- Downer EDI result beats guidance
 - Debt reduction and strong cash flows highlights
 - Legacy issues being dealt with
 - Brokers lift forecasts and price targets
 

By Chris Shaw

Having guided to a full year net profit after tax of $180 million, Downer EDI ((DOW)) delivered a positive surprise to the market by reporting a profit for FY12 of $195 million. The result was an increase of 17% relative to the previous corresponding period.

Macquarie saw some items of outright good news in the result, as Downer's net gearing has fallen by 800-basis points to 28% on a net debt to net debt plus equity (including operating leases) basis. Morgan Stanley agrees, estimating Downer will now have around 23% headroom with respect to financial covenants thanks to its improved debt position, up from 12% headroom previously. 

As well, Macquarie notes operating cash flows have strengthened, to the extent FY13 capex of $400 million can be funded internally. Morgan Stanley expects this improvement in cash flows will remove a key overhang, as the market had some concerns about Downer's ability to refinance around $300 million in debt by the end of the year.

Morgan Stanley notes the result showed some normalising of Downer's previous legacy issues such as the Curragh and Waratah contracts. This suggests management is doing a good job in turning around operations at Downer, to the extent underlying earnings momentum will now start to become more apparent.

Guidance for FY13 reflects this, as management has indicated net profit after tax for FY13 is likely to be around $210 million. As an example, this is around 9% higher than Macquarie had been forecasting for the period.

Downer's updated earnings guidance is also above others in the market, as Deutsche Bank has lifted its FY13 forecast by 9% and Morgan Stanley by 8%. Consensus EPS forecasts for Downer EDI according to the FNArena database now stand at 47c for FY13 and 52.8c for FY14. 

On the back of upward revisions to earnings forecasts brokers have also generally lifted price targets. The consensus target for Downer in the database has risen to $4.36 from $4.32, targets ranging from Credit Suisse at $3.50 to RBS Australia at $5.02.

The database shows Downer EDI is rated as Buy five times and Hold twice, which is unchanged from prior to the earnings result. Valuation and improving earnings momentum are the key drivers of the Buy ratings, with Deutsche Bank pointing out on its numbers Downer is trading on a FY13 earnings multiple of 7.5 times.

JP Morgan's numbers suggest Downer is trading on a 27% discount to its average valuation of $4.76, which appears too low given the solid earnings growth outlook. RBS Australia agrees, taking the view the market is overdoing concerns with respect to the Waratah rail contract and the state of Downer's balance sheet.

The issue for UBS is uncertainty with respect to the timing of both public and private infrastructure investment given the currently challenging operating environment. This uncertainty justifies a Neutral rating in the broker's view, even allowing for the apparent value on offer in Downer at current share price levels.

Goldman Sachs sides with UBS, rating Downer as Neutral on relative valuation grounds. Morgan Stanley is more bullish, seeing scope for Downer to re-rate materially higher as its current earnings multiple closes the gap relative to peers in the market. Morgan Stanley has an Overweight rating on Downer within an Attractive industry view.

 
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- Bradken full year result meets guidance
- Brokers viewed the result favourably, lower gearing well received
- A lack of specific guidance limits changes to earnings estimates
- Buy ratings continue to dominate for the stock

By Chris Shaw

Bradken ((BKN)) had guided to full year earnings in a range of $95-$102 million and yesterday delivered on this guidance with a full year net profit of $100.6 million. Earnings from the Rail and Engineered Products divisions were better than expected, while interest charges were also lower.

A highlight of the result was an improvement in operating cash flows, as Goldman Sachs notes when combined with lower total capex spend this allowed gearing as measured by net debt to EBITDA (earnings before interest, tax, depreciation and amortisation) to fall to 2.0 times against a forecast of 2.5 times.

The fall in gearing was well received by the market, RBS Australia noting this has allayed concerns Bradken may have needed to undertake a capital raising at some point.

For JP Morgan, the improvement in earnings for the Rail division shows management is making good progress in moving past problem contracts. At the same time, Bradken continues to leverage strong demand, which is being driven by higher mine production. 

One offset in the view of BA Merrill Lynch is the weak macro environment, as this has the potential to weigh on demand in the Industrial and Rail divisions in particular. This resulted in management at Bradken offering conservative outlook commentary for the coming year, while avoiding any specific earnings guidance. 

