price is $26.68, suggesting 18.5% upside to the last share price. The range of targets is $24.75 to $31.50. The dividend yield is 4.3% on FY13 and 4.7% on FY14 consensus forecasts.
 

See also, Orica Detonates Concern Over Earnings on March 19 2013.

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article 3 months old

Weekly Broker Wrap: Demand For Yield Persists

-Best opportunities for investors
-Capital returns most likely
-Diversification the key in picking E&C contractors
-Improving conditions for airlines
-Is the RBA being tardy in cutting the cash rate?
 

By Eva Brocklehurst

Demand for yield has dominated equity markets for most of the past two years. Interest rates are expected to remain low and Goldman Sachs expects investors will continue to reward companies returning capital against those that re-invest earnings. This should persist until there is more definite evidence of a recovery in growth. There is little room for further yield compression in the defensive, income-generating sectors as pay-outs are already high and, in some cases, dividend risks are mispriced in Goldman's view. The best opportunities are with companies that have conservatively managed their capital, despite the scope to increase cash returns. The broker believes the market response to the recent Woodside Petroleum ((WPL)) pay-out announcement suggests that short-term increases in returns to shareholders can be sufficient to drive a strong re-rating.

Cyclical industries dominate the list of stocks where cash returns are low, unsurprising given the recent earnings volatility. The broker's forecasts are for growth recovery in late 2013/early 2014 and this could see some names generate strong cash returns with accelerating earnings growth and rising pay-out ratios. Stocks that rank highest on Goldman's capital management scorecard include BlueScope ((BSL)), Lend Lease ((LLC)), Fairfax ((FXJ)), Beach Energy ((BPT)), Qantas ((QAN)), Origin Energy ((ORG)), Rio Tinto ((RIO)), Challenger Financial ((CGF)), Newcrest Mining ((NCM)) and JB Hi-FI ((JBH)).

On the other hand, many defensive stocks that have led the recent market rally are on the list of those for which pay-out ratios look stretched. Goldman worries about the valuation risk in many of these stocks as yields have compressed and dividends are potentially unsustainable. Companies are cautious and tactical capital returns, such as special dividends and buy-backs, are likely to be favoured over an increase to ordinary dividends. Goldman notes the market typically expects ordinary dividends to be a multi-year commitments. Moreover, the low borrowing costs with equity valuations at long-run average should make buy-backs earnings accretive for a high percentage of companies.

Goldman notes stocks with low levels of leverage include OZ Minerals ((OZL)), BlueScope, Downer EDI ((DOW)), Iluka Resources ((ILU)), Flight Centre ((FLT)), Wesfarmers ((WES)), Echo Entertainment ((EGP)), Cochlear ((COH)), PanAust ((PNA)), Carsales ((CRZ), Graincorp ((GNC)) and Lend Lease.

Goldman also asks the question as to whether the industry heavyweights will shift course. The broker attaches a low probability to the big miners significantly lifting pay-out ratios in the short-term, given the lack of visibility on commodity prices and a high level of maintenance capex. Debt-funded buy-backs are considered most likely because of the low leverage, heavily discounted UK listings and ability to lock in long-term funding at extremely low levels. Major banks may have room to lift pay-out ratios but the broker thinks special dividends are more likely, given uncertainty over capital standards and a soft credit environment. Commonwealth Bank ((CBA)) and Westpac ((WBC)) are best positioned for this.

The infrastructure and utilities sector has performed strongly in recent years and Goldman takes a backward-looking punt on picking winners, back-testing the predictive power of valuation metrics and financial data over FY00 to FY12. Among the lessons learned is that valuation-based stock selection works. Many of the metrics tested that generated positive returns achieved compound returns of over 10%. Another lesson is that selecting stocks based on distribution yield plus growth generated the strongest risk-adjusted performance.This strategy yielded compounded average returns of over 23% per annum for top quartile stocks.

Which stocks offer the highest current dividend yields in the infrastructure and utilities sector? Goldman notes Sydney Airport ((SYD)) and Spark Infrastructure ((SKI)). Those which offer the strongest forecast prospective dividend growth profiles are Spark, Australian Infrastructure ((AIX)) and Transurban ((TCL)).

For CIMB, a significant rise in costs is diminishing returns for asset owners in the engineering and contracting segment. Demand is not really the problem, as peaking activity has been well flagged and still remains well above historical levels. Rising costs will need to be shared or removed to ensure developments are viable. At best, CIMB thinks margins will be squeezed and those unable to assist clients in reducing costs will most likely be removed or replaced as a contractor. As an aside, the broker does not consider this is a specific problem for mining services but rather for all sectors.

For the contracting and engineering services, diversification by industry, geography and service should reduce economic impacts but won't entirely shield industry participants from the adverse effects of a downturn. A lot of earnings risk is already factored into share prices and attention should turn to emerging value. CIMB prefers companies which show diversity in international business, commodity type and service area. As a material improvement in Australian costs is unlikely in the near term, the broker urges caution across all Australian-focused engineering, construction, contracting, capital goods and other related service providers. Picking the bottom of the market will be difficult so the broker suggests an accumulation strategy. Preference is maintained for companies such as WorleyParsons ((WOR)), Ausenco ((AAX)), ALS ((ALQ)), Cardno ((CDD)), and Clough ((CLO)) for oil & gas exposure.

