citi initiates coverage on aio with a ...buy, page-6

Merrill Lynch report:

Focus now turns to return on assets

John Mullen will replace Mark Rowsthorn as CEO from next Monday. Mullen?s track record appears strong (CEO of DHL Express, significant transport/logistics experience), and his focus on returns seems to be aligned with Broomhead?s ROIC mantra. We believe the exit of Rowsthorn increases the chance that AIO explores options for its Container Ports. Even after last year?s write-down, ROIC in this Division is just ~6.5% versus PN Coal at 10%.
FY11E EBIT $539m

Our FY11E EBIT has been lowered by 1.5% after factoring in softer volumes at Container Ports and Intermodal. The system growth at the ports has slowed to 4% in the Dec quarter. We now forecast lifts at Patrick?s to increase by 2.5% in FY11 (was 3.5%) and 4.5% in FY12 (was 5.35%). This has a flow-on effect in Intermodal, where we expect NTK growth of just 3% in FY11 vs 4.75% previously.

Valuation remains at $1.80

We have factored in ~30mt of uncontracted coal haulage volume into our PN Coal forecast, equivalent to 50% of the imminent port expansions through to FY15.

This mirrors our QRN model and delivers a ~8cps upside to our valuation. As such, this offsets the decline in NPV at Container Ports and Intermodal on the back of the downward revision of growth rates.

Neutral maintained

With consensus FY11 EBIT at $550m, more downgrades across the Street are likely. We believe management may soften the FY11 outlook at the 1H announcement to give Mullen a clean slate to work with. We are expecting EBIT of $272m (pcp $228m) for 1H11, with QLD Coal contributing $36m of growth.

Targeting 22.6% EBIT growth
After making some revisions to our growth assumptions in the Container Ports
and Intermodal segments in FY11, we are now forecasting EBIT of $539m for the
year (previously $547m). This implies 22.6% growth vs. pcp.
The key changes we have made include:
􀂄 2H11 volumes: We are now expecting AIO?s volumes to grow by just 4% in
2H11, or 2.5% for the year. Previously we were at 3.5% in FY11 and our
revision comes on the back of recent discussions with Melbourne and
Sydney ports, who both suggested that volumes are looking soft. PoMC in
particular is expecting just 3-4% growth in volumes in CY11. Our adjustment
has taken ~$5m off our FY11 EBIT estimate.
􀂄 FY12 volumes: On the back of a softer CY11, our FY12 growth at Patrick?s
is now 4.5% vs. 5.35% previously, and this takes a further $4m off our FY12
earnings forecasts.
􀂄 Intermodal: With soft volumes at Container Ports, this will likely have an
impact on demand of services by freight forwarders. As such, we have
wound back our NTK growth forecast down to 3% from 4.75% previously.
The cumulative effect of these changes means that our FY11 EBIT is now $539m
and FY12 is now $625m (was $642m). However, our FY13 remains largely
unchanged at $684m (was $689m) due to the new assumptions we have made
around future coal haulage contract wins.

Applying new coal haulage assumptions
A large number of new coal haulage opportunities are expected to eventuate in
QLD and NSW over the next three years. The most imminent projects include
Northern Missing Link (23mt yet to be awarded), Hay Point expansion (11mt) as
well as NCIG Phase 2a (23mt). In our recent QRN initiation, we assumed that
these near term prospects are split 50/50 between QRN and AIO. As such, we
now factor in the ~30mt into our AIO model. These are volumes that company
has yet to capture.
We note that BHP/BMA dominates these expansion opportunities, owning over
30% of the volumes, while RIO and QCoal will have around 15% each. It is
difficult to forecast how the miners will award the unallocated volumes between
AIO and QRN, but for now we are comfortable with our 50/50 assumption.
We anticipate that these yet to be contracted volumes will come on line
progressively between FY13-FY15, reflective of our expectations for the ramp up
profiles at the ports. The charts below highlight our assumptions, which mirror the
growth profile we have applied to our QRN modelling.

Valuation remains $1.80/share
Our AIO valuation remains unchanged at $1.80 per share. The decrease in value
on the back of downgrades to Container Ports and Intermodal has been offset by
uplifts in our PN Coal valuation.

New CEO appointed
AIO has today appointed John Mullen as its CEO, to commence next Monday
14th February. This announcement comes as a surprise. Mullen was previously
the Global CEO of DHL Express and is also a non-executive director at TLS,
MAP and BXB, although he has signalled his intentions to retire from the Boards
of MAP and BXB.
Mullen had a strong track record at DHL, where margins at the business outside
of the US nearly doubled under his leadership. He also has significant
restructuring expertise, which is helpful given AIO?s current reorganisation into 3
divisions. It seems that Mullen has overcome the health reasons that forced him
to retire from DHL.
Implications of the management changes
Broomhead is evidently taking charge of the company, and this appointment
continues the changes in top level management which began when Angus McKay
was brought in as CFO last year. Given Broomhead?s focus has always been on
ROIC, we believe the exit of Rowsthorn has increased the likelihood that Patricks
could be divested. We note that Rowsthorn still holds 3.85% of AIO.

We estimate that even after last year?s $1bn write-down of goodwill, Container
Ports is achieving ROIC of just ca. 6.5%. On the other hand, PN Coal is returning
10% at present and trending upwards as new haulage contracts are captured. In
addition, the partial sale of DP Australia to Citi Infrastructure late last year at
13.0x 2010E EBITDA would not have gone unnoticed.
We acknowledge the valuation upside that could come from selling the Ports
division. We estimate that Ports is currently trading on 9.5x 2010E EBITDA, but
we note that:- (i) the Strategic Review is still to be completed so any value
realisation is months away, (ii) global ports trade on an average of 11x so not
that much upside to AIO?s Ports, & (iii) there is no certainty of buyers given
Hutch?s imminent entry into the market.
Broomhead has advised that AIO?s annual Strategic Planning Process will
commence shortly, although the agenda has not been disclosed. But with the
company confirming that the focus will be on shareholder returns, it seems to us
that at the very least, AIO will explore options for Patrick?s.
Lastly, we wonder what effect these changes have on the second tier of
management at AIO. We believe Paul Garaty, David Irwin and Chris Keast are
viewed positively by the market, but all have close relationships with Rowsthorn.
These Department Heads have seen a new CEO, CFO and Head of Strategy all
appointed within the last six months.