Aurizon Holdings: Some temporary impacts…temporary price decline?

About the author:

Author name:

By Nathan Lead

Job title:

Senior Analyst

Date posted:

15 February 2023, 7:00 AM

Sectors Covered:

Infrastructure, Utilities, Banks

• Aurizon Holdings' (ASX:AZJ) 1H23 earnings (EBITDA -7% on pcp, EPS -34%), cashflow, and DPS (-33% on pcp) were below expectations, and FY23 EBITDA guidance was downgraded 4%.
• 12 month TP reduced to (login to view). Implies both attractive valuation metrics and a share price rebound as the market digests the one-offs affecting FY23.
• We think there is both potential price upside and reasonable yield at the current share price (more attractive looking into FY25F). Upgrade to ADD from HOLD.

Analysis

Network EBITDA (52% of group) declined -4% and was 10% below expectations. AZJ cited volume impacts from wet weather, and H2 will be further hit by the Blackwater system derailment (FY23 revenue under-recovery c.$100m).

While H1 revenue is recognised on the basis of actual volumes, take-or-pay protection (c.$60m) accrues in 2H (paid in following 1H) and the revenue recovery via the regulatory regime (c.$40m) occurs in FY25. Earnings will benefit from a c.$95m revenue step-up in FY24 (WACC reset plus FY22 revenue cap).

Coal EBITDA (33% of group) declined -20% and was 8% below expectations. Earnings were impacted by 8% decline in volumes (prolonged wet weather), decrease in revenue yield (bottoms in FY23 with quarterly CPI escalation benefits appearing thereafter), and higher opex (note higher wage growth under new Qld EBAs).

2H23 will be further impacted by the Blackwater derailment. Volume weakness and hence capacity under-utilisation is preventing the achievement of operating leverage. We assume earnings improve from FY24 on CPI and volumes.

Bulk EBITDA (14% of group) increased +33% and was 16% below forecast. 1H23 was a higher revenue growth but even higher cost outcome than we had assumed. The growth was primarily driven by the OneRail Bulk (ORB) acquisition, while weakness was caused by wet weather and a number of other issues.

Given ORB’s contribution, we think revenue of the existing business grew 18% but the EBITDA margin declined by >6% (EBITDA -17%), indicating the upside if the business can be returned to previous margins (on top of further revenue growth and ramp up of ORB earnings).

AZJ believes it can deliver 15% EBIT margins by FY24 (1H23A 9%), at least 10% ROIC (within 2-4 years) on the $430m capex commitment (ex ORB acquisition) across FY21-25 ($230m remaining), and the combined investment should deliver its $250-300m medium term EBIT target.

Capital management: 1H23 DPS declined 33% to 7 cps (100% franked), 36% below our forecast but in-line with the decline in EPS. AZJ indicated the 75% dividend payout is likely to continue during the Bulk capex cycle ending FY24, hence it may be that the payout ratio lifts thereafter (we part-risk by assuming 85% from FY25F instead of 100%).

AZJ says that debt capacity within its credit rating constraints is likely to be fully utilised in FY24 but improves in FY25. No hybrid issue is required. The average cost of debt increased 60bps on FY22, but debt service will step up further in FY23 (debt funding of ORB acquisition) and FY24 (hedging of Network base rate expires), partly offsetting the uplift to Network revenues from the WACC reset.

Free cashflow was weak in 1H23 ($95m or -$40m after growth capex), but AZJ expects it to resemble FY20-22 levels in FY24 as EBITDA increases, cash tax reduces, and with timing of working capital impacts.

Forecasts changes

FY23 EBITDA guidance was lowered by 4% to $1420-1470m from $1470-1550m (FY23 consensus was $1505m); we downgrade to the bottom end of this guidance range. FY23/24F EPS lowered by 13%/6%, but FY25F upgraded by 9% (Network revenue cap adjustment for FY23, Bulk growth).

We downgrade DPS for FY23/24F, but upgrade FY25F alongside higher forecast earnings.

For the next 12 months, our forecast DPS of c.18 cps implies 5.2% cash yield (100% franked) at the current share price. FY25F DPS implies 7.5% yield.

Price catalysts

New contract wins in haulage. Reset of Network revenues (WACC parameters) and actual cost of debt (interest rate hedge expiry) in 2024.

Potential increase to dividend payout in FY25 as Bulk investment cycle subsides.

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.
• Weather impacts.

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