Aurizon Holdings: FY22 and One Rail done…next key event is ECR sale

About the author:

Author name:

By Nathan Lead

Job title:

Senior Analyst

Date posted:

09 August 2022, 8:30 AM

Sectors Covered:

Infrastructure, Utilities, Banks

• The key factors in the result for Aurizon Holdings (ASX:AZJ) was the softer Bulk result, weaker than expected FY23 outlook, Network macro benefits, and the One Rail acquisition.
• 12 month target price remains unchanged at (login to view). Yield beyond FY23 is c.7%.
• ADD retained on the basis of valuation support and solid dividend yield, but with reduced conviction given uncertainties.

Watch

Event

AZJ released its FY22 result, with EBITDA -1% on pcp and a 2H22 DPS of 10.9 cps (-24% on pcp, 100% franking), both close to market expectations.

Earnings were again supported by lower quality elements. We expect consensus EBITDA downgrades given first-time FY23 guidance.

Result analysis

EBITDA -1% to $1468m was within guidance ($1425-1500m) and <1% above Visible Alpha consensus. As well as one-off revenue impacts, Network (access revenue -4% on pcp, EBITDA -6%) had volumes below its regulatory forecast, with some of the access revenue shortfall to be recovered in FY24.

Coal (above rail revenue +1%, EBITDA +2%) was impacted by lower volumes and contracted tonnage. Bulk (revenue +9%, EBITDA -7%), the focus of growth capital deployment, missed its internal EBITDA target by 21%, suffering from lower volumes and business ramp-up costs.

The Other segment boosted group EBITDA through asset sales and provision adjustments. 

Underlying EPS was flat at 28.5 cps, beating consensus by c.3%. AZJ continued with its lowered dividend payout (down from 100% to 75%), as per its One Rail acquisition funding plan; expect another two dividends at the lower payout.

Free CF +13% to $664m was as expected, albeit was supported by capex ($551m) materially below guidance. Non-growth capex guidance is $500-550m/yr (including One Rail Bulk), with growth capex dependent on Bulk contracting outcomes.

AZJ has entirely funded the acquisition of One Rail with floating rate bank debt. It plans to term out this debt (including with a potential hybrid issue in 2023), with the funding task partly offset by the reduced dividend payout in FY23. Expect the cost of debt to rise (from avg. 3.4% into the 4% range), as well as higher gearing.

Outlook

First-time FY23 EBITDA guidance of $1470m-$1550m implies c.0%-6% growth on FY22 and compares to consensus expectations of $1560m pre-result.

We set our forecast towards the middle of the guidance range, targeting flat Network, a c.12% rebound in Bulk (ex One Rail), first-time inclusion of One Rail (c.$95m), 8% decline in Coal, and normalisation of the Other segment to -$30-40m/yr.

FY24F+ EBITDAis relatively unchanged, with the step-up from One Rail Bulk being offset by the Bulk and Coal downgrades and adjustment for the first-time disclosure of the preliminary Network FY24 revenue update.

However, incorporating the debt funding of the One Rail acquisition reduces earnings meaningfully. There is further uncertainty on EPS/DPS as AZJ has not finalised the non-cash D&A expense related to the acquired assets; our preliminary forecast sees a c.14% downgrade.

Valuation

Target price unchanged at (login to view), with the weaker short-term earnings offset by the growth in the Network asset base (higher CPI, lower regulatory depreciation). 

Our modelling assumes East Coast Rail is sold for Enterprise Value (equity value) of c.$1.1bn (c.$0.6bn).

AZJ says it has engaged with c.10 potential acquirers, with non-binding bids due in Sept-22 and a trade sale vs demerger decision due Dec-quarter CY22. Each $100m difference moves the AZJ equity valuation by c.5 cps.

Price catalysts

• ECR divestment (will have both balance sheet and look-through value implications).
• New contract wins in haulage.
• Reset of Network revenues in 2024 subject to WACC and inflation reset.
• Reinstatement of 100% dividend payout.

Risks

• Resilience of coal export demand and extent of supply-side constraints.
• Above rail contract capture, pricing, and retention.
• Network regulatory risks.
• Employee, cost and capital management (including M&A).
• ESG.

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