Traffic statistics from the airlines show domestic market capacity only grew by 3% in March. This means improving capacity restraint, according to UBS. Daily production of available seats has also consistently fallen on a sequential basis over the last six months. UBS thinks it is increasingly likely that Qantas and Virgin Australia ((VAH)) will cut the 5-7% capacity growth forecast for the June half year and generate positive yield in the June quarter. The broker notes that every 1% extra domestic unit revenue equates to $80m per annum extra pre-tax earnings for Qantas and $30m for Virgin. Jet fuel (Singapore benchmark in AUD) has dropped $15/bbl to $115/bbl since both companies reported in mid February. The broker thinks both airlines will benefit form improving operating conditions in the domestic market and easing fuel costs. Qantas remains the preferred pick on valuation and near-term momentum.

Macquarie took a look at reasons behind why the Reserve Bank of Australia has been reluctant to cut rates in recent years. Maybe the central bank wants Australians to save more and encourage firms to address weak productivity growth. The analysts believe this is desirable, and perhaps inevitable, but it's a painful process nonetheless. Household spending is not expected to resume the growth it enjoyed in the 1990s for some time yet. Macquarie takes a look at what Germany went through earlier this century. It took about five years for the benefits of the German reform process to outweigh the costs imposed. Monetary policy was not the key driver of the reforms either, but it did play a role in the background. The European Central Bank was reluctant to cut rates too far in 2002, creating an environment more conducive to reform, and then a spurt of rate cuts in 2003 helped offset some of the short-term negative effects. It meant reforms, when they were introduced, had a better chance of succeeding.

In the analysts' view the case for a cut to the RBA's cash rate in May is clear. Underlying inflation is running at the bottom of the 2-3% target band. The RBA expects growth to decelerate below trend over 2013 and for unemployment to rise further, which suggests that inflation will slow further from here. The strong currency continues to inflict pain on the tradeable goods sector of the economy. Despite that, markets are far from convinced of the likelihood of a May rate cut. If that's correct, and the central bank is keeping its powder dry, then there are some sobering implications for growth and the economy over the next couple of years, in Macquarie's view. When firms all focus on cutting costs to improve margins and profits it is likely to result in subdued growth, weak investment and rising unemployment. Where the economists differ from the RBA in characterising the situation for the year ahead is over the persistence of this softening in activity.

Returning to Germany, the ECB cut rates in two stages, initially cutting from 4.75% to 3.25%, waiting a year, then cutting again to 2%, leaving rates at a steady state then for a couple of years. Macquarie believes the ECB was channelling Germany's Bundesbank, which successfully dealt with a high inflation era 40 years ago. The RBA's original choice of the 2-3% inflation target was partly influenced by the success of the Bundesbank in keeping inflation in Germany around that level over the 1970s and 1980s. Also, Macquarie notes the RBA has consistently talked about the benefit of running growth (and inflation) a little weaker in the short term if it meant a more stable economy over the medium term.

High inflation is not a problem in Australia at present. Macquarie suggests that, once companies start cutting costs and improving efficiency, then the way in which monetary policy can assist that process is by preventing growth from falling too far. In Macquarie's view, action on the company side of the equation is now happening. This then suggests the RBA should become less reluctant to trim the cash rate.
 

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article 3 months old

Tox Free Scoops Up Wanless

-Acquires Wanless businesses
-Provides more diversity to Tox Free
-Brokers cautious about commercial sector
 

By Eva Brocklehurst

Tox Free Solutions ((TOX)), a provider of industrial and hazardous waste solutions, has made an acquisition in the industrial and commercial waste collection segment which brokers expect will be viewed positively by the market. There are three parts to the Wanless business and it operates in Queensland and Tasmania. The acquisition price, considered full, is $85 million and will be funded via a $43m institutional placement and new debt facilities.

The acquisition may not be cheap but it continues to diversify the company's business away from hazardous waste and resources markets, and that's good in JP Morgan's opinion. The broker finds the acquisition will complete the company's footprint in Queensland, providing a presence in Far North Queensland which it did not have before, and also a number of solid waste depots in South East Queensland, which service the more traditional manufacturing and commercial sectors.

The company has delivered solid financial results with strong returns to shareholders, UBS notes. The broker finds it commendable that management has made an earnings accretive acquisition at a time when major competitors do not have the balance sheets to do so.On the plus side, Macquarie notes acquisitions the company has successfully bedded down include Waste Solutions NT, Pilbara Waste and MMS in 2011 and DoloMatrix in 2012. These four had annualised earnings of $17m at the time of acquisition. For Tox Free, FY13 is also to produce benefits from the start up of new contracts with Origin Energy ((ORG)), Asia Pacific LNG and Fortescue Metals ((FMG)). Tox Free also provides industrial maintenance services through subsidiaries Tox Free Industrial Solutions, Barry Bros Specialised Services and Grime Fighters.

