Morningstar Equities

Morningstar Equities

Mainfreight Limited MFT-NZ| Strong Exchange Rate and Softer Europe Overshadows an Otherwise Decent Performance From Mainfreight

Morningstar Recommendation: Hold
Nachiket Moghe, CFA, Morningstar Analyst - 64 9 915 6776
Mainfreight’s first-half fiscal 2014 results were in line with our expectations. Underlying EBITDA increased 3.7% to NZD 63.3 million, reflecting double-digit growth in the core New Zealand division offset to some extent by disappointing results in Europe. Excluding exchange rate effect, group EBITDA was 6.1% higher than the corresponding period. Management indicated that second-half performance will be stronger than the first half because of continuing momentum in all divisions, except the U.S. and Europe. Our fiscal 2014 forecast also suggests a stronger second half. Consequently we are not changing our estimates but increasing our fair value estimate to NZD 11 per share from NZD 10.50 because of additional cash generated since our last update.

Mainfreight shares have rallied over the past few months on the back of a buoyant New Zealand economy, which has produced solid results for the New Zealand division and continued strong showing in Australia (on a constant currency basis). These two markets account for the vast majority of the firm’s operating earnings. However the stock is currently overpriced compared with our revised fair value estimate and could pull back if the global economy deteriorates or the problems in the firm’s European business persist. We continue to believe Mainfreight has no economic moat as it is a relatively small company in the global supply-chain and logistics arena. That said, management has done an exceptional job of executing on its growth plans, barring the European acquisition.

Growthpoint Properties Australia GOZ| Initiating on Growthpoint, Good Yield but Faces Headwinds in Office

Morningstar Recommendation: Hold
Tony Sherlock, Morningstar Analyst - 02 9276 4584
We initiate coverage on Growthpoint Properties, an Australian real estate investment trust (A-REIT), with a fair value estimate of AUD 2.40, implying a forward price/earnings ratio of 13 times and price/book of 1.14. At current prices, we believe the stock is fairly valued. The trust's portfolio is allocated 55% to industrial and 45% to office. The company has an attractive yield of 7.3%, but we believe this isn't enough to compensate for the lower-quality office portfolio and the associated poor outlook for the sector. Elevated gearing of 43% also reinforce our view that the stock is higher risk.

Headwinds in the office component are premised on a continuing soft economy, headcount reductions, and elevated new supply in all major cities, creating an unfavourable environment for rents. Growthpoint's office portfolio is unlikely to perform well given properties are in secondary locations. Office assets with these traits tend to suffer most from rising vacancies in weak markets. Offsetting this is the portfolio's respectable 6.2 year weighted average lease expiry, or WALE.

James Hardie Industries Plc JHX| A Stellar Result from James Hardie as the Market Provides Welcome Tailwinds

Morningstar Recommendation: Hold
Will Culbert, Morningstar Analyst – 02 9276 4416
James Hardie reported an outstanding first-half fiscal 2014 result, well ahead of expectations. Net normalised operating profit (which excludes asbestos and other adjustments) increased by 31% to USD 108.3 million. Market conditions have improved across the board and James Hardie has benefited from improved volumes and prices. It is difficult to find fault with this result–earnings were strong, margins expanded, the dividend was increased and free cash flow generation was much improved. Management also increased guidance for the full year, which ends in March 2014.

We have lifted our fair value estimate from AUD 9.00 to AUD 11.00. The increase stems from higher volumes and margins in the U.S. fibre cement division. We consider the shares to be slightly overvalued. There is no change to our investment thesis, high uncertainty or narrow moat rating, which is derived from a cost advantage resulting from years of successful research and development expenditure and market dominance.

Emeco Holdings Limited EHL| Emeco Forecasts Fiscal 2014 Loss but Lower Debt

Morningstar Recommendation: Hold
Ross MacMillan, Morningstar Analyst - 02 9276 4450
Emeco provided an operating update, forecasting fiscal 2014 earnings before interest, tax, depreciation and amortisation, or EBITDA, of between AUD 90 and AUD 105 million, after achieving EBITDA of AUD 188 million in fiscal 2013. Despite fleet utilisation rates stabilising at 43%, Emeco is forecasting an operating loss after tax of between AUD 10 million and AUD 17 million, after fiscal 2013 net profit after tax, or NPAT, of AUD 35 million. We anticipated NPAT tumbling 35% to just AUD 23 million in fiscal 2014, but our forecast is now looking overly optimistic. Emeco's earnings are being shattered by mining project cancellations, lower mining activity and significantly reduced global demand for mining equipment. New managing director Ken Lewsey anticipates a meaningful improvement in earnings during second-half fiscal 2014. We are not as optimistic, particularly in relation to stronger domestic mining activity. We lower our fiscal 2014 NPAT forecast to a loss of AUD 20 million and reduce our fiscal 2015 NPAT forecast by 67% to just AUD 8 million.

In an attempt to generate free cash flow and cut debt, Emeco is slashing capital expenditure to just AUD 30 to AUD 40 million, after spending AUD 179 million during fiscal 2013. Our capital expenditure assumptions have been substantially lowered for the next three years. Additionally, we are assuming no dividends during fiscal 2014 and 2015. Our fair value estimate is lowered to AUD 0.23 from AUD 0.25. We believe the share price is overvalued with the market assuming a recovery in earnings during second-half fiscal 2014, which we find difficult to envisage unless the thermal coal and gold price rebound higher.

No change to our no-moat rating and investment thesis, which notes Emeco is among the most volatile of mining service companies, with cyclical demand, high operating leverage and only very limited barriers to entry. Emeco's earnings volatility reinforces our very high uncertainty rating.

Mermaid Marine Australia Limited MRM| Project Delays Cause Mermaid Marine to Trim Outlook Expectations

Morningstar Recommendation: Reduce
Will Culbert, Morningstar Analyst – 02 9276 4416
Mermaid Marine has provided a trading update and indicated that it now expects flat earnings growth in fiscal 2014 and a 60% skew to the second half. We had previously forecast approximately 10% earnings growth in the coming year. Mermaid Marine's earnings have been negatively impacted by project deferrals in offshore construction work and drilling programmes. This has affected the Dampier supply base where volumes have been 30% below anticipated levels. The supply base has been an important driver of earnings growth in recent years and accounted for 55% of group earnings before interest and tax, or EBIT, in fiscal 2013.

We have reduced our fair value estimate from AUD 3.00 to AUD 2.80 on lower growth estimates for the supply base in the near term. The earnings growth has largely been deferred and some of the lost work in fiscal 2014 will be pushed into the following year. There is no change to our investment thesis, no-moat or high uncertainty ratings. Our fair value estimate corresponds to 10.8 times our fiscal 2014 earnings per share, or EPS, forecasts. The shares are currently trading at approximately 13 times EPS, which we view as expensive for a company with a highly cyclical revenue stream.

As the company noted in its release, the timing of project commencements and balancing supply base and vessel utilisation is always a challenge. However, activity going forward remains strong. On a medium-term view, Mermaid Marine will benefit from a solid pipeline of work in the oil and gas sector including Gorgon, Ichthys, Wheatstone and Prelude. Floating liquefied natural gas, or LNG, which is likely to be used at Browse, offers further potential upside. However, we again caution that the core area of risk is the deferment or cancellation of major LNG projects, which would create significant earnings headwinds. This trading update, which is based on a reasonably short deferment of work, further highlights the degree to which earnings can be impacted.

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