This lack of specific guidance has meant changes to broker earnings forecasts for Bradken have been relatively modest. With Bradken announcing the deferral of some new capex spending, Deutsche Bank has trimmed its EBITDA forecasts by 4% in FY13 and by 7% in FY14. This has been offset by lower depreciation and amortisation and interest expense assumptions, meaning little change to net profit after tax forecasts.

Moelis has been more positive and lifted earnings per share (EPS) forecasts by 5% through FY15, reflecting in part expectations of a solid uplift in margins in the Rail division. Goldman Sachs has gone the other way and trimmed EPS estimates by 4-9% through FY15, driven by cuts to expectations for the Rail and Mining divisions.

Consensus EPS forecasts for Bradken according to the FNArena database now stand at 73.2c for FY13 and 83.4c for FY14. Moelis and Goldman Sachs are not in the database, the former forecasting EPS for Bradken of 76.1c and 82c respectively and the latter 75.5c and 91c. Forecasts compare to EPS of around 60c achieved in FY12.

Changes to earnings forecasts generated changes in price targets, as the consensus price target for Bradken in the FNArena database now stands at $7.70, down from $7.96 previously. Targets range from Macquarie at $6.21 to JP Morgan at $8.62. Moelis has a target of $6.50, while Goldman Sachs's target is $6.30.

Aside from Macquarie, who has stuck with a Neutral rating, the other six brokers to cover Bradken in the FNArena database rate the stock a Buy. For JP Morgan this reflects a positive earnings outlook due to commodity demand remaining strong and Bradken's attractive exposure to this via a global manufacturing platform and good range of product lines. 

As well, JP Morgan suggests the strong balance sheet of Bradken will allow management to pursue growth opportunities. BA-ML also sees upside, pointing out Bradken is now near the end of a significant investment program. This suggests returns should improve as higher margin mining products and new capacity comes on line. 

Valuation is also supportive in BA-ML's view as with the stock trading on a FY13 earnings multiple of around 7.9 times at present, concerns such as the weak macro outlook and execution of future growth plans are already being discounted by the market. 

Moelis agrees, suggesting a FY13 earnings multiple of less than eight times, which implies a discount of more than 35% to the ASX Small Industrials, is undemanding. 

Investors in Bradken stand to benefit not only from a solid earnings growth outlook based on consensus EPS forecasts, but also an attractive dividend yield. Consensus dividend forecasts show an expected increase in payout from 41c in FY12 to 45c in FY13 and 51c in FY14, which suggests yields of 7.9% and 8.9% respectively. Dividends are expected to be fully franked.

Shares in Bradken today are higher in a stronger overall market and as at 1.25pm the stock was 10.5c higher at $5.845. This compares to a range over the past year of $4.62 to $8.68, the current share price implying upside of more than 32% relative to the consensus price target in the FNArena database.

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 - Outlook commentary a key for upcoming engineering and contracting sector results
 - Guidance expected to be conservative 
 - Stocks with good earnings visibility favoured to outperform
 - Brokers update sector picks

By Chris Shaw

Leading into full year profit results this month for the Australian construction and engineering sector, Morgan Stanley expects results will be broadly in line with forecasts as company specific risks have already been priced into stocks.

This suggests the market's attention will turn to the outlook for FY13, where Morgan Stanley expects strong growth and as a result share price upside. Deutsche Bank is a little more cautious, taking the view guidance statements accompanying full year results are likely to be conservative given an unsure demand environment. This is likely to be most obvious in company order books, where Deutsche expects mixed growth across the sector.

Goldman Sachs agrees outlook commentary is likely to be somewhat hazy, while most companies are regarded as unlikely to offer specific earnings guidance for FY13. This leads Goldman Sachs to suggest those stocks in the sector most likely to outperform post the upcoming reporting season are those offering reasonable earnings visibility over the short and medium-terms.

Specific attributes viewed positively by Goldman Sachs include exposure to maintenance services and production volumes, exposure to hydrocarbons and exposure both across the project life cycle and to the early stages of a project. 

At the other end of the spectrum Goldman Sachs would look to avoid exposure to development capex (capital expenditure), exposure to only part of the project life cycle and exposure to large, fixed price contracts. 

For Morgan Stanley, six themes that could emerge in the broker's view are increased confidence from later cycle names, a new strategic focus on operating expenditure, increasing difficulty with respect to cash generation, labour becoming a reducing constraint, some structural challenges at the margin and an increased focus on offshore growth.

