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Leighton 1H13 – deleveraging and industry headwinds

by William Arnold | Aug 20, 2013

A mixed 1H13 result with higher revenues but lower operating cashflows resulting in increased gearing of 36% compared YE12 of 33%.   Management’s strategic priority in 2H13 is to reduce working capital, which they believe will drive gearing to “below 30%” by YE13.  Given recent market volatility, Leighton’s USD 2022s are currently offering one of the widest spreads among Australian Yankee bonds and while there are industry and corporate governance concerns the current levels do offer investors an attractive entry point. Investors may also be attracted to USD issues if they believe the AUD will continue to depreciate relative to the USD.

Net operating cashflow generation was -$9m in 1H13 (vs $1.1bn in the prior half) driven by a surprise increase in receivables of $600m and a $400m decrease in trade payables. Management said that an increase in underclaims was the main driver of the increase in receivables, with two main sources:

1) scope increases in oil & gas (i.e. unplanned increases in work performed but not yet billed) and

2) challenges in the coal industry.

As background, underclaims represent work or variations that have been performed for customers but have not yet been billed. Once billed, they become contract debtors. Both debtors and underclaims are recorded within trade receivables, which currently total $4.4bn. Management is expecting a $500m reduction in underclaims in 2H13, and has said that the amount of underclaims has reduced post-June balance date.

Exposure to the Middle East through Habtoor Leighton Group (HLG) remained unchanged (around ~$900m through an equity stake of 45%, loans and receivables). Reducing this balance remains one of the key's to Leighton's balance sheet deleveraging. HLG's underlying performance improved in the half, achieving a break even pre-tax result (vs -$43m).

Excluding build up in working capital, funds from operations of $1.3bn was 38% higher than 1H12. Annualised Funds from operations/Debt reached 99% in 1H13 which is higher than the 45% expected by S&P for the BBB-. Leverage on a Debt/Annualised EBITDA basis was less than 1x, well within Moody’s expectations of 2.75x for the Baa2 rating.

The above mentioned working capital issues resulted in gearing remaining above the 25%-35% management target. The CEO stated that gearing would fall below 30% by year-end on the back of improvements in working capital.

Leighton has strong liquidity of $3.8bn consisting of $1.9bn in cash and $1.9bn in undrawn facilities against maturing debt of between $400-500m per year over the next 3 years.

Work-in-hand (WIH) is currently around $42bn. The breakdown of WIH is 48% infrastructure, 9% property, 37% contract mining (mostly coal) and 6% resources construction. Management noted a 20% drop (vs 1H12) in contract mining WIH.  70% of WIH is domestic and the remaining is international.

Management maintained its guidance of $520-$600m underlying NPAT for FY13. Management has also flagged cost reductions and stronger risk management frameworks across the operating companies in an effort to improve profit margins over time (group pre-tax margin objective of 3-4% vs 2.2% in 1H13).

Relative value

During the May-June sell off, Australian Yankee bonds were one of the hardest hit sectors of the Australian credit market. This volatility has led to attractive relative value.  In particular the Leighton USD 2022s are currently one of the highest spread bonds in the Australian Yankee market offering some 100bps more than comparable Aus Yankee BBB/BBB- bonds. 

While there are industry concerns (reports of mining contract cancellations) and corporate governance concerns surrounding the intentions of majority shareholder, Hochtief/ACS, the current levels do offer an attractive entry point.  Investors may also be attracted to USD issues if they believe the AUD will continue to depreciate relative to the USD.  Please call you FIIG representative for more information.

All prices and yields are a guide only and subject to market availability. FIIG does not make a market in these securities.