Aurizon Holdings: Contracted re-entry
About the author:
- Author name:
- By Nathan Lead
- Job title:
- Senior Analyst
- Date posted:
- 21 February 2023, 7:30 AM
- Sectors Covered:
- Infrastructure, Utilities, Banks
- Aurizon Holdings (ASX:AZJ) announced a re-entry into the interstate containerised rail freight market via a material long-term contract with Team Global Express.
- Forecasts upgraded, 12 month target price lifted to (login to view) per share.
- ADD retained, given 16% potential 12 month TSR (including c.5% cash yield) and c.9% pa five year IRR.
AZJ has been awarded an Australia-wide contract with freight forwarder Team Global Express (TGE, formerly Toll Global Express) delivering rail linehaul services for its containers transported interstate.
AZJ describes it as its biggest non-coal revenue contract ever, and is sufficient for it to describe the ASX announcement as market-sensitive.
The contract is for 11 years, with TGE describing it as worth c.$1.8bn over the term (we are more conservative in our modelling than this, but then include 10% additional haulage revenue above the TGE cornerstone to account for third party haulage).
AZJ says the contract has no take-or-pay protections (hence full volume risk), but has typical CPI escalation and fuel and track access pass-through mechanisms seen in other contracts.
AZJ will provide five weekly services east-west (Melbourne-Sydney-Adelaide-Perth) and two north-south (Brisbane-Sydney-Melbourne). The fully installed capacity of these services is >200k TEU per year, of which TGE will account for c.70% based on its (undisclosed) historical volumes. AZJ has not yet detailed the intermodal facilities it will utilise to provide these services.
The contract starts in April and ramps up to full service over by April 2024 (concerns us that there is a risk that TGE’s customers may depart over this period if service levels wane as AZJ ramps up).
AZJ is adding a further $120m over FY23-25 to its $430m Bulk investment (across FY21-25) to support the contract win, which includes bumping FY23 growth capex guidance up $40m to $250m.
AZJ says it expects the contract to be EBIT profitable at 70% capacity utilisation rate, and it will provide the targeted EBIT margin and returns (IRR, ROIC>10%) at 75-85% utilisation. At this stage, we factor in the investment spend but don’t assume that the return targets are entirely met.
Forecast and valuation update
2-3% FY24-25F EBITDA/EBIT upgrades, and 3-4% DPS upgrades across the period.
DCF-based 12 month target price lifts 9 cps to (login to view).
We are not yet convinced that the capital AZJ is deploying into the lower quality Bulk business (both One Rail Bulk acquisition and growth capex) to diversify its operations away from coal exports and tap into new growth avenues will deliver appropriate risk-adjusted returns over time.
Nonetheless, we see value in the stock at current prices, supported by the far higher quality Network and Coal haulage businesses. ADD retained.
New haulage contract wins. Reset of Network revenues (WACC parameters) and actual cost of debt (interest rate hedge expiry) in 2024.
Uplift to Coal earnings as revenue yield decline ceases and lifts with CPI. Potential increase to dividend payout in FY25 as Bulk investment cycle subsides.
- 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).
- Weather impacts.
- Domestic consumption (impacting containerised freight volumes).
- Strength of grain crop.
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