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Earnings Result Leaves Analysts Divided On Leighton
FNArena News - August 17 2009

By Chris Shaw

There were few major surprises in the full year profit result of Leighton Holdings (LEI), the engineering and contracting group posting earnings of $610 million with revenues and guidance for a flat result in FY10 all broadly in line with what the market had expected.

But the work-in-hand result is where most of the difference in analyst opinion has emerged, as for example Citi takes the view the composition of the work-in-hand number is something of a concern. While the property component of the measure has increased strongly the broker is not sure this is sustainable, while it also points out there was a slight fall in the more critical infrastructure and resources section of the order book.

The broker also notes group margins appear to be coming under pressure and while some of this can be explained by the swing to more property related work it is also an indication in its view some of the company's new work is being booked at very low margins. Credit Suisse result commentary also pointed to some margin pressure in the coming year as a point of focus.

In contrast Bank of America Merrill Lynch points out the group's current order book of $37 billion is 10% higher than it had been forecasting, while the margin on the order book currently appears to be at near record levels. Helping lift the overall level of work is guidance of a 10% increase in contract mining volumes in the coming year, which compares to the broker's previous expectation of a fall of around 5%.

On the broker's numbers, work-in-hand is now likely to push above the $40 billion mark over the coming year given the company is currently the prefererd bidder for some $10 billion in work and as this was better than the analysts had expected they have lifted their forecasts, with FY10 earnings increasing by 3% and in FY11 by 11%.

In earnings per share (EPS) terms the broker now expects 206c and 241c respectively, compared to Citi at 198.7c in FY10 and 204.5c in FY11 given it sees relatively flat earnings for three years as more likely. Consensus forecasts according to the FNArena database stand at 205.4c and 224.2c respectively for FY10 and FY11.

Just as the analysts differ on their views of work-in-hand going forward they differ with respect to ratings, the FNArena database showing the stock is now rated as Buy four times, Hold twice and Sell four times thanks to upgrades to Buy ratings from Bank of America Merrill Lynch, Macquarie and RBS Australia post the result.

The latter two have upgraded as they now see the stock as on the verge of a rolling earnings upgrade cycle given the worst of the economic downturn now appears behind the company, especially from FY11 on when earnings growth is anticipated to resume.

Macquarie puts this down to the forward order book being better than expected, while it also sees the company as a beneficiary of a stabilising economic environment globally. To reflect this the broker upped its EPS forecasts post the result by 7%, 14% and 15% for FY10 to FY12.

While the increases were greater in magnitude than those of Merrill Lynch, the latter notes the Leighton Holdings share price has traditionally had a strong correlation with work-in-hand levels, with each additional $1 billion in orders adding around $1 to the share price. Given it sees work-in-hand moving above $40 billion in FY10 the broker suggests its revised price target of $39.00, up from $24.32, may prove to be conservative, especially as the group's debt and balance sheet positions have also strengthened.

But JP Morgan takes the view the current share price more than factors in the result and outlook for work-in-hand and earnings, as even after factoring in changes to its forecasts the broker notes the share price is more than 20% above its valuation of $27.36. As a result the broker retains its Underweight rating post the result. Credit Suisse made similar points, noting at current levels the stock is trading above its longer-term historical multiple and at a premium to the sector.

Citi agrees, suggesting the share price is now trading as if a return to the heady old days of solid global growth rates is the only outcome, even when the company's CEO, Wal King, was hesitating to order additional equipment given his uncertainty as to whether the current upturn would prove to be sustainable.

Post the result the average price target for Leighton Holdings according to the database has increased to $33.35, up from $24.73 previously. This compares to a share price as at 11.50am of $36.88, the stock trading up more than 10% today despite a weaker overall market. Over the past year the stock has traded in a range of $16.15 to $47.14.