Aurizon Holdings: Update to add

About the author:

Nathan Lead
Author name:
By Nathan Lead
Job title:
Senior Analyst
Date posted:
07 January 2020, 3:41 PM
Sectors Covered:
Infrastructure, Utilities

  • We take advantage of recent share price weakness (down 14% since September) to upgrade to ADD. Total 12 month potential return at current prices is ~15%.
  • Mild forecast adjustments (mainly related to cash tax rates) and valuation rollforward lifts our 12 month target price (Morgans clients can login to view detailed reports and price targets).
  • Key attractions include the aggressively pursued buyback currently underway, forecast ~5.2% yield (~70% franked), and relatively predictable (albeit low growth) earnings that should have a relatively low correlation to the domestic economy.

Share price decline

AZJ’s share price peaked at $6.11ps in September and has since fallen 14%. There are no obvious drivers of the decline. Metallurgical and thermal export coal prices are off their recent highs, albeit they are not a direct driver of AZJ’s revenues (at least in the shortterm).

Government bond yields are up off their historical lows, albeit AZJ’s future earnings may benefit from this through the FY24 reset of the risk-free rate and debt premium impacting below rail revenues. Recent low CPI inflation hurts tariff escalation, albeit some of this dynamic will benefit costs.

AZJ has court disputes underway with the ACCC (Acacia Ridge terminal sale) and its Wiggins Island customers (top-up revenues) that are yet to be settled.

It has also initiated court proceedings against Genesee & Wyoming (G&W) for breach of pre-emptive rights over its Australian assets - there is a risk of a pause in the buyback and/or capital raising under the scenario that AZJ buys all (unlikely given competition issues) or part of the G&W Australian assets.

Also of significance is the recent resignation of AZJ’s head of Network who led the UT5 customer agreement negotiations.

$300m buyback underway since September - more to come

Since commencing on-market purchases on 17 September, AZJ has spent $215m of its $300m buyback program at prices between $5.23 and $6ps, accounting for ~5% of AZJ shares traded during the period.

The buyback will pause from 1 January until AZJ publishes its 1H20 result.

The capital restructure announced in August (securing a separate pool of debt against the above rail assets with a BBB+/Baa1 credit rating) releases $1.2bn of capital which looks likely to also be deployed into further buybacks.

A buying opportunity

The upgrade to ADD is predicated on an expansion in potential return to ~15% as a result of the share price decline and an increase in our target price (Morgans clients can login to view detailed reports and price targets). The target price increase is driven principally by a reduction in the assumed cash tax rate to no higher than 21% (25% previously).

We understand AZJ capitalises certain expenditure for accounting purposes which can be immediately expensed for tax purposes (eg. ballast undercutting and rail renewals in Network and locomotive overhauls in above rail), thus constraining cash taxes far below the 30% tax rate.

This contributes to a 3-4% upgrade to our operating CF forecast from FY21+. The multiples implied by our target price are not stretched at 1.2 EV:RAB for Network, 11 EV:EBITDA for Non-Network, and 9.5 EV:EBITDA/18.8 PER for the group.

Key risks are the coal export market, regulatory, above rail contracting, costout execution, interest/inflation rates, M&A, and buyback.

Next key event

The 1H20 result is due on 10 February, and we target 8% underlying EBIT growth to $440m (FY20 guidance $880-930m) and DPS growth of 16% to 13.2 cps (70% franked).

More information

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.

Disclaimer: The information contained in this report is provided to you by Morgans Financial Limited as general advice only, and is made without consideration of an individual's relevant personal circumstances. Morgans Financial Limited ABN 49 010 669 726, its related bodies corporate, directors and officers, employees, authorised representatives and agents (“Morgans”) do not accept any liability for any loss or damage arising from or in connection with any action taken or not taken on the basis of information contained in this report, or for any errors or omissions contained within. It is recommended that any persons who wish to act upon this report consult with their Morgans investment adviser before doing so.

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