- Analysts visit Crane Group assets of Fletcher Building
- Integration going to plan but macro conditions have weakened
- Potential for expected target timetable to slip
 

By Chris Shaw

Having recently acquired Crane Group, Fletcher Building ((FBU)) has held a site tour for broking analysts that has offered some additional insights into how the new assets are fitting into the group.

In the view of BA Merrill Lynch the integration of Crane Group has to date gone smoothly. This implies synergy benefits are being realised, Citi noting total annual realised synergies across the Corporate and Group Procurement operations are estimated at $16.6 million. Citi sees potential for further benefits to be achieved.

At the time of the acquisition management at Fletcher Building had set a target of 15% return on funds employed from the Crane Group assets, to be achieved by FY16. The site visit saw this target reiterated, as Deutsche Bank notes management are positive on the upside potential of the new businesses.

Increased earnings from the Pipelines and Tradelink businesses are expected to drive the achievement of this target, though Citi sees scope for some slippage in timing terms given macro conditions have worsened since the Crane Group assets were acquired.

As an example, Citi points out margin recovery in the Trade Distribution business is largely volume dependent. This is driven to a significant extent by residential and commercial construction levels, where the shorter-term outlook remains less than favourable. This will be offset to some extent by new supply contracts won in the Queensland Coal Seam Gas market.

According to BA-ML, the significant macro headwinds currently in place suggest Fletcher Building is unlikely to generate cost of capital returns from the Crane Group assets for at least the next four years. On BA-ML's numbers the assets need generate EBIT (earnings before interest and tax) of $129 million to meet the cost of capital, which compares to the $71 million achieved in FY11.

Allowing for the tough market conditions, BA-ML remains of the view Fletcher Building shares offer reasonable value at current levels given an earnings multiple of 13 times for FY12 and a solid balance sheet. 

What drives the Neutral rating of BA-ML is a belief any recovery in building activity in Australia and New Zealand is unlikely before FY13. As well, the fact the New Zealand assets appear to have reached a terminal market position suggests it will be the Australian market where any organic growth occurs.

Deutsche agrees with BA-ML and rates Fletcher Building as a Hold on valuation grounds. Citi is more positive and retains a Buy rating on Fletcher Building, a share price target of NZ$9.35 implying an expected share price return of almost 24% relative to current trading levels. 

Overall the FNArena database shows brokers are evenly split on Fletcher Building, with four Buy ratings and four Hold recommendations. The consensus price target according to the database is $6.80, unchanged from prior to the update.

Shares in Fletcher Building today are weaker and as at 1.00pm the stock was down 7c at $5.95. Over the past year Fletcher Building has traded in a range of $5.62 to $7.11. The current share price implies upside of around 14% to the consensus price target in the FNArena database.

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- Campbell Brothers (again) lifts interim earnings guidance
- Upgrade reflects continued strength in minerals testing volumes
- Brokers lift earnings forecasts
- UBS and Macquarie see value at current levels

By Chris Shaw

Having previously guided to 1H12 net profit of $90-$95 million, management at Campbell Brothers ((CPB)) has now lifted guidance to an expected result of $100 million. The upgrade reflects stronger than anticipated trading for the five months to the end of August.

While all divisions are understood to have been performing better, Macquarie suggests much of the upgrade in guidance reflects strength in minerals testing volumes. Commentary at the AGM of Campbell Brothers indicated global mineral sample volumes were tracking more than 30% higher in the first quarter of FY12 compared with the same period of FY11 and Macquarie's view is volumes have risen even higher through 2Q12.

As well, Macquarie takes the view environmental volumes were strong in 1Q12 and this is also likely to have continued through the half year. This positive trend should remain the case through to December, before a traditional season slowdown through the first quarter of next year.

The other boost to earnings comes from currency moves, as UBS notes a weaker Australian dollar relative to the US dollar is acting as a positive earnings tailwind. Each 1c move in the currency equates to a 1% move in earnings per share (EPS) on UBS's numbers.