The three parts of Wanless comprise Wanless Enviro Services, Smart Skip and Jones Enviro Services. Wanless Enviro had pro-forma FY13 revenue of $42m and provides solid waste services in Queensland, operating branches across the state. Smart Skip, pro forma FY13 revenue of $8m, is involved in the waste from construction and demolition in South East Queensland. Jones Enviro, pro forma FY13 revenue $12m, is an industrial and commercial waste recovery and recycling service in Tasmania.

One item that troubled JP Morgan was the large transaction cost involved, equating to around 7.5% of underlying acquired asset value. While the company removed these costs from the investor presentation in determining the accretion value of the acquisition, estimated at 8% on a pro-forma FY13 basis, JP Morgan argues it should be included as a cost borne by Tox Free shareholders in acquiring the asset. The acquisition price implies a FY13 enterprise value/earnings multiple of 5.8 times on JP Morgan's estimates, or 6.3 times when costs are included. 

UBS retains a Hold on the stock as the broker wishes to see more evidence of management executing in this new segment of the market. The broker is a bit concerned about the competitiveness of the commercial and industrial collection industry. JP Morgan agrees as it presents a very different market to Tox Free's base in hazardous materials and resources. The opportunities and market size of commercial and industrial waste are much greater but barriers to entry are lower.

JP Morgan also maintains a Hold rating. This takes the number of Holds to three on the FNArena database. CIMB has the third. The fourth broker covering the stock on the database is Macquarie, with a Buy rating. Macquarie believes the stock is fairly valued for the near term but is optimistic about medium-term options for growth, both organically and from acquisitions. The consensus target price is $3.43, signalling 1.2% upside to the last share price.
 

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article 3 months old

Outlook Bleak For Oz Engineers & Contractors

-Outlook for contractors is bleak
-Multi-year downturn in exploration seen
-Infrastructure exposed are best placed
-Larger contractors feeling the pinch
 

By Eva Brocklehurst

The outlook remains bleak for Australian engineers and contractors now resources capital expenditure is reaching a peak. Sure, there are some projects in oil & gas that are continuing but in many areas companies are cutting back and this has ramifications for mining  and energy services providers as well as civil contractors on infrastructure projects.

Citi describes it thus: CEOs are turning away from empire building to focus on cost and returns. That view may not be so new but the analysts at Citi expect the downside is likely to be greater than estimated, particularly for 2014. Modelling points to a sharp drop in mining capex in 2014 - globally. Mining capex is expected to decline 8% in 2013 and 19% in 2014. The model also points to a 12% decline in 2015. Pricing of mining equipment has deteriorated notably and prices are expected to be up just 2%, year-on-year, over the next 12 months. This compares with an average increase of 6% over the past 10 surveys Citi has undertaken on this measure. The result suggest that prolonged slower growth could drive consolidation amongst mining equipment providers.

Goldman Sachs recalls the recent termination of Leighton Holdings' ((LEI)) pre-strip contract with the BHP Billiton ((BHP)) Mitsubishi Alliance (BMA). The contract was terminated two years early and appears to be driven by BMA's decision to re-tender the contract and award it to a private contractor. For Goldman this underscores the coal industry rhetoric about placing pressure on supplier input prices that's becoming a reality. A positive development from all of this pressure, Goldman's view, is that Leighton is now walking away from loss-making contracts.

While accepting Australian coal producers are facing significant profitability pressures, there are instances of mine closures the analysts think are costing more than operating these mines at small losses. In this environment there is a preference, mainly among global producers with operational expertise, to increase the instances of owner operation over outsourced mining. Witness, Xstrata cancelled Leighton's Collinsville contract and Peabody has brought coal washing operations in house from contractor Sedgman ((SDM)). Risks abound for contractors in this environment.

Goldman Sachs expects a multi-year downturn in exploration activity and those companies heavily exposed to exploration are downgraded as result. This includes ALS ((ALQ)), Boart Longyear ((BLY)) and Imdex ((IMD)). The broker has a Sell rating on ALS, seeing an adverse combination of downside in minerals testing volumes, earnings risk and a demanding FY14 earnings multiple of 16 times. The other two have Hold ratings as they are moving into oversold territory. Increased resources investment has run its course following a strong run in commodity prices. Goldman forecasts that reinvestment rates in the resources sector will now trend back towards historical averages around 54% and companies will take a more selective view. This means a rebound in exploration and growth capex is unlikely in the short term.

JP Morgan's Contractor Expectations Index (CEI) is negative. Profit margins are seen sliding as major projects are delayed or cancelled. A peak in Australian engineering construction is expected within 6-12 months and the volume of work is coming under pressure. Many projects may be progressing but capex cost inflation and growing alternative sources of supply are weighing on new projects. The analysts note the value of new projects coming on line is less than the volume of current projects reaching completion and those that have been delayed or cancelled. It's not only resources, the private sector is also being cautious about major investments in economic infrastructure until there is greater policy certainty and a better balance of risk in private-public partnerships.