In general, Morgan Stanley suggests those contractors exposed to later stages of engineering construction activity will offer a more positive earnings outlook than will early stage peers. As management look to diversify earnings before any capex slowdown hits, an increased focus on opex (operating expenditure) is likely.

Customers are increasingly likely to hold back on cash payments in the view of Morgan Stanley, which leaves scope for some disappointment at the margin for some plays in the sector. At the same time labour availability is likely to remain a key concern over the shorter-term, though Morgan Stanley sees room for labour issues to moderate as soon as 2013.

Factoring in expectations for market conditions, Goldman Sachs suggests the best mix of attributes among Australian engineering and contracting plays are offered by UGL ((UGL)), WorleyParsons ((WOR)) and Sedgman ((SDM)). In contrast, the worst mix of attributes are offered by Leighton Holdings ((LEI)), Monadelphous ((MND)) and Downer EDI ((DOW)).

Deutsche Bank offers some opposing views, viewing the highest potential for a positive earnings surprise in the upcoming earnings period comes from Monadelphous and UGL, while WorleyParsons offers the greatest potential for a negative earnings surprise given evidence of some customers delaying projects.

This fits with recent comments by Citi, whose analysts note there is increased potential for iron ore capex in Australia to be delayed thanks to the combination of higher costs and falling iron ore prices. If projects such as BHP Billiton's ((BHP)) Outer Harbour were to be delayed, Citi expects engineering and construction companies would likely increase their focus on LNG opportunities. 

Within the sector, Citi points out Monadelphous and Leighton have the best track records with respect to LNG work, while the likes of UGL and Downer EDI would be expected to win some work in the sector.

Leading into results season, Morgan Stanley has made some minor stock-specific cuts to earnings forecasts for Leighton, Transfield ((TSE)) and WorleyParsons, while lifting forecasts for Downer EDI and Monadelphous. 

Expected reporting dates for stocks in the sector announcing earnings this month are Leighton Holdings and Bradken on August 7, UGL and Downer EDI on August 13, Matrix on August 17, Imdex on August 20, Emeco and Monadelphous on August 21, WDS on August 22, Sedgman and Ausenco on August 23, Seven Group on August 28, Transfield and WorleyParsons on August 29 and Boart Longyear on August 30. 

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 - Silex Systems offers a range of technologies
 - Most valuable is uranium enrichment technology
 - Solar power technology continues to progress
 - Bell Potter initiates coverage with a Buy rating

By Chris Shaw

Silex Systems ((SLX)) is a technology company with three main development streams – uranium enrichment, lower cost solar power and advanced materials development. This puts the company firmly in the 'clean tech' segment of the market, which offers benefits from the ongoing trend towards policy initiatives designed to create a greener economy.

Bell Potter has initiated coverage on Silex with a Buy rating, attracted by the fact commercial revenues are getting closer and prospects for the nuclear power industry appear to be improving post Fukushima-related issues.

The uranium market is an important one for Silex given its SILEX Technology, which is a low-cost technique for enriching uranium, accounts for most of Bell Potter's valuation of the business. Favourable safety and environmental impact reports lead Bell Potter to suggest US Nuclear Regulatory Commission approval for a full scale uranium enrichment plant is likely this month.

This would mean the GLE consortium of General Electric, Hitachi and Cameco could begin commercial production of enriched uranium in FY16. Bell Potter estimates enriched uranium is currently a US$6 billion market, growing to US$22 billion by around 2022. 

What sets Silex up well to play a major role in the enrichment market is the SILEX technology, which represents a new generation enrichment technique. The process involved the use of CO2 lasers to irradiate material in a process Bell Potter suggests could be as much as 20 times more efficient than current technologies.

The GE-led consortium is commercialising the SILEX Technology, with Silex Systems to receive royalties. Bell Potter's base case assumptions assume an 85% chance of success for GE's project and a 7% royalty for Silex, while optimistic case assumptions assume a 100% chance of success and a 12% royalty to the company.

Silex also operates in the solar power sector thanks to its Concentrating Photovoltaic (CPV) technology, which is based on producing electricity via semiconductors that create electric current through exposure to solar radiation. 

Bell Potter notes Silex's CS500 CPV cells offer among the highest conversion efficiency rates available in the world. The technology continues to be optimised, leaving Bell Potter confident Silex can eventually generate solar power at costs competitive with more traditional forms of electricity generation.

A pilot facility in Mildura is being used to develop the technology and assuming progress continues to be made, Bell Potter expects Silex will look to build capacity of 100MW at the site in coming years. Shareholder value would be created though the establishment of utility-scale solar power generation facilities.

