Category: Financial Markets
Growth in Aurizon bulk business to offset stagnant coal. Coal prices have recovered but downward pressure is likely to remain on haulage rates and volumes due to intense competition. The coal-haulage market is highly concentrated, with few competitors and a few large customers. Commercial contracts, which are typically five to 12 years in length, underpin defensive revenue with customer commitment to take-or-pay (around 70%), pass-through of rail network access fees, and annual consumer price index increases. These contracts have helped insulate the firm from volatility in coal demand and supply factors to date.
Aurizon’s non-coal bulk-haulage operations are typically low-margin and extremely variable, with customers based in the volatile agricultural, manufacturing and mining sectors. Aurizon’s iron ore customers are typically higher-cost juniors. The long-term outlook remains challenging for these firms, despite recent iron ore strength, as low-cost majors continue to bring on new supply, despite China slowing. Aurizon’s earnings from iron ore haulage could disappear over the medium term.
Aurizon’s Central Queensland Coal Network, or CQCN, provides essential transport infrastructure for the main metallurgical-coal-mining region in Australia. The CQCN is leased from the Queensland government until June 2109, with competitor access and access charges strictly regulated by the Queensland Competition Authority. Despite being highly regulated and needing large capital investment, the CQCN is a monopolistic rail system that provides Aurizon with highly predictable long-term revenue. Typically, regulated tariffs are the main source of Aurizon’s revenue from the CQCN, with the access undertaking set every three to five years. However, until 2027 network tariffs are set under an agreement with customers.
Financial Strength
Aurizon’s financial health is sound. As of June 2021, gearing stood at 45.6%, up from 37% in 2016 and 30% in 2015.Net debt/EBITDA of 2.4 times in fiscal 2021 is reasonable, and should fall modestly in the medium term in the absence of acquisitions or share buybacks. The firm pays out up to 100% of underlying NPAT as dividends. Further share buybacks are also possible, funded by proceeds from asset sales and debt. Cash flows are relatively reliable thanks to long-term take-or-pay coal-haulage contracts and the regulated rail network business. Capital expenditure has been fairly flat since fiscal 2017 at roughly AUD 500 million each year, mainly comprising stay-in-business capital expenditure. Aurizon has completed large-scale rail network extensions and is focused on cost-cutting. Investment in the bulk division is increasing but free cash flows should remain strong.
Bulls Say
- Restructuring initiatives should substantially decrease operating costs.
- Improving efficiency, essential transport infrastructure, and reasonable level of debt should ensure steady earnings, except in the most difficult circumstances.
- Aurizon is reducing overhead costs and improving network efficiency to generate economic returns.
- The bulk division has good growth prospects, though it is dwarfed by coal-exposed divisions.
Company Profile
Aurizon operates rail haulage of coal, iron ore, and freight, and owns a regulated rail network in Queensland. Bulk export coal haulage from mine to port contributes 40% of earnings. The freight and iron ore segment contributes 10% of earnings and undertakes the rail haulage of bulk agricultural, mining, and industrial products. The rail network, composed of 2,670 kilometres of coal rail network under a 99-year lease from the Queensland government, contributes around half of earnings.
(Source: Morningstar)
General Advice Warning
Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.
Investment Thesis:
- Prices of S32’s key commodities are expected to be in moderate to relatively flat range in comparison to FY21 realised prices
- The company is expected to produce significant free cash flow over the next three years, which would be adequate to support growth and capital management
- Substantial cash balance would provide flexibility and capital management
- Board to expand S32’s capital management program by $120m to $2bn, excluding $252m to be distributed to shareholders
- Regular dividends are being paid inspite of uncertainty and volatility
- Both Standard and Poor’s and Moody’s reaffirmed their respective BBB+ and Baa1 credit ratings
Key Risks:
- Key commodity prices decrease
- Global growth experiencing significant shock
- Inflationary pressures leading to cost blowouts and production disruptions
- Capital management initiatives are not handled by company adequately
- Currencies witnessing adverse movements
- Acquisition which may negatively impact the value of the organisation
Key Highlights:
- Despite ongoing challenges put forth by pandemic, record production has been observed in Worsley Alumina, Brazil Alumina and Australia Manganese
- Divestment of South Africa Energy Coal, the TEMCO manganese alloy smelter, and a portfolio of no-core precious metals royalties with the aim to reduce capital intensity and improve underlying operating margin
- Declaration of 2H21 dividend of 3.5cps, fully franked, at a payout ratio of 46% of underlying earnings. An addition of special dividend of 2.0cps was also declared, bringing the total dividend to 6.4cps versus 3.2cps in FY20.
- Strong operating performance and higher commodity prices drove a +153% increase in underlying earnings to $489m
- Underlying EBITDA of $1,564m was up +32%
- Margin of 26.4% up from 21.9% in FY20
- Underlying EBIT of $844m was up +89% from $446m in FY20, driven mainly by higher prices in aluminium, silver, zinc, nickel partially offset by the lower prices of coal, manganese ore and alumina
- Higher sales volume of $115m
- Controllable costs of $238m; offset by change in exchanges which reduced earnings by $185m, and higher electricity costs of ($103m)
- Allocation of $346m for an on-market share buy-back
Company Profile:
South32 (S32) is a globally diversified metals and mining company. S32’s strategy is to invest in high quality metals and mining operations where their distinctive capabilities and regional model enables them to extract sustainable performance. The regional model means their businesses are run by people from within the region. The company’s African operations are supported by a regional office in Johannesburg South Africa and Australian and South American operations by an office in Perth.
General Advice Warning
Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.