To reflect the update to guidance, both Macquarie and UBS have lifted EPS forecasts for Campbell Brothers. The increase for Macquarie is just 1% in FY12, while UBS has been slightly more aggressive in lifting its forecasts by 3% this year and by 2% in FY13. Consensus EPS forecasts for Campbell Brothers according to the FNArena database now stand at 279.5c for FY12 and 322.6c for FY13; these numbers might rise further as other stockbrokers go through a similar exercise of updating their estimates post management's revised guidance.

Earnings risk remains to the upside in the view of UBS, as if current growth rates are maintained through 2H12 this would mean a further 3% increase in full year forecasts for FY12. Margin improvement could also offer a boost to earnings, as UBS estimates a 100-basis point change in EBIT (earnings Before Interest and Tax) margins for the minerals business implies a 2% change in EPS.

The major risk to earnings is a sustained downturn that results in lower activity in minerals testing, but UBS notes Campbell Brothers is offsetting this risk by increasingly diversifying operations. As an example, the Ammtec and Stewart Testing acquisitions in recent months have added metallurgical testing and inspection services to the product offering.

This suggests earnings will be more resilient going forward, while UBS is also positive on the geographical expansion Campbell Brothers has undertaken by moving into new markets such as Latin America. Services in the South African and Canadian markets have also been expanded.

Macquarie's forecasts currently assume Campbell Bothers will grow revenues in the ALS minerals testing business by 20% in FY13, this reflecting organic growth only. If revenues were to be impacted by the current downturn and fall by 20%, meaning a 40% decline from current expectations, Macquarie estimates a fall of around 16% in EBIT for the ALS operations. This is an improvement from the 25% EBIT declines experienced during the GFC.

Having factored in the changes to earnings estimates, Macquarie sees the current valuation for Campbell Brothers as being supported by the earnings outlook. The yield is also relatively attractive, as on Macquarie's estimates Campbell Brothers will yield 4.7% in FY12 and 5.3% in FY13, franked to 50%.

This is enough for Macquarie to retain an Outperform rating, through the price target has been trimmed to $50.12 from $50.58. UBS also rates Campbell Brothers as a Buy, with an unchanged target of $52.00. The FNArena database shows three Buy ratings and three Holds for Campbell Brothers, with a consensus price target of $49.28.

Shares in Campbell Brothers today are higher and as at 11.30am the stock was up 74c at $41.50. This compares to a trading range over the past year of $32.50 to $57.00. The current share price implies upside to the consensus price target according to the FNArena database of around 16%.

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- Tox Free wins contract at APLNG project
- More contract wins expected in the region
- Earnings outlook strengthening but share price not reacting
- Brokers see value at current levels

By Chris Shaw

For some time both UBS and RBS Australia have had Buy ratings on waste management services group Tox Free Solutions ((TOX)) and news of a new contract signed by the company yesterday further supports their respective positive views.

Tox Free has announced a five-year contract for the provision of waste management services relating to construction activities at the Australia Pacific LNG plant on Curtis Island in Queensland. The contract begins immediately and UBS estimates revenues from the contract should total $20-$25 million.

The deal will underpin earnings expectations for Tox Free for FY12 according to RBS Australia, though forecasts are unchanged on the news as such contract wins have already been built into the broker's expectations.

The deal is strategically significant in RBS's view. This is because it positions Tox Free well for further contract wins in and around the Gladstone area as more LNG and resource projects in the region come on-line.

Potential contract wins won't be restricted to this area, RBS noting there are still around $75 million in contract tenders to be awarded around Australia. As well, Tox Free's recent acquisition in the Northern Territory strengthens the company's position relative to winning additional work from the Browse and Prelude developments.

A further plus for Tox Free according to RBS is management continues to focus on winning work in the mining and oil and gas sectors, where margins are stronger. This strength in margins should continue as management refuses to enter the more competitive metro municipal waste markets.