Silex's third technology is centred on Translucent Inc, puts layers of material such as germanium and gallium on silicon chips. The translucent chips created have applications in both the LED and power electronic sectors.

Under Bell Potter's base case assumptions Silex is valued at $4.96, rising to $10.26 using more optimistic assumptions. The broker has set its price target around the mid point of these valuations at $7.50.

The main driver of a re-rating to this target price in Bell Potter's will be the uranium enrichment technology, especially given the potential for an re-rating on any announcement this month on approval for a full scale enrichment plant. 

Others in the market agree, as both RBS Australia and JP Morgan rate Silex Systems as a Buy. While JP Morgan has not updated its view on the stock since Silex posted interim earnings in February, RBS last month reiterated its view the stock offers upside from good news on the enrichment plant. RBS has a price target on Silex of $6.63.

In a slightly stronger market shares in Silex today are higher, trading up 13c at $3.92 as at 1.00pm. Over the past year Silex has traded in a range of $1.80 to $4.52.

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 - Slowing in junior mining exploration impacting on Campbell Brothers
 - Management offers cautious guidance for FY13
 - Earnings forecasts and price targets mostly revised lower
 - RBS suggests earnings guidance commentary is conservative

By Chris Shaw

At yesterday's annual general meeting for mineral testing service Campbell Brothers ((CPB)), management offered cautious outlook commentary reflecting the likely impact on the core ALS Minerals division from lower exploration activity among junior mining companies in particular.

As Deutsche Bank notes, junior miners at present account for around 50% of global exploration spend. The fact these companies are finding it difficult to raise capital for exploration activity is likely to see sample volumes and prices decline from what are currently peak levels. 

This implies an earnings impact for Campbell Brothers, one JP Morgan suggests will come earlier than had previously been expected. The updated guidance from management for 1H13 net profit after tax of $130-$140 million supports this view, as JP Morgan's full year forecast for net profit of $261.8 million implies a flat second half. This compares to a forecast for interim net profit growth of around 30% relative to the previous corresponding period.

Factoring the updated outlook commentary into broker models sees reductions to earnings forecasts for Campbell Brothers. Changes to estimates in FY13 have been relatively modest, while cuts to FY14 numbers have been far more significant, with reductions of as much as 30% relative to previous numbers.

Consensus earnings per share (EPS) forecasts for Campbell Brothers according to the FNArena database now stand at 381c for FY13 and 372c for FY14. The revised forecasts have impacted on price targets, with the consensus target in the database falling to $52.53 from more than $60.00 previously.

Targets range from Deutsche Bank at $46.16 to RBS Australia at $69.76. RBS's target reflects the fact the broker has not adjusted earnings forecasts on the back of the updated guidance from management. In RBS's view the market has overreacted to the earnings commentary offered by Campbell Brothers, as it ignores the increased diversity of operations that now include markets such as Energy and Food/Pharmaceutical testing. 

According to RBS, the outlook for a flattening in second half earnings applies specifically to Mineral Geochemical testing, which accounts for less than half of estimates earnings and has already been allowed for in the broker's model.

The implication is Campbell Brothers is being purposefully conservative with respect to outlook commentary. Adding weight to this view is the intention of management to invest a further $80 million in capital expenditure in FY13, which RBS suggests is a sign volumes are not expected to contract over the mid to longer-term.

This leads RBS Australia to suggest Campbell Brothers should still be able to growth revenue and earnings by around 20% in FY13, followed by further growth of around 10% in FY14. Earnings forecasts as a result are above consensus, RBS forecasting EPS of 393.3c in FY13 and 447.4c in FY14.

JP Morgan is less confident, suggesting along with the expected tougher conditions for the ALS Minerals division the outlook for the Life Sciences operations is also mixed. Negative sentiment towards mineral exploration-exposed stocks is likely to continue until global macroeconomic conditions stabilise, which in JP Morgan's view limits the potential for share price outperformance for Campbell Brothers.

This justifies an Underweight rating according to JP Morgan, while the FNArena database shows Campbell Brothers is rated as Buy once, Sell once and Hold five times. Morgan Stanley is not in the FNArena database but sides with RBS and rates Campbell Brothers as Overweight within an In-Line industry view.

