Australia | Feb 13 2009
By Greg Peel
Four weeks ago Leighton Holdings ((LEI)) announced a profit warning on its interim result. The market was suddenly forced to realise that Australia’s leading construction contractor was not quite as bullet-proof as first thought, given profit was set to fall over 50% to $100m. The stock took a bath.
Yesterday, Leighton announced that result as $111m, surprising most analysts who had reasonably assumed that guidance updates only one month out should be pretty close to the mark. Some analysts had already assumed a better result, but still had to make at least some upward adjustment. So why the sudden change?
Leighton’s share price jumped about 9% on the news yesterday, before settling back to be up about half that on the day. Did the profit takers move in? Or did closer scrutiny of the underlying numbers tell a slightly different story?
Let’s consider first that prior to the announcement the FNArena B/H/S ratio was showing 1/5/3, indicating there was already some disagreement among analysts as to Leighton’s value. Post the result, that ratio is now 2/2/4 following one upgrade to Buy from Hold and one downgrade to Sell from Hold. The issue is only clouded further.
Deutsche Bank was the most enthusiastic this morning, possibly because the analysts had appeared to have the lowest profit expectation going in. While it is appreciated that the loss of the joint venture in the United Arab Emirates was a blow, Deutsche was pleasantly surprised by local revenues. “Resources continues to surprise on the upside,” said the analysts, ” as LEI operates low-cost mines for blue chip clientele”. While Deutsche anticipates the numbers in both the Middle East and Australia will slow ahead, the analysts still believe there is room for more upside surprise. Hence an upgrade to Buy.
ABN Amro is the other Buy rating, and this morning the analysts joined their counterparts at Deutsche by declaring the local result to be an encouraging one, offering further upside as government stimulus drives infrastructure spending. ABN notes that Leighton is the biggest in the country, and while many peers are struggling with debt laden balance sheets, Leighton is not.
Thereafter, opinions begin to turn more negative.
GSJB Were (Hold) believes Leighton’s order book is going to peak in FY09, but that the market is already factoring this in. Macquarie (Neutral) is particularly worried about Dubai and the rest of the UAE, as well as a slowing resource sector and project write-downs ahead.
Dubai is Disneyland on Debt. Despite what one might immediately assume, Dubai has no oil. Those hotels, resorts, marinas, and tallest-in-the-world towers are all built on high leverage, and built to service the wealthy in the financial markets and elsewhere. Dubai is a disaster waiting to happen. Nearby Abu Dhabi is dripping in oil, but with global oil demand foundering one assumes the call for Leighton’s services is only going to wane. The lost JV also shows that Middle East contracts can simply be walked away from.
UBS (Neutral) has delved more into the nitty-gritty of Leighton’s result, and come out describing it as “mixed and more mixed”. UBS, among others, has pointed out that while Leighton has upgraded FY09 revenue guidance by 15% to 34% there was no corresponding increase in profit guidance. This is indicative of misleading “margin lag”, the analysts explain. Revenue is booked on projects (such as Brisbane’s north-south tunnel) before margins are recognised. This has meant a “neat” $50m “buffer” on FY10 profits, UBS suggests.
BA-Merrill Lynch (Underperform) agrees with UBS on the quality of Leighton’s result. The analysts are among others who make note that an apparent margin gain in the first half actually included a $47m profit on currency hedging, meaning that underlying margins actually fell. Citi picks up the story by suggesting the currency difference “is troubling to us”. Previously Leighton used to include currency effects in each project’s accounts. Now it has been netted on the bottom line. Why?
Throw in potential write-downs ahead for BrisConnections and other equity investments not marked to market, and notable weakness in the Middle East, and it was Citi who this morning downgraded to Sell.
JP Morgan was already at Underweight, and has suggested “there are a number of areas of concern to come out of the result”. Apart form those already mentioned, JPM suggests the property division is still beholden to tight credit markets, and that while Indonesian coal contract mining is “going gangbusters” the much celebrated Indian equivalent is not.
The end result of this dissention among brokers has been a drop in the average share price target to $22.30 from $25.39, on a spread from $16.00 (Citi) to $30.07 (which is not one of the Buy raters, but Hold rater Weres!).
One is constantly reminded, as the result season shifts into another gear, not to judge a book by its cover. Leighton shares are down a further 2% this morning.