Is there any positives in the outlook? The CEI at 34.5 is up 18% from six months ago but down 18% from 12 months ago. The rebound is driven by smaller contractors becoming less bearish. The large CEI was up 1% from six months ago at 43.3. Large contractors may be more positive as far as order books go but profit margin expectations have deteriorated sharply. The small CEI was up 27% from six months ago to 31.2, driven by less pessimism on margins and order books. It appears smaller projects are continuing at a better rate.

For JP Morgan some contractors can find mitigating circumstances in the spread of their work such as Downer EDI ((DOW)) or Lend Lease ((LLC)), as the have a limited exposure to resource and energy. For others such as Monadelphous ((MND)) and Leighton there are difficulties in maintaining revenue growth and margins. Monadelphous has short work duration and a strong level of growth which is likely to come under pressure and Leighton is distracted by other problems such as gearing and the Middle East. Transfield Services ((TSE)) and UGL ((UGL)) have worked through a number of problems in operations and their operations and maintenance exposures may be a help as the installed base of assets grows.

While oil & gas companies are joining others in the resources sector in the downturn segment of the construction cycle, JP Morgan finds the economic construction sector is a bit further ahead, in the stabilising segment of the cycle. Growth expectations have improved and respondents are increasingly positive about the road, water, electricity and rail sectors. Expectations have stayed constant for the telecommunications sector despite the NBN roll-out. There have been some new infrastructure projects announced in the last six months but JP Morgan has not observed any significant increase in total project values. The analysts believe this reflects a reliance on the modest recovery in economic infrastructure to make up for the pull-back in mining and oil & gas. 
 

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article 3 months old

Downer Reveals Value in Diversification

-Road maintenance, infrastructure key to growth
-Electrical, Instrumentation prospects in LNG
-Waratah train contract could be extended
-No problems so why are shares sold off?
 

By Eva Brocklehurst

Diversified engineering services provider, Downer EDI ((DOW)), shows just how valuable being "diversified" is in the current economic climate. Often conglomerate companies encounter difficulties in good times, spreading too thinly trying to take advantage of many opportunities. Now, with some areas of the economy sustaining soft conditions, Downer still has plenty of work.

Road maintenance and infrastructure are the stand out categories for growth that Citi has identified. NSW and Queensland are outsourcing more road maintenance and these two states account for 60% of the market. At this stage, they outsource just 20%. Citi views this as a $2 billion per annum revenue opportunity for Downer if these two states raise outsourcing to the level of Victoria and Western Australia (70%). Downer has a 30% market share in this area. Citi acknowledges that NSW and Queensland have talked about outsourcing more road maintenance for some time but suspects that fiscal pressure, and new hands on the tiller, may now provoke the required action.

Downer's Infrastructure Australia should be able to increase earnings margins to 5% by FY15 against the 4.4% sustained in the first half of FY13, according to Citi. This should reflect the benefits from the full integration of engineering and works, cost savings and the rolling off of loss-making projects. On the resources side of things, Downer's earnings should be supported by involvement in the most active segment - LNG. JP Morgan concurs, finding Downer's leading position in electrical and instrumentation (E&I) should help the company pick up more work in LNG as projects approach this phase of construction. The broker also flags Downer's success on the NBN and the broader opportunities in telecommunications and renewable energy that can provide work in the E&I area.

There are risks of course, as contract mining is under pressure and there are margin pressures with rail. Miners are cutting operating costs by reducing overburden removal and strip ratios and cutting ancillary services. Citi notes this has resulted in margin pressure for Downer. In response, Downer is improving plant utilisation and cutting its own overheads. JP Morgan also thinks the exposure to iron ore and coal mining, despite the slowing in Chinese economic growth, will still prove supportive to Downer. The development of the Roy Hill iron ore mine, for which Downer EDI is bidding on earthworks and E&I, should provide a $1.2 billion opportunity, in Citi's opinion. 

JP Morgan recently upgraded Downer to a Buy, citing the fact the company had made progress in stabilising its business, particularly the Waratah train project. Train delivery schedules are on track and, based on current production in Cardiff and in China, JP Morgan expects Downer can deliver all 78 sets required by mid 2014. There is potential upside here. Under the terms of the original contract between Reliance Rail and the NSW government there is an option for extending delivery by 20 trains. This option expires this month. JP Morgan believes the government may choose to extend the delivery outside of Reliance Rail (the public/private participation vehicle). As Downer EDI has been able to solve the problems with manufacturing and design that weighed on the Waratah project originally, the broker believes any extension order could provide earnings upside.

More positives? There has also been a significant improvement in profitability and a return to headline revenue growth for Downer New Zealand, reflecting momentum on Christchurch rebuilding and new work in major telecommunications. Both brokers see a valuation gap emerging, with JP Morgan observing that, since the beginning of March, the share price has fallen 17%, in line with peers. Downer returned to paying dividends in the first half, with a 10c interim payment, partly franked. This was substantially more than JP Morgan had expected and the broker sees no impediment to regular dividends with some level of franking.