While RBS has made no changes to earnings estimates on news of the contract, UBS has lifted its numbers slightly through FY14. In earnings per share (EPS) terms UBS is now forecasting 18c for FY12 and 20c for FY13, while RRB expects outcomes of 18.3c and 18.9c respectively.

Price targets are unchanged at $2.65 for UBS and $2.44 for RBS. JP Morgan also covers Tox Free and rates the stock as Neutral with a target of $2.35.

What makes Tox Free a Buy for UBS is while so far this calendar year the share price is essentially unchanged, during the same period earnings per share estimates for FY12 have increased by around 16%.

Expectations of compounded EPS growth of 14% for FY11-FY14 suggests value, as UBS's numbers imply an earnings multiple for FY12 of 11.5 times and for FY13 of 10.5 times.

RBS agrees there is value in Tox Free at current levels, as its numbers suggest the stock is trading at a 14% discount to valuation at current levels. RBS argues a premium is justified, as Tox Free enjoys an oligopolistic position in some markets, has a solid balance sheet and delivers above average margins.

Further contract wins and the potential for acquisitions to boost earnings are other reasons why Tox Free could be re-rated which helps underpin RBS's Buy rating.

Shares in Tox Free today are slightly weaker and as at 10.35am the stock was down 2c at $2.13. This compares to a trading range over the past year of $1.70 to $2.52. The current share price implies upside of around 16% to the consensus price target according to the FNArena database of $2.48.

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- Fleetwood wins new contract with BHP Billiton
- Deal should deliver solid boost to revenues
- Additional contract wins offer upside earnings risk
- Yield also attractive, supports value in the stock

By Chris Shaw

Fleetwood ((FWD)) this week announced the signing of a five-year contract with BHP Billiton ((BHP)) for the manufacture of up to 240 ancillary building floors per year. The floors will include ablutions facilities, security offices, crib rooms and administration units. 

The deal is a clear positive for Fleetwood, as while Credit Suisse suggests there is broad variability in the potential value of the contract it is likely to be more than the $25 million value of a similar contract with Rio Tinto ((RIO)) in FY09.

RBS Australia agrees, estimating the contract could add between $30-$60 million to annual revenues for Fleetwood. This has seen RBS push up its earnings per share (EPS) estimates, numbers for FY12 being increased by 8% and for FY13 by 10%. 

Credit Suisse has similarly lifted forecasts but by a lesser amount, increasing its estimates by 1-2% through FY13. DJ Carmichael has split the difference and increased EPS forecasts by 3.2% and 4.2% respectively for FY12 and FY13.

This leaves DJ Carmichael forecasting EPS for Fleetwood of 90.2c this year and 103.9c in FY13. This compares to consensus EPS forecasts according to the FNArena database of 93.2c for FY12 and 98.9c for FY13 (note not all brokers have updated their model post the announcement).

Given EPS for FY11 was about 89c, earnings growth for Fleetwood for FY12 appears relatively modest. But in Credit Suisse's view risk to forecasts are to the upside at present, this thanks to a strong pipeline of contract opportunities. 

As management indicated when releasing FY11 results last month, the contract tender environment for portable accommodation remains robust. As well, DJ Carmichael suggests any increase in utilisation at the Searipple accommodation village would also offer some upside risk for earnings.

Management has guided to a solid 1H12 result from Searipple and RBS notes occupancy levels are at present tracking in line with this guidance. While a softening is expected in the second half of FY12, there should be a pick up in FY13 as a number of major projects start to come on-line.

On the recreational vehicle side of the business, RBS has been in touch with management and the indication is so far in FY12 production volumes have not increased at the rate expected by the market. RBS had modeled conservative numbers in expectation of such an outcome and so remains comfortable with its forecasts, which stand at the upper end of market estimates.

Changes to earnings estimates have seen some increases in price targets, RBS lifting its target to $13.56 from $13.16 and Credit Suisse by 14c to $11.54. The consensus price target in the database now stands at $12.60, up from $12.52. DJ Carmichael is not in the database but has lifted its target by 20c to $11.70.

