Aurizon Holdings Limited

Company Overview:  Aurizon Holdings Limited (ASX: AZJ) is a leading rail freight operator in Australia that connects miners, primary producers, and industry with international and domestic markets. The company operates three main segments – Network, Coal and Bulk. Under its Coal segment, AZJ transports coal from mines in Queensland and New South Wales to end customers and ports. Under its Network segment, AZJ is involved in the provision of access to, and operation of, the Central Queensland Coal Network (CQCN). And under its Bulk segment, the company transports bulk mineral commodities, agricultural products, mining, and industrial inputs to its customers. 

AZJ Details

Decent Growth Prospect Backed by Operational Efficiency Improvements: Aurizon Holdings Limited (ASX: AZJ) is Australia’s leading rail-based transport business that provides customers with integrated freight and logistics solutions across an extensive national rail and road network, traversing Australia. The company generates the majority of its revenue through the provision of access to, and operation of, the Central Queensland Coal Network (CQCN). As of 7 January 2021, the market capitalisation of the company stood at ~$7.19 billion. The company is focused on providing value to shareholders through managing its capital effectively and returning surplus capital to investors. In line with this commitment, the company has delivered $3.5 billion in distributions to shareholders over the past five years, including $1 billion in share buy-back. Over the last five years (2016 - 2020), the company has witnessed significant improvement in its bottom line with Statutory NPAT growing at a CAGR of ~70.26% over the period.

5-Year Financial Summary (Source: Company Report, Thomson Reuters)

By simplifying the business model and focussing on core services for its customers, AZJ has built strong foundations for itself, placing it well for long-term growth. Looking ahead, AZJ is focused on accelerating cost competitiveness and achieving competitive advantage through asset efficiency. The company expects operational efficiency improvements to remain a key driver in the business.  With a robust balance sheet and long-dated contracted revenue streams, the company seems well-positioned to fund its future operations.

FY20 Result Highlights: Despite the economic uncertainty that unfolded during H2FY20, the company delivered Earnings Before Interest and Tax (EBIT) of $909 million well within guidance and 10% higher than FY19. The rise in EBIT was driven by the increase in the revenue of Bulk and Network segment. Further, the company reported statutory NPAT of $605 million, up 28% on FY19.

During FY20, the company completed a $400 million on-market share buy-back, which delivers additional value for shareholders. AZJ’s Coal business delivered 214 million tonnes of coal for customers during FY20 and won several important contracts, including a contract extension with Peabody where it transports all existing volumes and new business in Queensland and New South Wales, and a contract with BlueScope for haulage in the Illawarra region in New South Wales. During the year, the company’s Bulk business also delivered decent results, winning various new haulage contracts and delivering ongoing cost and efficiency benefits.

FY20 Results (Source: Company Reports)

Top 10 Shareholders: The top 10 shareholders have been highlighted in the table, which together form around 20.43% of the shareholding. BlackRock Institutional Trust Company, N.A. and Vanguard Investments Australia Ltd. hold the maximum interest in the company at 3.86% and 3.24%, respectively.

Top 10 Shareholders (Source: Refinitiv, Thomson Reuters)

Key Margins: For FY20, the company’s gross margin stood at 74.5%, higher than the industry median of 39.2%. For the same period, the company reported a net margin of 19.8%, higher than the industry median of 13.3%. Current ratio stood at 0.49x in FY20. ROE for FY20 stood at 13.4%, up from 10.1% in FY19, demonstrating the company’s improving returns.

Key Metrics (Source: Refinitiv, Thomson Reuters)

Dividend History: The company has a decent track record of returning surplus capital to investors via dividends and share buy-back. Supported by consistent free cash flow generation, AZJ has delivered $3.5 billion in shareholder distributions over the past five years, including $1 billion in buy-backs. For FY20, AZJ has paid a final dividend of 13.7 cents per share, taking the total full-year dividends to 27.4 cents per share, 70% franked. Notably, the FY20 dividend was 15% higher than FY19 dividend. The company’s annual dividend yield currently stands at 7.08%, higher than the 5-year average dividend yield of 5.11%.

