Aurizon Holdings: Coal and Network supporting Bulk’s growth

About the author:

Nathan Lead
Author name:
By Nathan Lead
Job title:
Senior Analyst
Date posted:
10 August 2021, 11:00 AM
Sectors Covered:
Infrastructure, Utilities

  • The FY21 result beat expectations, while first-time FY22 earnings guidance was in-line.
  • The story remains one of Coal and Network facing long-term sustainability issues, but in the meantime generating strong cash-flow to support a pivot into Bulk.
  • We have dialled back our forecasts. Target price drops 3 cps to (login to view). Downgraded from ADD to HOLD given recent share price strength.

FY21 key result items

EBIT -1% to $903m beat the guidance range $830-880m and consensus $888m. Network (EBIT +9%, WIRP fees true-up) and Bulk (+24%, revenue growth) were the growth drivers and beat our forecasts. Coal (-21%, lower contracted tonnage and pricing pressures) was in-line, while the Other segment weakened.

Quality of the earnings, as per 98% EBITDA cash conversion, was high.

2H21 DPS was 14.4 cps (70% franked) was above our/consensus forecast 13.7/13.2 cps. Dividend payout ratio was once again 100%.

Free cashflow $734m (includes asset sales) vs investor day indications of c.$700m. Within this free cashflow, sustaining capex was $446m vs D&A of $579m.

Outlook statements

First-time FY22 EBITDA guidance of $1425-1500m (-1% decline at mid-point), based on approx. flat Coal earnings, Bulk revenue growth, and Network revenue decline. Consensus had been targeting c.$1456m.

First-time FY22 sustaining capex guidance of $475-525m. Growth capex could be at least $50m given opportunities in Bulk (AZJ continues to target a doubling of the business over the next decade). LT stay-in-business capex remains c.$500m/year.

Other points of interest

Coal re-contracting risk is dissipating, with only 10% of Coal contracted volumes expiring within the next 4 years. Portfolio contract pricing is expected to decline as lucrative contracts with New Hope’s New Ackland and Yancoal’s Moolarben cease in FY22. AZJ indicated contract repricing pressures would ease beyond FY22.

Aurizon Holdings (ASX:AZJ) says it has c.$900m of debt capacity within its current credit ratings. However, it did not pull the trigger on another buyback, instead leaving the capacity to pursue Bulk growth opportunities.

Forecast and valuation update

We align our FY22 EBITDA and sustaining capex forecasts to guidance. Beyond FY22, we forecast earnings to moderate given Network’s WACC reset in FY24 and earnings pressures within Coal (margin decline alongside reduction in contracted capacity and pricing). Bulk continues to grow but at a slower rate.

Our June 2022 DCF valuation has decreased 3 cps to (login to view), due to forecast changes. The valuation is dependent on long-term valuation/terminal growth assumptions, which in turn depends on coal sustainability/decline vs the speed and extent of Bulk’s growth (noting Bulk has lower quality earnings than Coal).

Investment view

Downgrade to HOLD given recent share price strength. The cash yield (6.9%) and cheap trading multiples (7x EV/EBITDA, 14x PER) continue to be attractive. However, we are cautious that the stock may continue to be buffeted by sustainability and ESG concerns.

Price catalysts

1QFY22 above rail volumes and AGM (October). Release of Independent Expert’s capacity assessment report for Network due September.

Removal of 15% shareholder cap (probably requires change of Qld Govt).

Risks

Long-term: resilience of coal export demand and extent of supply-side constraints.

Business units: Above rail contract capture, pricing, and retention. Below rail regulatory impacts (including FY24 risk-free, debt premium, and inflation reset).

Business wide: Employee, cost and capital management (including M&A).

Investor: ESG headwinds.

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