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Morningstar | ALS Limited Hits High End of 1H Fiscal 2019 Earnings Guidance. No Change to AUD 3.85 FVE.

We make no change to our AUD 3.85 per share fair value estimate for no-moat ALS Limited. The materials testing company reported a 29% increase in underlying first-half fiscal 2019 net profit to AUD 90.3 million, at the high end of AUD 85-90 million guidance, and ahead of our low-end AUD 85.2 million forecast. However, the key driver of profit beating our mark was lower-than-anticipated depreciation, a poorer quality noncash driver. Net operating cash flow underwhelmed at AUD 87.6 million, down a third on second-half fiscal 2018. The majority reflects a build in working capital rather than any systemic issues, but disappointed regardless. The interim dividend of AUD 11.0 cents was slightly ahead of our AUD 10.4 cent target, reflecting an expected 60% payout but on the slightly higher earnings.

Generally speaking, divisional revenue was ahead of our expectations, but at lower than anticipated margins. Life sciences EBITDA margin fell only slightly to 20% from 20.5%, with declines in the U.S. and Asia. But the industrial segment suffered a sharp margin decline with new maintenance contracts generating increased revenue but at lower margin--the market remaining highly price sensitive. The exception was minerals where both revenue and margin beat our forecast, including an increase in EBITDA margin to 30% from 26.5%. This came courtesy of a 14% pcp increase in sample volumes on strong commodities markets. The global spend on exploration activities has continued to rebound, but our longer-term view remains less optimistic, anticipating price retreat for a suite of commodities in real terms to our midcycle forecasts.

ALS Limited has provided first guidance for fiscal 2019 NPAT of AUD 170-175 million, and we increase our forecast by 4% to a high-end AUD 177 million, from AUD 170 million prior. An upgrade to our Minerals forecast - following the strong first half result--more than offsets a reduction in our life sciences estimate.

While we are bearish, favourable conditions for geochemistry markets are expected to persist in the near term.

At AUD 7.90, ALS Limited shares have pulled-back marginally from recent AUD 8.25 highs but remain at almost double our fair value estimate. The share price translates to a P/E of 22 based on our fiscal 2019 earnings forecast, too high given our longer-term outlook. Our fair value estimate equates to a little changed fiscal 2023 EV/EBITDA of 7.3, P/E of 12.8, and dividend yield of 4.7%, all discounted at WACC. In nominal terms, the P/E and yield improve to 8.2 and 7.4%, respectively. We think this aggressive enough, particularly given our already bullish outlook. We forecast group EBITDA to grow at a five-year CAGR of 6.1% to AUD 366 million by fiscal 2023. This includes strong 9.1% growth for life sciences, more modest 3.1% growth for industrial including tribology, but pedestrian 1.3% growth for minerals in line with our forecast for declining commodity prices. We think the share price implies a market factoring-in five-year group EBITDA CAGR of 16.7%. This quantum of EBITDA CAGR and more was regularly achieved by ALS Limited during the halcyon days of the China resources boom. But we think it will be more difficult to replicate on a far larger earnings base, and from life sciences rather than geochemistry.

ALS Limited continues on its share buyback program, AUD 122 million of the total AUD 225 million target to December 2019 completed. We continue to view this a poor use of funds given the price premium to fair value. To date, 17.5 million shares or 3.5% of the capital base has been repurchased. We think it the more puzzling given net debt versus this time a year ago has increased 35% to AUD 587 million, and that is ignoring operating leases. While not astronomically high, annualised net debt/EBITDA of 1.7, or 2.4 including operating leases, is somewhat elevated at a time when acquisitions in life sciences remain core to the growth strategy.