Emeco Holdings Limited

Company Overview: Emeco Holdings Limited (ASX: EHL) is engaged in selling, renting, and maintenance of heavy earthmoving equipment for customers in the mining industry in Australia and overseas. The company provides EOS, equipment productivity and management tool, for both Emeco and customer-owned fleet and generates earnings from the provision of equipment rental and maintenance solutions to the earthmoving industry. The group supplies safe, reliable, and maintained equipment rental solutions to its customers and offers repair and maintenance and component and machine rebuild services for its customers’ equipment.

EHL Details

Decent Earnings and Returns in FY20: Emeco Holdings Limited (ASX: EHL) is engaged in the selling, renting, and maintenance of heavy earthmoving equipment for customers in the mining industry in Australia and overseas. As on 4 August 2020, the market capitalization of the company stood at ~$351.97 million. Despite the challenges of COVID-19, EHL continued to execute upon its strategy of creating a more sustainable and resilient business. Earnings of the company continued to grow, supported by its large fleet of in-demand assets, and the acquisition of specialist underground mining services business, Pit N Portal. The company retains a broader customer value proposition, a more balanced commodity mix and diverse customer base. It is focused on managing costs while prudently allocating capital to generate strong returns and drive strong free cash flow.

During FY20, EHL continued to grow its rental operations, securing several key longer-term contracts across Australia. It also continued to build Force workshops business, thereby broadening its customer service offering. During FY20, the company reported another year of increased profitability with operating EBITDA of $246.1 million, reflecting an increase of 15% on FY19 and operating EBIT of $138.2 million, up by 10% on FY19. This was mainly due to increased operating utilization of the rental fleet and improvements in rental rates on new and renewed contracts. While COVID-19 crisis did not substantially impact the business of EHL, the company saw a slight decline in utilization in Q4 and received some off-hire notices in the Eastern Region. In the Western Region, there were some increased costs related to social distancing and due to border closures.

The strong earnings and cash flow generation in FY20 further reduced the net debt of the company, resulting in leverage falling below its 1.5x FY20 target to 1.46x from 2.0x in FY19. Whilst the focus of the company on cash flow and deleveraging is unchanged, a stronger and more resilient balance sheet will provide the board with more flexibility to capital deployment moving forward. As at 30 June 2020, the company reported an increased cash balance of $198.2 million, largely due to the conversion of EBITDA to net operating free cash flow and $97.0 million drawdown of the revolving credit facility.

The deleveraging strategy of the company has been unwavering over the past five years and generated decent earnings and cash flows to drive operational focus.

FY20 Financial Highlights (Source: Company Reports)

Details of Top 10 Shareholders: The following table provides an overview of the top 10 shareholders of Emeco Holdings Limited. Black Diamond Capital Management, L.L.C. is the largest shareholder in the company, with a percentage holding of 17.94%.

Top 10 Shareholders (Source: Refinitiv, Thomson Reuters)

Key Margins: During FY20, gross margin of the company stood at 25.1%. In the same time span, EBITDA margin of the company was 44.5%, higher than the industry median of 22.3%, indicating higher profitability. During the year, net margin of the company witnessed an improvement over the previous year and stood at 12.2%, up from 7.2% in FY19. This indicates that the company is well managing its costs and is capable of converting its revenue into profits. In the same time span, Return on Equity of the company was 23.8%, as compared to the industry median of 8.3%. This suggests that the company is well managing the capital of its shareholders and can generate profits internally. During FY20, current ratio of the company stood at 1.43x, up from 1.29x. This shows that the company is liquid enough to pay its current liabilities using its current assets. In the same time span, debt/equity ratio of the company was 1.74x, and assets/equity ratio of the company stood at 3.05x, lower than the previous year ratio of 2.36x and 3.88x, respectively.

Key Margins (Source: Refinitiv, Thomson Reuters)

Segment Business Overview: The Company’s business operations comprise three segments: Rental, Pit N Portal and Workshops. During FY20, revenue from the Rental segment increased by 5.9% to $425.1 million with operating EBITDA margins increasing from 58.3% in FY19 to 61.0% in FY20 as strong cost controls and operating efficiencies continued to impact positively on the results. Total Workshops activity increased from $114.7 million in FY19 to $163.8 million in FY20, reflecting a significant increase of 42.8% on YoY basis. Together with mid-life equipment model of EHL, the workshops rebuild capability is integral to reduce costs and has facilitated another year of strong return on capital at 21.0%, well above the cost of capital. The Pit N Portal segment was established via acquisition on 28 February 2020 which provides a range of mining services solutions and associated services to customers in Australia. During FY20, Pit N Portal earned revenue of $35.3 million and Operating EBITDA of $9.0 million at a margin of 25.5%. Pit N Portal has also improved its commodity and customer diversification through a number of long-term hard rock projects with mid-tier mining customers.

Rental Division Financial Highlights (Source: Company Reports)

Key Risks: The onset of COVID-19 has impacted the earnings in 2H20 because of some additional costs and the fall in coal price, resulting in a reduction in utilization in the Eastern Region. The preparation of the consolidated financial statements requires management to make judgements, estimates and assumptions, which may be impacted by unforeseen events. The group is also exposed to credit risk, liquidity risk, and market risk.  

Future Expectations and Growth Opportunities: The company is likely to witness another successful year in FY21 because of its increased focus on new longer tenure, fully maintained contracts, providing additional commodity diversification. With the equipment market remaining tight, EHL seems to be well placed to service market demand and is confident in its ability to redeploy fleet into new projects. Post the long-term contract awards and extensions with Saracen and Evolution in FY20, the company is likely to witness strong demand in gold and iron ore, which will support continued growth in earnings and margins in the Western Region.

The Group also expects strong bidding activity across all Rental regions and Pit N Portal despite the price decline for coal. Softness in coal markets may limit short term growth. However, current conditions do not indicate a significant decline in earnings in FY21. EHL expects growth in FY22 as the Western Region continues to witness strong momentum, Pit N Portal wins further projects and the Eastern Region places equipment into new, fully maintained projects. The company is focused on improving quality, cost effectiveness and efficiency through continuous improvement projects and implementing technology-based systems and processes. It is investing in technology and systems to facilitate growth and widening its value proposition. It aims to further increase the resilience of the business by continuing to grow customer, revenue, and commodity diversification.

Key Valuation Metrics (Source: Refinitiv, Thomson Reuters)

Valuation Methodology: EV/Sales Multiple Based Relative Valuation Approach (Illustrative)

EV/Sales Multiple Based Relative Valuation Approach (Source: Refinitiv, Thomson Reuters)

Note: All the forecasted figures are taken from Thomson Reuters, NTM: Next Twelve Months

Stock Recommendation: EHL is executing its strategic objective of diversifying its commodity exposure. It aims to be the lowest cost, highest quality provider of mining equipment and is focused on diversifying its commodity exposure. As per ASX, the stock of EHL is inclined towards its 52-weeks’ low of $0.485, proffering a decent opportunity for the investors to enter the market. We have valued the stock using the EV/Sales multiple based illustrative relative valuation approach and have arrived at a target price of lower double-digit upside (in percentage terms). Considering the attractive trading levels, decent performance in FY20, and a positive long-term outlook, we recommend a ‘Buy’ rating on the stock at the current market price of $0.935, down by 2.094% on 04 August 2020.

EHL Daily Comparative Chart (Source: Refinitiv, Thomson Reuters)

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