Aurizon Holdings: Hard to ignore c.10% free cashflow yield

About the author:

Nathan Lead
Author name:
By Nathan Lead
Job title:
Senior Analyst
Date posted:
13 September 2021, 9:00 AM
Sectors Covered:
Infrastructure, Utilities

  •  We upgrade to ADD, given improved return potential at current prices.  This includes c.7% dividend yield and c.9% upside to our revised target price of (login to view). 
  • AZJ’s revenue protections and the essential and long-dated nature of its assets make its earnings less correlated with the business cycle, providing a defensive element to a portfolio. Also, its strong cashflows and debt capacity give it flexibility to pursue growth investment and/or undertake capital management initiatives. 

Group overview

AZJ is Australia’s largest rail-based transport business. Its two operating groups are Network (QCA-regulated coal track infrastructure in central Queensland) and Above Rail (unregulated coal haulage and Bulk ops). FY21 EBIT was split Network 54%/Coal 34%/Bulk 12%, hence 88% from coal export-related activities. 

Strategy

A focus on ROIC and efficiency in Coal, and regulatory certainty and cost-out in Network, is expected to provide a stable core for AZJ to deliver shareholder returns and achieve its Bulk growth aspirations (double segment EBIT this decade). 

Earnings, cashflow, and dividend performance

FY21 EBIT declined -1% on pcp (or -6% excluding revenue one-off), mildly ahead of market expectations. Network (EBIT +9%, or -2% excluding revenue one-off) and Bulk (EBIT +24%) were the growth drivers. Coal (EBIT -21% on pcp) suffered from lower contracted tonnage and pricing pressures. We put this earnings result in the context of Network volumes down -8% and Coal haulage down -6% on pcp.  

The quality of the FY21 earnings was high, with 98% of EBITDA converted into cash. This helped deliver free cashflow of $734m, or $589m from continuing operations. This cashflow plus increased leverage funded c.$530m dividends (100% earnings payout) and a $300m share buyback. Over FY17-21, AZJ has returned $1.30/share in dividends and the equivalent of 51 cps in buybacks. AZJ indicated it has c.$900m of debt capacity within its BBB+/Baa1 credit ratings.

Outlook

FY22 EBITDA guidance of $1425-1500m (-1% decline at mid-point) was based on: approx. flat Coal earnings (+5% volume growth and cost decline vs contract rate pressure); Bulk revenue growth; and Network revenue decline (cycling revenue one-off in FY21). AZJ has also provided FY22 sustaining capex guidance of $475-525m vs $446m in FY21 and long-term stay-in-business capex of c.$500m/year. 

Beyond FY22, we’re expecting mild EBITDA decline through FY23-24. This is due to falling interest rates impacting Network’s WACC reset in FY24 and Coal earnings pressures (decline in contracted capacity and pricing). We assume Bulk continues to grow but have not factored in AZJ’s growth targets nor required investment.  

We’re expecting free cashflow to average c.$675m/year across FY22-24F (albeit depends on how much capital is required to meet Bulk’s growth aspirations).  

AZJ’s modelling of Australian coal exports indicates volumes should rise through to 2030, but by 2040 could be below 2020. Under these scenarios, AZJ expects to generate an average free cashflow over FY21-FY40 of c.$500-$650m/year. 

Valuation

Our DCF-based 12-month target price is (login to view). We acknowledge the valuation is dependent on the long-term sustainability of coal exports vs the speed and extent of Bulk’s growth (noting Bulk has lower quality earnings than Coal). 

Investment view

Following recent share price weakness, we upgrade to ADD. We would expect AZJ’s cash yield (7.5%) and cheap trading multiples (7x EV/EBITDA, 13x PER) to attract value investors tolerant of AZJ’s ESG and sustainability concerns.

Price catalysts

1QFY22 above rail volumes and AGM (October). Release of Independent Expert’s capacity assessment report for Network due September. Removal of legislated 15% shareholder cap (probably requires change of Queensland government).

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.

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