Aurizon Holdings: Capital management vs low growth outlook
About the author:
- Author name:
- By Nathan Lead
- Job title:
- Senior Analyst
- Date posted:
- 12 February 2020, 1:20 PM
- Sectors Covered:
- Infrastructure, Utilities
- While a material increase in earnings was expected, 1H19 EBIT beat our forecast.
- EBIT forecast changes are -1% to +4% (driven by the Non-Network segment), while our 12 month target price has reduced (Morgans clients can login to view detailed reports and price targets).
- Although Aurizon (ASX:AZJ) faces a low growth outlook, we think investors will be attracted its dividend yield, significant share buyback initiative, and valuation support. We maintain our ADD recommendation.
- Next key release is the March quarter above rail volumes on 16 April.
1H20 EBIT increased by 12% on pcp, delivered with 5% revenue growth and 190bps increase in margin.
EPS increased 19%, leveraging the operating result and a decline in shares on issue from the buyback. DPS payout continued to be 100%, thus the interim dividend increased 20% to 13.7 cps (70% franked).
Operating cashflow (-1%) and net debt (-5%) were both stronger than expected, with strong cash conversion of EBITDA (98%), asset sales, and a tax refund, partly offset by a UT5 true-up payment to Network customers.
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The key positives
1H20 beat our EBIT forecast by 3%, with the outperformance delivered by Non-Network (EBIT +10%, 8% ahead of forecast); Network performance was as expected (EBIT +14%).
Bulk was the standout within Non-Network (EBIT >200% growth) albeit off a low base, driven by contract wins and operational efficiency, and management continues to be positive about Bulk's transformation outlook.
FY20 EBIT guidance was unchanged at $880-930m (FY19A $829m), inclusive of a 10Mt downgrade to the outlook for FY20 Coal haulage volumes partly offset by discontinuation of Bulk sustaining capex impairment.
Coal re-contracting risk has been reduced in the short-term due to contract extensions and new volumes with Peabody and Coronda (now only 9% of contract volumes are expiring in next 3 years).
With limited growth opportunities, cash returns to investors remains at the forefront, with 100% dividend payout and a $100m increase in the share buyback to $400m (with a further $1.2bn of capital likely to be deployed into buybacks over time).
The key negatives
Management expects limited Coal above rail revenue (CARR) growth across FY20-22, with competitive pressure on contract pricing (management has pursued contract wins at the expense of pricing) offsetting volume growth and price escalations.
We have lowered our CARR growth forecast, but assume Coal will be able to maintain its margins via cost-out, and the improvement in Bulk earnings will also help to mitigate the Coal pressures.
We also note that Coal revenue quality is declining, with the proportion of capacity charge or take-or-pay-style revenue as a proportion of CARR reducing from high-60% of CARR to low-60%.
Our 12 month DCF-based target price has decreased (Morgans clients can login to view detailed reports and price targets), implying an undemanding 9x EV/EBITDA.
In the current low interest rate environment, income-oriented investors will be attracted to the forecast dividend yield of 5.1% (~70% franked) with mid-single digit compound growth across FY21-23F.
The expanded $400m share buyback should recommence post-result release (another $1.2bn is likely to occur over time), providing additional on-market buying support for the stock.
Morgans clients can login to view our detailed report and share price target for Aurizon Holdings (AZJ). Alternatively, please contact your Morgans adviser or nearest Morgans office for access.
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