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Value Becoming The Issue For Leighton Holdings
FN Arena News - May 20 2008

By Chris Shaw

Following the Federal Budget, when the Rudd Government announced increased spending on infrastructure projects, shares in Leighton Holdings (LEI) enjoyed solid gains, rising from below $50.00 per share to close to $58.00 helped by a solid profit result for the first nine months of the group's financial year that put it on course for 30% earnings growth in FY08. (FNArena noted the move in a story entitled "Good Times Continue For Leighton Holdings", 17/5/08).

While the combination was enough to see UBS upgrade the stock to a Buy a few days after Macquarie made the same move the change occured at around the same time as JP Morgan downgraded the shares to a Neutral rating, suggesting while the group's outlook remained positive it was fully priced into the stock and so on valuation grounds it was difficult to justifying buying at such lofty levels.

Well the news keeps getting better for the group in terms of the work-in-hand outlook as yesterday a consortium in which the company was a member was named as the successful bidder for the Brisbane Airport Link project, a more than $4.0 billion dollar project in which the group is expected to take an equity stake of between 5-10%.

While JP Morgan notes there will be little near-term earnings impact from the project win ABN Amro points out it does provide a boost to later year numbers, so it has adjusted its forecasts for FY10-FY12 slightly higher to reflect this. Macquarie has seen fit to lift earnings in coming years as well, pushing up its FY09 number by 2% and its FY10 forecast by 4%, which has resulted in the broker lifting its target price on the stock to $60.09 from $54.76.

This puts Macquarie towards the upper end of the range with respect to price targets for the stock, the FNArena database showing ABN Amro leading the way at $64.00 (up from $63.00 prior to the Airport Link project win) and an average target price of $57.73, up from $56.94 previosuly.

Macquarie's Outperform rating is based on the expectation the additional work from the Airport Link contract and other projects on the group's books, which now total in excess of $32 billion, will support earnings growth of around 20% annually over the next three years.

ABN Amro is similarly positive and suggests the company is in the middle of an ongoing earnings upgrade cycle even allowing for increased economic headwinds in coming years. Additional new contract wins such as the upcoming M4 road project in Sydney offer scope for upside earnings surprise and Deutsche Bank points out the company remains incredibly well placed to win new contracts given its success rate of more than 80% on projects valued at more than $500 million.

As well, UBS points out acquisitions are also possible and there is little if any upside presently factored into its model for such moves.

But Citi now shares the concerns of JP Morgan, arguing the stock's recent rally makes the value less compelling, as even allowing for a 25% premium to the broader market for FY09 (given the strong earnings growth outlook) the broker can only come up with a price target of $57.40, which means limited upside from current levels. As a result the broker has downgraded to Hold from Buy.

Another note of caution comes from UBS, the broker pointing out while work-in-hand has increased thanks to the Airport Link contract there is now slightly higher risk for the group as the project includes some fixed price and time elements. This is where things could come unstuck, as those with longer memories will remember the difficulties the company had with a couple of similarly styled contracts a few years ago and the negative impact they had on both earnings and investor sentiment.

On the back of the news of the Airport Link contract win consensus earnings estimates for Leighton in earnings per share (EPS) terms according to the FNArena database now stand at 215.9c this year and 260.9c in FY09, while the database shows the company is rated as Buy five times, Accumulate once and Hold three times.

Shares in Leighton today are slightly weaker in line with the broader market and as at 1.30pm the stock was down 10c at $54.52. The trading range over the past 12 months has been $36.58 to $65.62.