Australia | Sep 03 2008
By Chris Shaw
Since expanding into the Middle East in general and the United Arab Emirates in particular, Leighton Holdings ((LEI)) has never had any trouble finding work. This fact is emphasised by the group announcing yesterday its 45%-owned subsidiary Al Habtoor Leighton Group had won a new contract where Leighton’s share is expected to be worth around $295 million.
But as UBS points out, it is the form of the contract that has raised some potential issues, as for the first time, the group has signed an alliance contract rather than its usual cost + structure. With a cost + structure, risks are limited, as cost increases are built in, but with the alliance structure, the client and consultant share upside and downside risk and return based on previously agreed benchmarks, the broker points out.
In the broker’s view, the use of alliance contracts means increased risk, especially in the UAE, where labour, steel and cement costs are rising strongly. By comparison, there is essentially no risk for the contractor in a cost + contract, so while it is not unduly concerned by this first alliance deal, any continuation of such a structure in future would mean a shift in the risk/reward equation for the company’s operations in that region.
In contrast, JP Morgan has no issue with this form of contract, suggesting alliance deals are likely to become increasingly popular in the region given ongoing tight market conditions. The broker suggests the deal may actually help de-risk the project given current capacity constraints in the marketplace.
The broker also sees fundamental growth from the group’s exposure to the region as continuing, which it expects will translate into solid earnings growth in coming years. On its numbers, the company is expected to deliver earnings per share (EPS) of 238.8c in FY09 and 305.2c in FY10, which compares with the FY08 result of 212.1c on a normalised basis.
The issue remains price, in the broker’s view, as on its numbers the stock is currently trading at 19.3x its FY09 forecasts. It sees limited value at current levels, so the stock is only rated a Hold with a target of $47.56.
UBS disagrees, suggesting the group’s exposure to still strong markets means work in hand is likely to continue to grow from the current level of around $34.5 billion, which would support further growth in earnings. As a result, it rates the stock as a Buy with a price target of $50.00.
The broker is currently forecasting EPS of 250.9c in FY09 and 288.5c in FY10, while the FNArena database shows consensus EPS forecasts of 253.7c and 305.9c respectively. According to the database, Leighton is rated as Buy six times and Hold three times, with an average price target of $50.20. Macquarie leads the way with a target of $55.25, while GSJB Were is the low marker with its target of $45.00.
Today, shares in Leighton Holdings are slightly weaker and as at 12.55pm the stock was 38c lower at $45.81. Its trading range over the past 12 months is $38.30 to $65.62.