On Citi's number crunching, Downer has capacity for $250-400m in bolt-on acquisitions by FY14, based on gearing around 25-30%. The stock may have a poor history of returns but the broker still thinks the return on investment and return on equity should increase to 13.7% and 12.9% respectively in FY14. Downer's performance historically has been clouded by problematic contracts but the problems with Waratah trains and Curragh coal no longer present. Also, Citi hails the better risk management that's now in place. So why should Downer be cast in the shade along with sector peer Leighton Holdings ((LEI))? JP Morgan believes there are no stock-specific issues at present for Downer, while Leighton is facing corporate governance concerns. It must all be to do with blanket downgrading of the sector.

Citi and JP Morgan are wholeheartedly in the Buy camp, along with five others on the FNArena database. The only other recommendation is a Hold from Credit Suisse. The range of price targets is $5.55 to $6.40 with the consensus target of $5.88 suggesting 21% upside to the last traded share price. Dividend yield is 4.7% based on consensus FY13 estimates and rises to 5% for FY14.
 

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article 3 months old

Rudi’s View: Amcor – Resilience And Capital Discipline

By Rudi Filapek-Vandyck, Editor FNArena

The secret, so to speak, was printed prominently in the 2010 Annual Report: Amcor ((AMC)) is well positioned by having a substantial growth opportunity that is not dependent on economic recovery (emphasis mine).

At that time, only a few were genuinely paying attention. So painful remains the memory of Amcor's disaster years among investors and stockbrokers that up to this day many refuse to even reconsider the company as a potential investment option. I know of one stockbroker who persistently shows the palm of his hand while turning away his head whenever someone dares to mention the company's name in his presence.

Most funds managers and stockbrokers are straightforward and honest about it: they missed the Amcor turnaround story and by doing so their clients have missed out on one of the better investment opportunities the Australian share market has had on offer between 2009-2012. Consider this: while the Australian share market in general wasn't going anywhere until mid-2012, Amcor shares continued posting double-digit gains, every year, of which a little less than half stemmed from steady dividends. When the Big Rally announced itself in mid-2012, Amcor shares further extended their market-beating performance.

The table below shows the performance of Amcor shares post 2007 (add circa 5% in non-franked dividends to each year's return). Note also the relatively modest fall in 2008 when margin calls and panic selling had become a daily phenomenon in the share market:

 

To grasp the essence of what makes "Amcor", and to fully understand its internal dynamics, it's best to think of an international conglomerate. Investors in Australia have in recent times fallen in love with Wesfarmers which is officially an industrial conglomerate combining retail outlets with coal mines, insurances, fertilisers, investment banking and listed warehouse retailing properties, but in practice conglomerate Wesfarmers is predominantly a consumer (retail) oriented story. Most conglomerates ultimately cease to exist as during times of troubles management teams find it too difficult to successfully manage different types of operations that often have little in common, let alone any operational synergies.

In the US, Sara Lee has abandoned tobacco and women's underwear to solely concentrate on food products. In Australia, Mayne Nickless and Pacific Dunlop no longer exist (though spin-offs like Mayne Pharmaceuticals, Cochlear and Ansell still do). Amcor has many conglomerate-alike characteristics, with 300 plants located in 42 countries, producing all kinds of packaging, from metal screw tops to cardboard boxes to PET bottles to transparent films for food and medicines. As stated in the opening paragraph: Amcor too has had its rough times.

The difference is, however, inside Amcor are a lot of natural synergies between divisions and across geographies through common customers and distribution channels. Another difference is that Amcor's problems didn't have much to do with its conglomerate-like character, but more so with the break-neck speed at which acquisitions were being announced and executed at the turn of the century. One journalist wrote at the time: No-one, not even Amcor itself, knows exactly how many businesses have been acquired in years past. Before mid-decade that strategy had come unstuck and Amcor quickly turned from market darling into fallen angel and then it descended further into a grizzly bad memory from the past. One that cost a lot of investors a lot of money.

Warren Buffett once said the trouble with most turnaround stories is they never actually turn around, so what has made the difference for Amcor? By 2005 new management and the Board acknowledged Amcor had lost its way. A restructuring was undertaken with the aim of improving core competencies and shedding underperforming businesses. The program was called "The Way Forward". In 2009 the program's principles were embedded within a new operating model; "The Amcor Way". Then Dame Fortuna smiled upon the company.

Heavily-indebted Rio Tinto was struggling for survival amidst lower commodity prices after having overpaid for the acquisition of Alcan in a bid to fend off suitor BHP Billiton. As Rio Tinto became a forced seller of assets, Amcor snapped up Alcan Packaging for a bottom of the cycle price tag of US$1.948 billion, representing 5.1 times calendar year 2009's profit before interest, tax, depreciation and amortisation (PBITDA). Amcor instantaneously became twice as big but also with (at least) twice as many growth opportunities. Management certainly hasn't disappointed by extracting more synergies than originally suggested, ahead of schedule.

