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Morningstar | No-Moat ALS Limited’s AUD 3.85 FVE Unchanged, but Market Optimistically Prices-in Much More. See Updated Analyst Note from 31 Mar 2019

We make no change to our AUD 3.85 per share fair value estimate for no-moat ALS Limited. At AUD 7.60, ALS Limited shares have pulled-back only marginally from February AUD 8.20 highs and remain at almost double our fair value estimate. The share price translates to a P/E of 21 based on our fiscal 2019 earnings forecast, too high given our longer-term outlook. Our fair value estimate equates to an unchanged 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 5.9% to AUD 362 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 longer term. We think the share price implies a market factoring-in five-year group EBITDA CAGR of more than 16%. This quantum of EBITDA CAGR and more was regularly achieved by ALS Limited during the halcyon days of the China resources boom. The market obviously feels there is pedigree upon which to anchor. But we think it will be more difficult to replicate historical growth rates on a far larger earnings base, and from life sciences rather than geochemistry. ALS has capable competition in life sciences from the likes of majors such as Bureau Veritas, SGS and Intertek. Life sciences comprised 55% of first-half fiscal 2019 EBITDA and comprises 53% of our fair value estimate.

ALS Limited continues on its share buy-back program, AUD 130 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/fair value. To date 18.7 million shares or 3.8% of the capital base has been repurchased.

We think it the more puzzling given compared with this time a year ago, net debt has increased 35% to AUD 587 million, ignoring operating leases. While not life-threateningly 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.

The strategy remains for expansion into new geographies (Asia, Americas, Europe), with a focus on bolt-on and strategic acquisitions with a minimum return on capital employed of 15%. The most recent purchases were in February for a total AUD 51 million in cash, including a pharmaceutical and personal care testing company in the U.S., and a maritime and industrial inspection business in Chile. ALS exploited overpriced scrip to great effect in recent decades to effectively purchase businesses on comparatively favourable multiples. We don’t think the current strategy of instead using cash for buy-backs, is likely to allow as favourable EPS accretion.

We make no change to our fiscal 2019 NPAT forecast of AUD 177 million, and ALS has not updated guidance for AUD 170-175 million provided with its first-half earnings release in November last year. Our above-high-end-of-guidance forecast acknowledges favourable conditions for geochemistry markets persisting at least into the near term. Global spend on exploration activities has rebounded but our longer-term outlook remains for price retreat for a suite of commodities in real terms to less favourable midcycle forecasts.