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Fin. Services Guide


Huntleys' Investment Information Pty Ltd

Australian Financial Services Licence No. 240892

ACN 090 665 544
ABN 95 090 665 544
Level 36, Australia Square
264 George St
Sydney, NSW 2000

Tel: 1800 03 44 55
Fax: (02) 9475 4196

<<< Previous Article Issue 21 (05/06/2008) Next Article >>>

Babcock & Brown Limited (BNB)
Previously Reviewed:--


Recommendation: Buy Price: $10.61

Sector
Asset Origination & Funds Management
Market Cap
$3536.3
52 Week High/Low
$34.78 - $11.90

2 Year Price Chart



Note: Marker indicates price of $10.61 at publication date.
Risk
Moat Rating: Narrow
Business Risk: Medium/High Pricing Risk: High

Year 12/05(a) 12/06(a) 12/07(a) 12/08(e) 12/09(e)
NPAT ($m) 180.0 308.6 525.1 632.0 731.8
EPS (c) 73.4 115.4 160.7 177.4 205.4
% Change 73.9 57.2 39.2 10.4 15.8
DPS (c) 23.0 36.0 54.4 64.0 75.0
Franking (%) 38.0 50.0 50.0 50.0 50.0
Dividend Yield (%) 2.17 3.39 5.13 6.03 7.07
PER 14.46 9.19 6.60 5.98 5.17

Source: Aspect Huntley analyst estimates

Avge Annual Growth Rates 10yr 5yr 1yr
Earnings per Share -- -- 49.0%
Dividends per Share -- -- 51.1%





AGM reassures on earnings guidance


At its AGM BNB reiterated guidance for FY08 NPAT of at least $750m, or 15%+ growth above FY07 due to:


* Strong locked-in growth in recurring revenue from the specialist fund and asset management platform


* Significant growth in revenue from the development pipeline in wind energy, power transmission, PPP projects and residential real estate developments


* A record $5bn+ in committed uninvested capital across the specialist funds platform, concentrated in infrastructure and aircraft leasing


* Acquisitions already made by the specialist fund platform in FY08.


This reassured the market on the day, but only briefly. Having bottomed at $12.26 on March 17, the day the US Federal Reserve rescued Bear Sterns, the shares ran up to $16.45 in early May. Subsequent falls have been due to:


* The correction on the broader market


* Dull earnings guidance from peer Macquarie Group


* Earnings downgrades and negative commentary pertaining to US investment banks


* Babcock & Brown Power's (BBP) embarrassing admission to a shortfall of $300m in funding capital expenditure. This caused heavy falls in other B&B listed funds


* The collapse in the share price of UK bank Bradford & Bingley, and a deeply discounted placement and rights issue


* Various bad news from other banks and a feeling the credit crisis could continue for months yet, both triggering fresh falls in financial stocks around the world.


Currently BNB shares are extremely 'high-beta', meaning on most days they will rise or fall more than proportionately relative to the market. This makes the stock an interesting leveraged trade/short for those bullish/bearish on the index. The shares will remain sensitive to sentiment on US investment banks and financial stocks more broadly. There will be no sustained recovery in the share price until the credit crisis is perceived to have ended and financial stocks make a general recovery.


However, while investors wait for the credit crisis to end we think the stock deserves a better rating than a 6 PER, where it is priced to go broke or suffer lasting, serious impairment. We think BNB will be around a long time as we predict investor demand for infrastructure will remain strong and private funding of infrastructure around the world will increase, creating opportunities for BNB and its peers.


Our $36.00 valuation is based on a FY09 PER of 14.5 times - less than our Macquarie Group valuation of 16.0 times - which reflects a long-term view of the business and doesn’t assume another bull market in financial stocks. The valuation might currently seem generous but the multiple looks past the credit crisis and does not price in short-selling or margin calls. Even a multiple of 10 times FY08 earnings gives a $17.74 valuation, 62% above current prices. Investors can see the major fear priced into the stock. Essentially we think the stock will be rerated due to:


* Gradual recovery in equity and debt markets coinciding with intensive efforts by the BNB group to demonstrate the value of its assets


* Successful refinancing by group entities


* Growth in funds under management from the development pipeline


* Ongoing asset recycling and the growth of cash and undrawn facilities towards management's target


* The establishment of new wholesale funds and asset management mandates focused on specific regions and asset classes


* Investment of the specialist funds’ uninvested capital.