Shareholder Returns (Source: Company Reports)

Update on the Sale of Acacia Ridge Terminal: AZJ is in the process of completing the sale of Acacia Ridge Terminal (the Terminal) in Brisbane. The Australian Competition and Consumer Commission (ACCC) had requested the Full Federal Court to stop the sale. However, the Court unanimously dismissed ACCC’s appeal. Later ACCC lodged its application in the High Court to seek special leave to appeal Federal Court’s decision. On 8 December 2020, the High Court also rejected ACCC’s application, allowing AZJ to progress the $205 million sale of the terminal to Pacific National. AZJ has already received non-refundable payment of $35 million, and the remaining $170 million is payable on transaction completion, which is expected during 2HFY21. The sale now requires final approval by the Foreign Investment Review Board.

$300 million Buy-back Update: Post completion of $400 million on-market buy-back program in FY20, the company announced a new $300 million share buy-back, which is expected to be completed in FY21. Up to 21 December 2020, the company bought back ~60.02 million shares under the on-market buy-back program for a total consideration of ~$247.15 million and the lowest price paid on 2 November 2020 of $3.725 per share and highest price paid on 3 September 2020 of $4.460 per share.

Q1FY21 Above Rail Volumes Update:  Due to the impact of COVID-19 pandemic on coal demand and reduction of aggregate coal import volume by China, AZJ’s total coal volumes in Q1FY21 declined by 5% (YoY) to 50.0mt. It is expected that the railing will improve in H2FY21 as steel capacity comes back online in key export markets. In the Bulk segment, AZJ’s total volumes during Q1FY21 stood at 13.1mt, up 13% on pcp, driven by iron ore, principally the commencement of railings for Mineral Resources (January 2020). The total above rail volumes for Q1FY21 stood at 63.2mt, down by 2% on pcp.

Quarterly Above Rail Volumes Trend (Source: Company Reports)

Key Risks: The ongoing COVID-19 pandemic could impact the demand for coal across different countries and might create supply chain issues for AZJ.  The company may face competition from parties willing to compete at reduced margins and accept lower returns and greater risk positions than AZJ. The company’s earnings may be impacted by deterioration in counterparty credit quality, mine sale to a lower-tier party, mine profitability, contract renewals, supply chain disruptions and/or macro-industry issues.

Outlook: The future success of AZJ is reliant on key demand drivers of the Australian resources sector in global markets. Although the COVID-19 pandemic has created a short-term uncertainty around the demand for coal, the fundamental demand drivers of Australian metallurgical and thermal coal remain strong. AZJ is on track to achieve its FY21 EBIT guidance of $830 million – $880 million. The coal volumes during FY21 are expected to be in the range of 210 - 220mt. Further, the revenues during FY21 are expected to be impacted by flat volumes. The company’s priority during FY21 is the continuation of operational efficiency improvements supporting contracted volume growth.

Key Valuation Metrics (Source: Refinitiv, Thomson Reuters)

Valuation Methodology: Price to Earnings Multiple Based Relative Valuation (Illustrative)

Price to Earnings Multiple Based Relative Valuation (Source: Refinitiv, Thomson Reuters)

Note: All forecasted figures have been taken from Thomson Reuters, NTM: Next Twelve Months

Stock Recommendation: The stock of AZJ has corrected by 8.29% in the last one month and is trading below the average 52-weeks price level band, offering a decent opportunity for accumulation. On the technical analysis front, the stock has a support level of ~$3.718 and a resistance level of ~$4.44. We have valued the stock using the P/E multiple based illustrative relative valuation method and arrived at a target price with an upside of low double-digit (in % terms). For the purpose, we have taken peers like Qube Holdings Ltd (ASX: QUB), Atlas Arteria Group (ASX: ALX), Lindsay Australia Ltd (ASX: LAU), etc. Considering the company’s long-dated contracted revenue streams, growth in bottom line, decent operational and financial performance in FY20, track-record of paying regular dividends, current trading level and valuation, we give a “Buy” recommendation for the stock at the current market price of $3.890, up by 0.516% on 7 January 2021.  

AZJ Daily Technical Chart (Source: Refinitiv, Thomson Reuters)

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