For Morgan Stanley there is reason to remain positive, as Campbell Brothers continues to reshape its business towards less cyclical exposures, which is seen as cushioning any earnings decline to some degree. Credit Suisse points out that CPB has been enjoying a PE premium to the Australian mining services sector but that will likely now be challenged.

Morgan Stanley points out the latest update from management suggests a slowdown in earnings growth rather than a downturn in earnings for the minerals testing business. Given this, Morgan Stanley continues to forecast earnings growth in coming years with EPS forecasts of 406c in FY13 and 439c in FY14.

For Deutsche Bank, a Hold rating for Campbell Brothers is justified as while the stock is trading below global testing peers such a discount is justified given greater exposure to the cyclical minerals market and the risk of a pullback in minerals exploration spending.

Valuation also justifies a Hold rating for Deutsche as the broker's earnings forecasts imply a total shareholder return of 3.4% for the coming year. BA Merrill Lynch agrees a neutral view on Campbell Brothers is appropriate, as until earnings re-base it is hard to adopt a more positive stance on the stock despite valuation support at current levels.

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 - Goldman Sachs initiates with Neutral rating on Cardno
 - Shift to greater environmental sector exposure a positive
 - Organic earnings growth slowing, acquisitions provide an offset
 - Valuation an issue following recent share price gains

By Chris Shaw

Cardno ((CDD)) is a global engineering and environmental consulting group, with exposure to most aspects of non-residential construction spending and a growing presence in the international environmental sector thanks to a series of acquisitions in recent years.

Goldman Sachs has initiated coverage on Cardno with a Neutral rating, reflecting the view a capitalised average growth rate for earnings per share (EPS) of 7% through FY14 is not enough to justify a more positive rating given strong share price performance of late.

The earnings growth expected should come from a combination of organic growth and growth through acquisitions. Goldman Sachs is forecasting organic growth of around 3% annually, as the stronger growth of previous years reflected stimulus spending and the impact of this is now fading. As an offset, management has demonstrated an appetite for buying growth given $674 million of acquisitions over the past eight years.

This focus on acquisitions should continue and offers some upside risk to earnings in coming years. On the numbers of Goldman Sachs, $100 million in acquisitions should add around 6-7% to group EPS. The broker estimates for FY13 the balance sheet for Cardno could accommodate $60 million in acquisitions based on a long-term gearing target of 40%.

The acquisitions of recent years have allowed Cardno to shift to a more defensive earnings profile, as exposure to structural growth in the environmental sector has risen. As noted by Goldman Sachs, sales from environmental operations have risen to 41% of Cardno's total sales from less than 10% since FY10, while sales from the Americas have also increased from 30% to 55% over the same period.

As well, Goldman Sachs points out more than 70% of Cardno's work comes from repeat clients, while the fact the group's largest contract is less than 5% of total sales indicates no reliance on one large customer.

In terms of earnings forecasts, Goldman Sachs anticipates EPS for Cardno of 62.5c this year, rising to 65c in FY13. This compares to consensus forecasts according to the FNArena database of 60.7c and 65.5c respectively.

The issue for Goldman Sachs is valuation, as at current levels Cardno is trading on an earnings multiple above that of global peers and at an 11% premium to average multiple for the ASX Small Industrials index. This is elevated compared to historical levels, as Goldman Sachs notes Cardno's five-year average earnings multiple to the Small Industrials is a discount of 16%.

While the current multiple is partly justified by the fact Cardno now offers a more defensive earnings stream, the premium remains excessive in the view of Goldman Sachs. RBS Australia agrees, having this week downgraded Cardno to Hold from Buy.

The change in rating comes on the back of changes to earnings estimates post two more US acquisitions by Cardno and is also a reflection of strong recent share price performance. This has pushed the stock to a level where a Buy rating is no longer justified in the view of RBS.

Not everyone agrees, as the FNArena database shows Cardno is rated as Buy twice and Hold twice. Macquarie and UBS have retained Buy ratings post Cardno's recent US purchases, both seeing scope for further share price upside despite the gains of recent months.

Comparing the consensus price target for Cardno according to the FNArena database of $7.72 to the current share price supports the view valuation upside is somewhat limited at present as the share price is trading around 4.5% above the consensus price target. The consensus target is somewhat distorted though by Credit Suisse's target of $6.07, which has not been updated since January of this year according to information available to FNArena.

Shares in Cardno today are down slightly in a weaker market and as at 11.30am the stock was 1c lower at $8.09. Over the past year the stock has traded in a range of 44.27 to $8.19.

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