All this allowed the 2010 Annual Report to declare that Amcor had by now become a "substantial growth opportunity", regardless of what happened in the global economy. There are not many companies in the Australian share market that are ever able to make such a bold statement, let alone in the midst of a raging bear market.

It's not all related to Alcan Packaging.

With a geographical reach that is virtually unmatched in Australia (except, maybe, by News Corp) Amcor's worldwide operations are a reflection of what is going on the world; always a problem somewhere despite upside elsewhere. At the same time, with some 85% of products and customers related to the food, beverage, tobacco and healthcare sectors, Amcor's operations have a strong built-in resilience. Note that profit growth and dividend increases in recent years have occurred despite a deep and nasty recession in Europe which just happens to be Amcor's most important market!

The conglomerate-like character has been further emphasised by two very tough years for operations in Australia (just like every other local manufacturer) and management has responded with restructuring and cost cutting. The years ahead should see a jump in profitability for these operations as closures of the Petrie recycled cartonboard mill in Queensland and a plant in Thomastown, Victoria should see a material boost in margins and earnings from 2014 onwards.

Don't also forget Amcor is leveraged to better economic momentum in the US, the group's second largest market, while 65 plants and more than 8,000 workers in 24 Emerging Markets now represent some 19% of total group revenues. Since 2000, sales into emerging markets have grown at a compound rate of 18% per annum. As the average consumer in emerging countries grows wealthier by the day, this underpins an increasing demand for packaging. Amcor is already, according to its own assessment, in possession of an unrivalled footprint across South and Central America, Eastern Europe, Russia and Asia, including India and China.

Amcor's operational diversification is strikingly illustrated in the following chart (thanks to BA-Merrill Lynch):

An additional luxury is that the businesses generate a lot of cash flow and now that the bulk of restructuring and integration of Alcan Packaging is done, management will have plenty of shareholder friendly options available, apart from reducing the company's debt ($3.8bn). The past years already saw a $150m share buyback plus a new dividend policy that should pull future increases in line with profit growth. There should still be plenty of growth potential inside the existing operations as margins remain below competitor's levels. Acquisitions, including Alcan Packaging, typically depress margins, which offers room for improvement.

Acquisitions remain firmly on the agenda. Amcor spent some $920m over the past twelve months but management has declared it will remain a responsible investor. This is not a throw-away statement, given the company's failure in the past. There is an investment hurdle of 20% Return on Funds Employed (ROFE); if no suitable investments can be found, the company will seek to return excess cash to shareholders by way of increased dividends and/or share buy-backs.

Admittedly, the drivers behind larger profits in the years ahead are different for the operations in developed economies where product innovation and cost reduction remain key ingredients, while growth will be easier to obtain in emerging markets.

Is there nothing that can disrupt this forecast?

Oh yes, there is. In fact, there's plenty! And outside control of Amcor's management too. With 85% of all profits generated in foreign currencies, predominantly euro and USD, currency fluctuations can have a significant impact for Australian shareholders. Amcor estimates that every euro 1c move impacts net profit by A$5m and every US1c move impacts net profit by A$3m. The good news is, of course, that in case of AUD weakness, Amcor will be a major beneficiary.

As a global manufacturer, rising input costs are always a threat as any pass-ons to customers happen with a delay. Raw materials are typically 30% to 60% of the total cost of production. Important thus. The largest categories of raw materials for Amcor are resins, resin-based films, aluminium, cartonboard and inks.

Another negative is that Amcor's Price-Earnings (PE) ratio has now risen to the upper level of its historical PE range (see chart below). Investors not yet on board might want to wait for share price weakness or to buy on dips in order to avoid disappointing returns in the short term.

In summary: Amcor's All-Weather(*) characteristics which include resilient revenues, pricing power and a wide geographical and product diversification are at this point in time complemented with several drivers that should ensure strong growth lies ahead. These profit-drivers include recent acquisitions, growth in emerging markets, cost reductions, and ongoing operational improvement. Virtually every analyst covering the stock acknowledges there's plenty of room for unaccounted positive surprises, regardless of further acquisitions. Amcor may well be cruising towards an operational sweet spot in the years ahead.

Ignoring any further upside potential, below are present projections on the basis of FNArena's consensus estimates:

In 2012, Amcor launched a new program "Journey to Greatness" with management explicitly stating: "The objective is to deliver consistent improvement in returns to shareholders, measured as growth in earnings per share and increases in the dividend."

Investors should always consider weaknesses and strengths when assessing investment opportunities. In the case of Amcor, I believe these are:

Weaknesses: - currency fluctuations can heavily impact on profits for Australian shareholders - so can rising input costs were commodities to experience another bull market - acquisitions remain firmly on the agenda and they come with specific risks - Amcor carries $3.8bn in debt which will create headwinds from the moment interest rates start rising

Strengths: - fast growing emerging markets on top of a resilient customer base in developed economies - Amcor aims for top three positions in all markets in which it operates which should guarantee pricing power - multiple profit drivers in years ahead - excess cash virtually guaranteed (which can also turn into a negative in case of mishandling by management)

Bottom Line: shareholders should continue to enjoy growth in the years ahead, while positive surprises in markets like the US, Europe and/or Australia will only add extras to the upside potential.
 