Ratings are unchanged, with the database showing Fleetwood is rated as Buy three times and Hold twice. DJ Carmichael rates Fleetwood as Accumulate (one notch below Buy).

What makes Fleetwood more attractive in the face of somewhat subdued earnings growth expectations in FY12 is an attractive dividend yield. DJ Carmichael's forecasts imply a fully franked yield of 7.1% for FY12 and better than 8% for FY13, while RBS's estimates suggest respective yields of 7.85% and 8.49%. 

The yield looks supportable in the view of Credit Suisse given Fleetwood has no debt and enjoys solid cash conversion from its operations. As well as the attractive yield, Fleetwood appears to offer value longer-term given forecast earnings multiples according to RBS of 10.9 times in FY12 and 10 times in FY13. 

 
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- McMillan Shakespeare a market leader in salary packing
- Company has strong earnings growth history
- Further solid growth forecast in coming years
- Goldman Sachs initiates with a Buy rating

By Chris Shaw

McMillan Shakespeare ((MMS)) operates in the salary packaging and vehicle leasing markets, generating 70% of earnings from salary packaging and 30% from leasing operations. Goldman Sachs notes McMillan Shakespeare is comfortably the Australian market leader in salary packaging, enjoying 50% market share. This is around double that of the nearest competitor.

Since 2005, McMillan Shakespeare has enjoyed strong earnings growth, Goldman Sachs noting over the last six years earnings per share (EPS) have grown at a compound rate of 41%. Solid growth is expected to continue, Goldman Sachs estimating compound earnings per share growth of 13% over the next three years.

This growth should be driven in part by expansion in the health and charities sector, where growth has been double that of general employment over the past decade. Cross-selling of novated leases to the operating lease customer base should also provide a boost to earnings.

A further attraction in the view of Goldman Sachs is a high and rising return on equity (ROE). ROE in the Remuneration Services division has consistently been around the 40% mark, a level seen as sustainable given ongoing fixed cost leverage.

While ROE in the Asset Management business is currently around 16%, Goldman Sachs expects this will increase as cross-selling of novated leases to the asset base picks up. A debt funded fleet expansion is also expected to help in this regard. 

Shareholders could also benefit from what Goldman Sachs suggests is an undergeared balance sheet. Debt as a portion of debt plus equity stands at around 50%, well below peer levels of around 80%, so offering scope for management to consider additional growth options going forward.

While any change in regulatory regime with respect to salary packing is a risk for McMillan Shakespeare, Goldman Sachs sees any such changes as unlikely. This is due to both powerful vested interests such as the health sector and charities and the fact it would be very difficult to replace current entitlements with a direct grant system.

Given the potential for continued earnings growth, Goldman Sachs is forecasting earnings per share (EPS) of 71.8c this year and 82.2c in FY13. This compares to consensus EPS forecasts according to the FNArena database of 72.6c and 81.6c respectively.

On Goldman Sachs's numbers, McMillan Shakespeare is trading on a FY12 earnings multiple of 12 times, which is around 10% below its historical average. This appears cheap given the solid earnings growth outlook.

To reflect the value on offer, Goldman Sachs has initiated coverage with a Buy rating.

Others covering McMillan Shakespeare agree, as the FNArena database shows all three brokers to cover the stock rate it as a Buy. For Credit Suisse the attraction is a strong growth platform already in place, while both Citi and BA Merrill Lynch see the perceived impact of the current tax debate as overdone. 

This suggests McMillan Shakespeare is good buying at current levels. Also attractive for investors is the yield on offer, which is 5.3% in FY12 and 5.7% in FY13 based on the earnings estimates of Goldman Sachs. Dividends are currently fully franked.

The consensus price target for McMillan Shakespeare according to the FNArena database is $11.19, broadly in line with the $11.08 target of Goldman Sachs. 

Shares in McMillan Shakespeare today are slightly weaker, trading down 7c at $8.49 as at 1.35pm. This compares to a trading range over the past 12 months of $6.37 to $10.60. The current share price implies upside of better than 30% to the consensus price target according to the FNArena database.

