Aurizon Holdings: A major capital play via One Rail acquisition

About the author:

Nathan Lead
Author name:
By Nathan Lead
Job title:
Senior Analyst
Date posted:
27 October 2021, 10:30 AM
Sectors Covered:
Infrastructure, Utilities

  • While there is a valuation impact, we think the c.10% share price decline is an over-reaction to Aurizon Holdings' (ASX:AZJ) acquisition of One Rail. ADD retained.
  • 12 month target price (login to view). FY22-23F DPS cut -30% (rebounding FY24)

Event

Aurizon Holdings (ASX:AZJ) will acquire One Rail (OR), subject to ACCC approval. Following completion of the acquisition, AZJ plans to divest One Rail’s East Coast Rail. Completion of the acquisition is targeted for Jan-Apr 2022, and the divestment during CY22.

Analysis

The acquisition cost is $2.35bn plus c.$80m transaction costs, implying 10.5x EV/EBITDA (CY21F). This is below the 11.2x EV/EBITDA paid by the vendors in 2019, but at a significant premium to AZJ’s recent trading multiple of c.7x EV/EBITDA.

If we assume East Coast Rail is worth 7-8x EV/EBITDA, then AZJ has paid 15-17x EV/EBITDA for One Rail Bulk. Even with this significant premium, AZJ says the acquisition is superior to buying back its own shares.

The $2.43bn acquisition cost will be fully debt funded, with $500m layered against the divested business and the remaining $1.93bn of additional debt raised against AZJ’s Above Rail operations. This incremental debt funding comes from:

  1. $900m of existing debt capacity within its target BBB+/Baa1 credit ratings;
  2. debt capacity from One Rail Bulk;
  3. reduced dividend payout over 1-2 years;
  4. increased capacity from convincing the rating agencies to reduce downgrade triggers; and
  5. hybrid issue for 50% equity credit in rating agency credit metrics.

AZJ plans to reduce its dividend payout from 100% (since 2015) towards the bottom end of its 70-100% policy range for 1-2 years to support credit metrics. Hence, a c.30% downgrade to DPS so as to retain c.$150-300m. However, under the demerger option existing AZJ investors would have access to East Coast Rail’s distributions (we think 3.7cps/13% downgrade offset); a trade sale at our valuation would provide a c.4% offset to the downgrade via debt paydown (1.2 cps)

Forecast and valuation update

While we have not yet factored the acquisition or its funding into our forecasts, we have downgraded our CY22-23F DPS by c.30% as per reduced payout and removed assumed buybacks from our modelling.

Given the above changes, the acquisition cost and assuming a preliminary valuation of $1.1bn for East Coast Rail (c.8 EV/EBITDA) and $0.75bn for One Rail Bulk (8.5x EV/EBITDA) our valuation declines to (login to view target price).

Investment view

ADD retained. With recent share price decline, potential TSR is c.12%.

Price catalysts

Attractive sale price for divestment of East Coast Rail (will have look-through value implications for AZJ’s coal haulage business).

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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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.

Solid top-line outcome: BAP’s 1Q22 revenue was flat on the pcp, an extremely resilient result given the extent of lockdowns in the period (~70% of stores impacted) and the strength of the pcp (cycling 27% growth). Composition comprised: Trade +2%; NZ -10%; Retail -12%; and Specialist Wholesale +7%. Overall, BAP stated that non-lockdown areas are outperforming expectations. ▪ 1Q22 trade & retail: Trade/Burson revenue was up +2% on the pcp (LFL sales - 1%; cycling 8% pcp); NZ/BNT revenue was down -10% (LFL sales -15%; cycling +4%); and Retail/Autobarn revenue was down -12% (LFL sales -16%; cycling +36%). Within the Retail segment, online sales were +80% on the pcp. Stores percentages impacted by lockdown were: Trade 70%; NZ 100%; and Retail 50%. ▪ Specialist segment results: Specialist wholesale revenue is up 7% on pcp, with Auto electrical/Truckline divisions ‘performing strongly’; and WANO underperforming. ▪ GM pressure expected to be temporary: BAP stated GM was stable across Wholesale and NZ (45% of FY21 revenue); and down ~50bps Trade and Retail (~55% of FY21 revenue), driven by promotional and online pricing in lockdown areas (we assume no margin pressure witnessed in non-lockdown areas). BAP expect margins to revert once lockdowns ease. ▪ The cost base has increased vs pcp, a function of duplicated DC costs (commencement of new VIC DC), and higher group and team member support (covid related) costs. BAP noted FY22 store rollouts and refurbs are on track.

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