 

Trivia: Amcor's annual sales four years after the purchase of Alcan Packaging are still below the implied $14bn at the time of the acquisition, but its profits are much higher and so are dividends for shareholders, showing the success of successive restructurings and operational improvements put in place by management over the years.

(*) Amcor was nominated an All-Weather Performer in my recent eBooklet "Making Risk Your Friend. Finding All-Weather Performers". This eBooklet was published earlier this year and has been made exclusively available to paying subscribers of FNArena (6 and 12 months).

This is the third in a series of analyses on individual companies. Previous stories:

- Rudi's View: CommBank, The Most Consistent, Reliable Performer (14 December 2012)

- Rudi's View: Newcrest's Production Ace (25 October 2012)

(Do note that, in line with all my analyses, appearances and presentations, all of the above names and calculations are provided for educational purposes only. Investors should always consult with their licensed investment advisor first, before making any decisions.)  

P.S. I - All paying members at FNArena are being reminded they can set an email alert for my Rudi's View stories. Go to Portfolio and Alerts in the Cockpit and tick the box in front of 'Rudi's View'. You will receive an email alert every time a new Rudi's View story has been published on the website. 

P.S. II - If you are reading this story through a third party distribution channel and you cannot see charts included, we apologise, but technical limitations are to blame.

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article 3 months old

Orica Detonates Concerns Over Earnings

-Earnings impact from weather, Minova
-Brokers downgrade forecasts
-But there are some positives
-Hope in future strategy
 

By Eva Brocklehurst

The flooding of Australia's east coast coal fields this year, in particular the duration of the wet in NSW, has caused Orica ((ORI)) to reduce forecast explosives volumes and mark down earnings expectations by $10-15 million. The company advised of the earnings impact in an investor conference yesterday and also flagged ongoing weakness in the Minova business, which supplies consumables and services to the mining industry. These were the two main negative implications from the briefing, but brokers took heart from the fact that the company did not downgrade full-year profit guidance.

The market's negative share price reaction to Orica's news was overdone as far as JP Morgan is concerned. The broker has still downgraded forecasts for FY13 earnings but believes the majority of this will come from the low valuation Minova business. To put this in context, a 23% reduction in the broker's forecasts for Minova reduces group earnings forecasts by 2%. The downgrade for explosives earnings is weather related and, therefore, should revert to mean in FY14. JP Morgan notes a lot of the volume reduction was in the Hunter Valley, in anticipation of the impact as the big wet moved south. In all, the broker considers the valuation impact on the stock is minimal. The broker suspects some analysts might be using the first half 2012 earnings and deducting $10-15m without adding back lost production margins from the Kooragang Island plant shutdown in FY12. That could understate the outlook for FY13 earnings as a result.

Minova is suffering from weak demand in both Australia and the US as well as price competition. For Macquarie, the business may be just 4% of earnings but has taken away much of the prior growth expectations. Macquarie now expects a 56% decline in Minova's full year earnings as opposed to Orica's expectations of 20%. Macquarie sees a positive in the big wet. These situations increase demand for high margin emulsion product and there is potential for the earnings to be made up later in the the year. On balance, the broker notes the key will be non-recurrence of Kooragang Island outages that took $90m out of the earnings equation previously. It just depends, when lost earnings are added back in, how much is negated by the Minova deterioration.

Deutsche Bank is quite upbeat about the future, believing the $10-15m figure is conservative and the impact could be lower, around $6.5m on estimation. The broker also highlights the company's restructuring progress with Minova. This will be completed in FY13 instead of FY14 as initially planned. Okay, conditions continue to be difficult in underground coal mining but the broker believes the company is well placed to benefit from a recovery in mining activity and suspects the market is not taking into consideration the company's strategy on operational improvement.

UBS is positive about the outlook for domestic explosives volume growth but cautious about the maintenance of margins after five years of strong growth. The supply/demand balance is becoming less favourable and when this is combined with increasing customer pressure it suggests to the broker that domestic margins have peaked. This limits the scope for earnings upside. UBS has also disagreed with Orica's target of an 18% contribution from the Bontang ramp-up, and new Burrup and Kooragang Island projects from FY16 and FY18 respectively. This is because the capital costs are high. The broker suspects the industry will not be able to support the higher ammonium nitrate prices that are required for these projects to achieve targeted returns in the years following commissioning. UBS has downgraded its recommendation to Hold from Buy.