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- Engineering and Contractor sector results met expectations
- Weak macro outlook a threat to earnings
- Higher costs and margin pressures also an issue
- Brokers highlight their sector preferences

By Chris Shaw

For Australian engineering and contracting companies the recent FY11 reporting season was largely a case of delivering results in line with expectations rather than beating market estimates. Earnings per share growth in average came in at 15.7% according to UBS, while balance sheets improved as debt levels declined.

Highlights in the period were sales growth and some margin expansion, BA Merrill Lynch noting this was particularly the case for early cycle plays, these companies benefiting from higher capacity utilisation.

The major issue to emerge from reporting season according to BA-ML is a worsening macroeconomic environment threatens to derail what are currently optimistic earnings growth forecasts. This suggests some economic stability and a re-acceleration of global growth will be the major sector driver from here, as at present it is difficult to justify being more optimistic regarding forecasts.

For BA-ML this uncertainty means late cycle plays offer the greatest opportunity to outperform as new contracts should deliver some increase in margins. In contrast, early cycle companies will be more heavily reliant on capex to deliver incremental earnings growth.

At the same time, Deutsche Bank notes increasing levels of competition are generating some margin pressures on new contracts. This is especially the case in relation to electrical and mechanical work in the resources sector and infrastructure maintenance work.

A key risk in Deutsche's view is labour costs, as companies that need to increase their headcount in Australia in particular may experience additional margin pressure given the ongoing wage rises in recent years.

The other issue for Deutsche Bank is the prospect of a further deterioration in operating cashflows across the sector in FY11, thanks to both problematic contracts and weak market conditions. Deutsche sees scope for this trend to extend through FY12.

UBS is more positive, suggesting the outlook for the mining services industry in general could be strengthening given a solid level of contract announcements recently, contractors being locked in for significant periods of time and ongoing tendering activity on projects yet to reach a final investment decision.

For UBS, investors should focus on quality, growth and valuation when considering investing in the mining services sector. Building a matrix including these variables leads to NRW Holdings ((NRW)), Monadelphous ((MND)) and Fleetwood ((FWD)) generating the highest scores according to UBS. All three stocks score Buy ratings. 

Elsewhere in the sector, UBS also has Buy ratings on Ausenco ((AAX)), Boom Logistics ((BOL)), Bradken ((BKN)), Emeco Holdings ((EHL)), Industrea ((IDL)), Macmahon ((MAH)) and Mermaid Marine ((MRM)).

In contrast, BA-ML's suggestion late cycle plays are now better placed means the broker's top picks in the sector are Bradken, Sedgeman ((SDM)) and Mastermyne ((MYE)). Bradken offers leverage to both capex and increasing production volumes, Sedgeman has a growing presence in offshore markets and Mastermyne has continued to win new contracts that are boosting earnings.

Deutsche adjusted some ratings during reporting season, upgrading Boart Longyear ((BLY)) to a Buy while downgrading Transfield Services ((TSE)) to a Hold rating. 

The upgrade for Boart Longyear reflects strong demand for its drilling services products and increasing productivity levels from new drill rigs, while the downgrade for Transfield was the result of the company's need for more capex to obtain previous growth projections.

Boart Longyear becomes the top sector pick for Deutsche Bank, while Buy ratings are also ascribed to WorleyParsons ((WOR)) and Leighton Holdings ((LEI)). The former is favoured for exposure to recovering oil and gas markets and the potential for a positive earnings surprise from further margin recovery, while Leighton is a Buy on valuation grounds as the current 15% discount to the market is unwarranted in Deutsche's view.

Further down the pecking order, Deutsche has Hold ratings on UGL ((UGL)), Downer EDI ((DOW)) as well as for Transfield. For UGL the stable earnings stream is attractive but this is priced in at current levels according to Deutsche, while a subdued outlook for Downer EDI's markets is likely to limit potential for outperformance. There is also ongoing risk relating to the execution and funding of the Waratah trains project.

 
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