Emeco Holdings Limited

Company Overview: Emeco Holdings Limited (ASX: EHL) is engaged in selling, renting, and maintaining heavy earthmoving equipment to customers in the mining industry in Australia and overseas. The company was established in 1972 and was listed on ASX in July 2006. 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

Broadened Customer Base and De-leveraged Balance Sheet: Emeco Holdings Limited (ASX: EHL) is engaged in the business of selling, renting, and maintaining heavy earthmoving equipment to customers in the mining industry in Australia and overseas. As on 10 November 2020, the market capitalization of the company stood at ~$435.24 million. During FY20, the company has made significant progress on its growth objective to build a sustainable business that generates shareholder value through the cycles.

Over the years, the company has witnessed decent growth by securing longer-term contracts across Australia and wider customer base. The company is diversifying its commodity exposure with business growing around coal, and gold and iron ore revenue increasing by 2.7 times. The company further increased its resilience with the addition of several long tenure contracts and extensions with Whitehaven, Saracen, and Evolution. The company is likely to witness a growth in its production due to the open pit mining contract for Red 5 Limited’s Great Western Project. It is also likely to widen the value proposition of Pit N Portal.

During FY20, the company has reduced the cost of rebuilding own equipment and is working on improving the ROIC. With the expansion of its service offering through the acquisition of Pit N Portal, the company has seen an increase in mid-tier mining customers. The operating revenue of the company went up to $540.4 million in FY20 because of improvements in rental rates on new and renewed contracts and increased operating utilization of the rental fleet.

Despite the global headwinds in 2020, the company generated free cash flow of $71.2 million, deleveraging its net debt/operating EBITDA further down to 1.46x, below its target of 1.5x. The company is reducing its debt and is optimizing its capital structure and reported a cash balance of $198.2 million at 30 June 2020. At the end of the period, the company also reported decent profitability with an increase of 10% in operating EBIT to $138.2 million. The company’s mid-life equipment model, along with the rebuilding capability of workshops is helping the company to reduce its costs and has facilitated another year of strong return on capital at 21%, above its cost of capital of 9%. The rental segment of the company witnessed a continued growth in earnings and margins, driven by strong customer demand and ongoing focus on costs.

Summary of Operating Costs (Source: Company Reports)

Details of Top 10 Shareholders: The following table provides an overview of the top 10 shareholders of Emeco Holdings Limited.

Top 10 Shareholders (Source: Refinitiv, Thomson Reuters)

Higher Profitability and Stable Balance Sheet: During FY20, gross margin of the company stood at 25.1% and reported higher profitability with an increase in EBITDA margin from 42.8% in FY19 to 44.5% in FY20. In the same time span, the company managed its costs and reported a net margin of 12.2%, higher than the industry median of 8.1%. During FY20, the company well-managed the capital of its shareholders and reported an improvement in Return on Equity to 23.8%, up from 19.2% in the pcp. Looking into the balance sheet, the company reported a decent liquidity position with current ratio of 1.43x in FY20, higher than the industry median of 1.26x. During FY20, the company deleveraged its balance sheet as evidenced by a fall in debt/equity ratio to 1.74x, from the prior year ratio of 2.36x. The business also seems to be financed with a larger proportion of investor funding and retains a financially stable balance sheet with assets/equity ratio of 3.05x, down from 3.88x in FY19.

Key Margins (Source: Refinitiv, Thomson Reuters)

Emeco Repays its 2022 Notes: The company has repaid 100% of its outstanding March 2022 notes of US$142 million. The repayment was funded from the existing cash and the net proceeds of the recently underwritten pro rata entitlement offer of $149 million. The company has activated an option to extend the maturity of its $97 million revolving credit facility to September 2023 due to the completion of refinancing and repayment of notes. The combined transactions have resulted in a healthy balance sheet with an extension in debt profile to FY24, pro-forma net debt $224 million and net leverage ratio of 0.9x.

Five-Year Financial Summary: Over the span of 5 years from FY16 to FY20, the company reported a significant increase in revenue from $167 million in FY16 to $540 million in FY20. This reflects a CAGR of 34.10%. In the same time span, basic EPS of the company turnaround from negative 15.1 cents to positive 20.2 cents. This shows that the company is expanding its margins by lowering its costs. EHL has also reported a decent improvement in its balance sheet with total assets rising from $427 million in FY16 to $1.08 billion in FY20.

Five Year Financial Summary Source: Company Reports

Key Investment Risks: The company is susceptible to a variety of risks, including supply chain risks, inability of the group to deliver its products and services, and the likelihood of disruption to the operations of the group’s customers. The group is actively managing the impacts and risks arising from COVID-19 and also has the exposure of financial risks, including credit risk, liquidity risk, and market risks from its financial instruments.

Future Expectations and Growth Outlook: The company is likely to report another solid year in FY21, with focus on new longer tenure, fully maintained contracts, and additional commodity diversification. EHL seems well-placed to service market demand and remains confident in its ability to redeploy fleet into new projects. It is executing its strategic objective of diversifying its commodity exposure and is aiming to be the lowest cost and highest quality provider of mining equipment. The company is judiciously allocating capital to generate healthy returns and drive decent free cash flow.

Key Valuation Metrics (Source: 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: The company may see strong demand in gold and iron ore and is likely to witness strong growth momentum in FY22 because of project wins in Pit N Portal and Eastern Region. As per ASX, the stock of EHL is trading at attractive levels, close to its 52-weeks’ low levels of $0.457. The stock of EHL corrected by 13.03% in the past three months.On a technical front, the stock of EHL has a support level of ~$0.594 and a resistance level of ~$1.068. We have valued the stock using the EV/Sales multiple based illustrative relative valuation and have arrived at a target price offering an upside of lower double-digit (in % terms). Considering the current trading levels, de-leveraged balance sheet, improving margins, and five year performance summary, we recommend a ‘Buy’ rating on the stock at the current market price of $0.840, up by 4.999% on 10 November 2020.

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

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