Aurizon Holdings: Fine tuning in advance of FY20 results
About the author:
- Author name:
- By Nathan Lead
- Job title:
- Senior Analyst
- Date posted:
- 14 July 2020, 9:44 AM
- Sectors Covered:
- Infrastructure, Utilities
- Aurizon Holdings (ASX:AZJ) will report its FY20 result on 10 August. As a result of Q4 volume weakness, we expect EBIT to be at the bottom end of the $880-930m guidance range.
- 12 month target price reduces (Morgans clients can login to view detailed reports and price targets).
- The forecast dividend yield of 5.9% (~70% franked, 100% earnings payout) continues to be appealing, as does the relative revenue resilience, investment grade balance sheet, and potential for further buybacks.
Components of AZJ's revenues/costs escalate in line with CPI. CPI expectations implied by the CPI swap curve have fallen meaningfully (and we note the RBA expects negative CPI in the short term), which is a headwind to earnings growth.
The outlook for interest rates as per the yield curve has also dropped noticeably (short term bank bills are ~10bps and 10 year swaps at <100bps).
Lower interest rates result in lower debt service on new and unhedged debt, but also reduce future Network track access revenue (via the risk free rate and cost of debt premium reset in FY24).
Network (~52% of EBITDA)
We think actual system volumes on the CQCN in FY20 will be ~12Mt less than the 240Mt used for tariff setting purposes, causing track access revenue to fall short of the regulatory allowance. This shortfall is mitigated in value terms by the recovery permitted under the regulatory regime in FY22.
It is disappointing that the 40bps step-up in WACC allowance triggered by the system capacity Report Date has not occurred, with the delay costing $2m/month. Regulatory assumptions for the risk free rate, cost of debt premium, and inflation are reset in FY24, which we expect will cause a reduction in Network EBITDA.
A step-down in actual cost of debt will take longer to achieve, due to the timing of debt maturities.
We expect AZJ will be pursuing Network cost-out given the fixed opex revenue allowance, albeit headcount reduction may be difficult during the COVID-19 period.
Non-Network (~48% of EBITDA, with ~85% being Coal haulage)
Based on coal export data, we think AZJ may fall slightly short (209Mt, 84% contract utilisation) of its FY20 Coal haulage guidance of 210-220Mt. However, 50-60% of revenue is based on contracted capacity not volume hauled.
There is a risk that contracted Coal capacity falls below 250 Mtpa given recontracting and mine depletion risks, albeit AZJ may capture new contracts.
We assume it takes until FY24 for contract utilisation to once again lift above 90%.
The decreased CPI inflation outlook has a significant impact, with Coal haulage rates linked to CPI but wages growing at fixed rates as agreed under EBAs (employee costs comprise the majority of costs).
Cost-out therefore continues to be an important driver, and progress on Bulk transformation the potential upside surprise.
We have adjusted our FY20 EBIT forecast to $882m (-3%) compared to guidance of $880-930m, and believe AZJ can deliver low-$900ms EBIT (ex revenue cap adjustment) across FY21-23F.
Completion of the Acacia Ridge terminal sale to PN looks likely to be pushed back to 1H22 given the ACCC's legal challenge.
Given this, and the lower earnings growth outlook, we taper back our buyback expectations, targeting $800m over the next 3 years (vs $1.2bn capacity) while remaining within the rating requirement of FFO:debt>30%.
Our DCF valuation implies ~1.2x EV/RAB for Network and 10.7x EV/EBITDA for Non-Network, 8.8x EBITDA overall. The share price implies ~8x EV/EBITDA and ~16 PER (FY21F).
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