A summary report by Austock on Australian Contractors LEI, DOW,...

A summary report by Austock on Australian Contractors LEI, DOW, TSE, UGL, titled ‘looking for sustainable profits with low risk’. The key messages of this report can be summarised as follows:

• In measuring the relative positioning of contractors, DOW was rated the preferred pick due to its high exposure to passenger rail and recurring local government spending and its geographical exposure to Australia and New Zealand
• LEI is considered to have the least desirable industry exposure (due to commercial property construction)
• UGL is considered to be more exposed to cyclical sectors than DOW or TSE due to its reliance on mining capital spend via its Rail and Resources divisions and the US services business expected to underperform as customers scale back on services
• Potential threats to contractors include: Mark to market and asset write-down’s (LEI and TSE exposed); Underperforming acquisitions at the top of the market exposed to goodwill impairment (DOW only contractor to have not made a big acquisition in the past 2.5yrs); Funding issues on large new infrastructure projects; Project cancellations or deferrals; Margin pressure (LEI most at risk due to high margins during the boom).
• Based on the abovementioned threats, DOW is considered to have the edge over its competitors.
• Order book methodology varies between contractors, with UGL and TSE beneficiaries due to currency translations.
• As a result of a series of recently announced wins by UGL, Austock expect UGL will report a larger order book at the end on FY09
• “Geoff Knox is 13 months into his role and has changed 2 of the divisional CEO’s (Consulting and Mining) and has appointed a Group Operations Manager to oversee the cost out process. We are starting to see positive changes at DOW, but we are still conscious that changing a poor culture is not an easy task and takes time. Post big write off’s in FY06 & FY07, DOW has now had 3 successive halves without earnings surprises and is slowly regaining investor confidence.”

Austock ratings:

LEI - initiate coverage with a Sell and price target $17.90, citing LEI’s more cyclical profile due to its construction exposure to property, large infrastructure projects and Dubai. Believes LEI’s operating leverage points to a likely margin contraction.

TSE – initiate coverage with a Hold and price target of $2.40, citing comfort with TSE’s positioning and lack of construction exposure. This however is overshadowed by the risk of missing FY09 guidance and losing up to three large contracts which are up for renewal.

UGL – maintain Sell recommendation and price target of $8.60, citing that despite its excellent track record its industry and geographical exposure is inferior to DOW. Believes UGL’s Resources and Rail divisions are likely to underperform in FY10

DOW – Hold recommendation, downgraded from Buy following recent share price strength, with a price target of $5.50. In the analysts opinion DOW has the best industry and geographical exposure and is the pick of the sector. “Failure to expand in the boom years has positioned DOW well on a risk front. Following 3 halves of no earnings surprises, we reduce our risk rating to medium (from high)”.