For BA-Merrill Lynch it is clear Minova is challenged, but there is some light at the end of the tunnel. Orica indicated mining services is growing market share and increasing penetration in mine site services. Furthermore, Orica has maintained over 80% of its own contracts up for tender and won over 57% of new contracts, globally, that were previously held by competitors. The stock is the broker's pick in the sector as it retains significant leverage to continued growth in explosives volumes in Australia and Asia. There is also margin expansion from converting commodity ammonium nitrate volumes to higher value mine site services.

Morgan Stanley takes a different tack: the news is ushering in the beginning of a downgrade cycle. Morgan Stanley, which does not feature on the FNArena database, rates the stock as a Sell. A number of negative structural factors are coming into play and the broker believes the stock is expensive, given the risks. For Morgan Stanley, the company may not have altered its guidance but implies it could be forthcoming. The broker was below consensus for FY13-15 earnings forecasts and is now 7-13% below. Why is Morgan Stanley so bearish? The client base is seeking cost savings while there is a rising cost base. Import parity prices are falling and placing pressure on the company's supply and services margins. In particular, Morgan Stanley cites the risk in Indonesia from exposure to Chinese imports, noting 15% of Orica's Bontang volumes are directly exposed and contracted volumes are likely moving into a softer pricing environment.

There's no Sell rating on the FNArena database. Just six Buys and two Holds. The consensus target price, from a range of $26.60 to $31.50, is $27.93, showing 14.5% upside to the last share price. The stock shows a 4% dividend yield on consensus FY13 earnings forecasts. 

article 3 months old

Seven Group On The Right WesTrac

By Andrew Nelson

Tuesday’s interim result from Seven Group Holdings ((SVW)) provided yet another significant outperformance of market expectations, although brokers are lining up to point out there’s plenty more upside than just strong and consistent earnings. Although, a big earnings beat is still a pretty good place from which to start.

As far as analysts at CIMB are concerned, the real highlight of the day was the significant working capital release. After factoring in the company’s now considerable listed-asset portfolio, the business now sits atop a very effective net cash position. Operating cash was almost six times the broker’s expectation and saw the company finish the half with a net debt of just $830m, which equates to gearing of 23%. The improvement is quite significant when compared to last year’s 40% at the end FY12.

WesTrac Australia was a standout, with the broker noting that margins are holding up well despite the strong growth experienced in its lower margin Equipment Sales business. Given guidance was pretty much unchanged, the broker sees this as a good indicator of the increased predictability and defensiveness of WesTrac earnings in what for others is a difficult, post peak capex environment.

Guidance is pointing to a weaker 2H given Equipment Sales are expected to have reached what is a very high peak, but CIMB is little concerned at this point, noting the market is already looking at FY14. The broker expects WesTrac Equipment Sales will pullback by around 30%, but this should be at least somewhat if not completely offset by ongoing growth in higher margin Product Support revenue. All up, the broker only sees a 5% decline in FY14 operating earnings for WesTrac.

BA-Merrill Lynch had a similar reaction to the result, very keen on the WesTrac performance and thus upgrading FY13-14 forecast earnings by 23% and 17%. Otherwise, BA-ML’s hit list reads the same as CIMB’s: top line and margin outperformance from WesTrac and the ongoing deleveraging via strong cash flows and asset sales. In fact, the broker says when taking into account the value of a liquid listed portfolio, which sits at around $804m, the business is pretty much un-geared at current levels.

Macquarie is of a similar opinion, while JP Morgan also sees increasing upside coming from WesTrac China, noting some signs the operation seems to be on early track to recovery. The broker is confident about the underlying drivers of demand for Chinese heavy equipment and expects the operation to become an increasingly important earnings driver over the medium term.

Valuation appeal also plays a big part in the attraction, CIMB noting that despite the recent strength in the share price, the stock still trades at a better than 30% discount to offshore Caterpillar dealer peers and a 17% discount the broker’s sum of the parts valuation.

And when you add in a balance sheet that is deleveraging at pace, the ongoing work to simplifying corporate structure and what is a defensive and resilient earnings base, CIMB and all the other brokers in the FNArena database, bar one, believe these sorts of discounts are unwarranted. Thus, the stock is just one Hold call away from straight Buys in the database, trading at 14.1% discount to the consensus price target.

Deutsche Bank is the broker sitting at Hold and unsurprisingly, the broker also has the lowest price target and thus the least appreciation for the valuation story. The broker liked the WesTrac performance, the stronger balance sheet and the better than expected FY guidance. Upgraded guidance comes despite the cautionary note that has been sounded. In fact, DB lifted its FY13 net profit forecasts by 13% and FY14 by 5%.

With the broker positive on all of the elements everyone else is positive on, where does the Hold call come from? Simple: the broker sees a few things that worry it more than the others. First, there’s the threat of a sustained global commodity market downturn; it’s not expected, but far stranger things have happened and they way things look know, it’s at least not hard to imagine. Next, the company’s prospects are tied, to some extent, to a Caterpillar dealership agreement that needs to be maintained and a controlling shareholder that needs to be kept happy.

So despite Deutsche Bank’s price target jumping from $7.80 to $11.45 post the result, it isn’t enough to change the broker’s view that the risk-reward profile is balanced.
 

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