If you are a long suffering shareholder in Leighton Holdings, Australia’s largest contractor with operating divisions Leighton Contractors, Thiess, John Holland and Leighton Offshore, the suggestion that there might be some value in thinking of the stock as a ‘yield’ play is going to sound pretty crazy. From the dizzy heights of $63.57 in December 2007, the stock fell to a low of $14.40 in June this year. It has bounced back a little since then, and closed on Friday at $16.52.
Last Wednesday, Leighton released its results for the first half year. While they largely met Leighton’s guidance and broker forecasts with an UPAT of $255 million (Underlying Net Profit after Tax), the market didn’t like it, sending the shares almost 6% lower. On Thursday and Friday, some of this ground was made back.
[1]Source: ASX
Half-year result
Comparing the first half year with the corresponding half year in calendar 2012:
Revenue: $11.5 bn (up 7.5%)
EBIT: $685m (up 56.1%)
UPAT: $255m (up 122%)
Gearing: 36.4% (up from 32.2% in Dec 2012)
Dividend: 45c per share, 50% franked (cw 20c, unfranked)
On the face of it, not too bad. Importantly, Leighton reconfirmed guidance for the full calendar year as follows: “underlying profit after tax of between $520 million – $600 million” and “gearing to be within the target range of 25% to 35% by 31 December”. This implies a UPAT for the second half in the range of $265m – $345m.
The yield and PE story
Leighton’s dividend for the first half of 45c per share represented a payout ratio of 60%. Assuming this is maintained in the second half, the dividend yield (based on a share price of $16.52) is:
[2]Although guidance was not provided, the dividend in the second half should be at least 50% franked – making it a little more attractive to SMSFs. On a Price/Earnings basis, broker consensus is for underlying earnings per share in 2013 of 165.1c – seeing Leighton trading on a multiple of only 10.0.
What the brokers don’t like
There were two main things in the report that the brokers didn’t like. Firstly, trade receivables (the amount owed to Leighton by its clients) blew out from $3.8 billion at 31 December to $4.4 billion at 30 June. This deterioration of $600 million in working capital, was noted by Leighton as “unacceptable”, and put down to scope growth and project variations in the resources sector. The word ‘underclaims’ is used, which represents “work variations that have been performed for clients but have not yet been billed”. CIMB commented that “the immediate outlook now rests on the company’s ability to collect $500 million of underclaims. If unable, the company will miss guidance by a wide margin”.
The brokers also didn’t like the fall in ‘work in hand’, which declined by 7.8% from $43.5 billion at 31 December 2012 to $40.1 billion on 30 June, 2013. Most of this decline was due to a reduction in contract mining work in hand, which fell from $18.6 billion to $14.9 billion as declining coal prices led to volume reductions in coal contract mining in Australia and Indonesia.
Leighton points out that across the cycle, some sectors will grow and others contract, and its focus is to increase operating margins. It makes the case that it is a diversified business, with exposure to resources and economic infrastructure roughly the same. In resources, contract mining makes up 86% of the work in hand.
[3]
[4]Source: Leighton Holdings
There are also ongoing corporate governance “concerns”, although these seem grossly overblown. Leighton’s major shareholder is Hochtief AG, which is majority owned by the Spanish group ACS. Hochtief has been using the creep provisions of the Corporations Law and buying Leighton shares on market, and according to the latest filing on 20 July, now owns 56.39% of Leighton.
The Leighton strategy
Leighton CEO Hamish Tyrwhitt announced a three-pillar strategy in 2012 – ‘stabilise, rebase and grow’. Critical to this strategy is re-building the balance sheet (leading to the divesture of some non-core capital intensive businesses), improving the net margin and the introduction of an enhanced risk-management system for project evaluation and project management.
On the ‘rebasing’ phase (where the company is currently positioned), five key initiatives are being pursed – working capital improvement, strategic procurement, group shared services, group asset management and management structures. Macquarie noted the progress the company is making on procurement savings.
The bottom line
According to FNArena, the market is negative about Leighton – a consensus rating of -0.4 (+1 is the highest, -1 is the lowest) – with a target price of $16.37.
That said, the company is making some good progress on its (fairly simple) strategy and can demonstrate an improvement in margin. Noting the risks about the collection of the underclaims and other difficult projects, the PE and yield numbers speak for themselves. It is really a question about whether you can back management’s guidance about UPAT and gearing.
In the higher risk category, however within a diversified portfolio, buy for yield.
Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.
Also in the Switzer Super Report:
- Peter Switzer: Are we tapering over the cracks? [5]
- Greg Fraser: Stock in focus – Wesfarmers [6]
- James Dunn: Smack down – more earnings pain [7]
- Rudi Filapek-Vandyck: Buy, Sell, Hold – what the brokers say [8]
- Penny Pryor: FoFA shake-up – Joe Hockey [9]
- Geoff Wilson: McMillan Shakespeare on the comeback [10]
- Penny Pryor: All steam ahead for property [11]