Risk To Downside For BNB

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This story features MACQUARIE GROUP LIMITED.
For more info SHARE ANALYSIS: MQG
The company is included in ASX20, ASX50, ASX100, ASX200, ASX300 and ALL-ORDS

By Chris Shaw

When credit and financial market conditions were good equity investors were more than happy to apply hefty multiples to Babcock & Brown ((BNB)) as its model of rolling out new funds and clipping the ticket for management funds made it appear there was little that could stop it delivering on earnings growth expectations.

Now market conditions are tougher and investors want companies that can deliver on their promises, which has put the group in a tougher position as management at last week’s annual general meeting admittted it had essentially failed to deliver given the poor performance of a number of associated funds.

The meeting also heard while earnings guidance for 2008 was being at $750 million first half earnings would be flat on last year at about $250 million, meaning it would require around two-thirds of profit to be generated in the second half of the year. This, according to Credit Suisse, means there is scope for earnings to come in below market expectations.

As an example the broker notes management is expecting wind asset sales of around $500 million in the second half compared to its own forecast of around $459 million, while UBS offers a similar argument in pointing out any slippage in terms of the timing of deals done by the group means actual results could come in below expectations.

The one thing most brokers in the market agree on is the stock appears cheap at current levels as UBS estimates the shares are presently trading on around 5.4 times FY09 earnings, this despite the core business performing solidly. As evidence of this the broker notes asset recycling is continuing at a solid pace and cash and undrawn facilities are approaching the group’s target level.

The issue for UBS and others is that the company must restore the confidence of investors for value to be realised. Such a realisation of value will require a restructuring, closing or de-gearing of its listed trusts as only then in the broker’s view will it be able to deliver solid financial returns across all its investment vehicles.

As ABN Amro points out with all the earnings growth now expected in the second half of the year the achievement of guidance will require relatively stable market conditions and in the current environment this is far from assured. It too sees timing issues as a problem as if transactions continue to be postponed it will make it very difficult for the company to achieve expected earnings.

To reflect this the broker has made minor cuts to its earnings estimates, cutting its net profit after tax numbers by 2-3% this year and in 2009. While UBS has retained its forecasts Credit Suisse has been more severe, cutting its forecasts by 10% this year and 5% next year. It is now forecasting earnings per share of 186c this year and 199c in 2009, which compares to ABN Amro at 195c and 207.8c and UBS at 201c and 236c. Consensus forecasts according to the FNArena database are 190.3c and 205.3c respectively.

Lower earnings estimates mean lower price targets, Credit Suisse dropping its target to $18.80 from $20.00, ABN Amro to $14.60 from $15.00 and Deutsche Bank from $30.00 to $28.00. This brings the average price target in the database to $20.66 from $21.76, while Thomson One Analytics shows a median price target of $25.00. It is worth noting not all brokers covering the stock have updated their models post the AGM.

Overall the FNArena database shows five Buy ratings and two Holds, though Credit Suisse probably summed the stock up the best in saying with a weak first half result likely and a failure to deliver on expectations there has been brand damage inflicted on the company, so while it continues with its Outperform rating, the stockbroker sees rival Macquarie Bank ((MQG)) as the better buy at present.

Shares in Babcock & Brown today are weaker and as at 11.30am the stock was down 27c to $12.19, which compares to a trading range over the past 12 months of $11.90 to $34.78.

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