The risks to this view, or the bear points, are:


* Deal slippage or more writedowns triggering a downgrade to the FY08 guidance


* Asset prices stagnate, reducing principal investment revenue (where BNB makes a one-off profit on selling assets off its own balance sheet). BNB is not able to make up the difference with recurring revenue. NPAT falls in FY09


* The credit crisis drags on into 2009, keeping sentiment on financial stocks depressed


* The complex accounts catch up with shareholders. An important transaction or development fails because of inability to refinance


* The poor security price performance of listed BNB funds discourages investors from investing in new unlisted funds.


* BBP is unable to refinance its corporate facility, turning BNB's provision of bridging finance into a longer-term proposition


* In an environment of greater scrutiny of listed infrastructure funds the BNB group is unable to resolve its internal conflicts.


Before the credit crisis began we rated BNB's business risk as medium-high and share price risk as high. In light of the risks, these ratings remain.


The upside risks, or bull points, are:


* The credit crisis ends in coming months and sentiment on global financial stocks recovers


* The current inability to list new funds on the ASX doesn't stop earnings growth. New wholesale (unlisted) funds make up the difference


* BNB and its funds refinance their debt as it matures, on terms not materially worse. Despite the credit crisis this is the trend, for example Babcock & Brown Infrastructure's (BBI) refinance this week of its Alinta funding. The BBP debacle was an exception


* BBP refinances using bank debt after a short period using bridging finance from BNB


* The equity market recovers substantially and talk turns to when BNB will resume launching listed funds


* The market decides BNB is undervalued.


Having spoken with the company at length this year we were confident in the earnings guidance, which is after provisions and writedowns and is probably conservative. The non-cash items and the timing of windfarm sales this year will shift all earnings growth to the second half of the year.



BNB needs to rework its business model


The main problem for BNB is not investor demand for infrastructure, nor the company's development pipeline which continues to grow, but the impairment of the listed infrastructure fund as the vehicle for delivering the infrastructure to investors. This is a direct result of the credit crisis. BNB's funds are highly geared, unable to raise fresh equity because security prices have fallen to dilutive levels, have low interest cover, credit ratings and low coverage of distributions, and overpaid for Alinta. Allowing this to happen has damaged BNB's reputation, a point the Chairman admitted at the AGM. While the underlying assets are mostly of quality and are performing well, the funds' financing reflects a bygone era of cheap and readily available debt and equity.


We have also been critical of the conflicts created by external management of infrastructure funds. BNB has incentive to add more assets to increase base and advisory fees but this increases gearing, dilutes returns on the best assets and raises ongoing questions about which party got the better deal. Corporate governance consultancy RiskMetrics' April report touched on this, among other concerns.


BNB also acknowledges it needs to reduce complexity and communicate better with the market. The credit crisis exposed both, particularly in the case of BBP's refinancing.


Management says its main short-term objective is to close the gap between the listed funds' net asset values and their security prices. There are a number of ways to do this other than privatising the funds. In our view the main long-term challenge is to have a distribution model which works under all market conditions. That, or become more fleet-footed as markets change. Bad press and fear about the listed funds has swamped all the good or reassuring news about the rest of the business, including the switch to unlisted funds. The North American wholesale infrastructure fund is on track to raise US$2.5bn, not the US$2.0bn originally forecast, and the Asian wholesale infrastructure fund looks set to raise more than its US$1.0bn target.


At the AGM BNB confirmed there is no 'remotely material' debt against any director shares. So there are no margin call triggers for hedge funds to target.





<<< Previous Article Next Article >>>


© Copyright Huntleys' Investment Information Pty. Limited (HII) (a wholly owned subsidiary of Morningstar, Inc.), 2008. All rights reserved. Australian Financial Services Licence no. 240892. No material may be reproduced, except as allowed by the Copyright Act, without the prior written approval of HII. Some of the material provided by HII is copyright and is published under licence from ASX Operations Pty Limited ACN 004 523 782 ('ASXO'). Consensus forecast data is copyright Thomson Financial.



DISCLAIMER: While the above-mentioned advice and information are based on information, which HII consider reliable, its accuracy and completeness cannot be guaranteed. This report is made without consideration of any specific clients investment objectives, financial situation or particular needs. Accordingly, the client should, before acting on the advice, consider the appropriateness of the advice, having regard to the client's objectives, financial situation and needs. Those acting upon such information do so entirely at their own risk. For a copy of HII's Financial Services Guide, please go to http://www.aspecthuntley.com.au/FSG or phone HII on (02) 9276 4544 to request a copy.



DISCLOSURE: The directors and associated persons or entities of HII may have an interest in the securities discussed in this report.






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