EUR 850.00 For Business Accounts Only

Morningstar | Tough September Quarter for Aurizon; No Change to FVE

Narrow-moat Aurizon's volumes fell moderately in the September quarter 2018 but performance should improve over the rest of the fiscal year. We maintain our forecasts for mid-single-digit falls in EBITDA in fiscal 2019 and 2020, before recovery from 2021. Our AUD 3.80 fair value estimate is unchanged, and at current prices, the stock is roughly fairly valued.

Strong coal prices should underpin earnings in the haulage business in the near term, while earnings for the regulated rail network are expected to fall materially once the new regulatory tariffs are implemented. Aurizon has delayed start of the new tariffs by taking the regulator to court, but regulatory decisions apply retroactively once finalised so any overearning will be clawed back. The longer-term outlook is unappealing, as we expect coal prices to weaken significantly as Chinese fixed investment slows. This is a major issue for Aurizon given its almost total reliance on the coal industry.

Coal volumes fell 5% in the September quarter due to poor production from a major miner in Queensland, and in New South Wales, a train derailment and industrial action. Management expects new contracts and above-rail productivity improvements to drive better volumes for the rest of the fiscal year, and maintained guidance for 215-225 million tonnes. Coal prices remain high, and coal miners will be trying hard to maximise exports. This should help volumes reach management’s target, in the absence of extreme weather. While the near term is positive, our longer-term view is bearish, with Morningstar forecasting metallurgical and thermal coal prices to fall significantly over the medium term as China demand falls. This should more than offset growth in demand from India and other emerging markets.

Bulk volumes were weakest in the quarter, down 19% as iron ore miner, Cliffs, closed operations in Australia. Other negatives included lower grain volumes because of the drought and end of the Wilmar sugar contract.

Separately, the Queensland intermodal business was sold to Linfox for AUD 7.3 million. This is a good result compared with the alternative of shutting it down, as closure costs of up to AUD 40 million can be avoided. Additionally, Aurizon secured a 10-year contract to provide bulk rail haulage services to Linfox as part of the deal. The prized Acacia Ridge intermodal terminal is for sale separately. Major competitor Pacific National agreed to buy it for AUD 205 million, but we think the deal will be blocked on competition concerns. Court clearance is being sought in November. Aurizon will probably have to settle for a lower offer from another party.

Having refocused on its core competencies of coal and bulk rail haulage, Aurizon is again looking for growth. At the annual general meeting, management expressed interest in haulage of additional export minerals where Aurizon can operate at scale, and in proximity to its existing operations. As long as the firm shows more restraint than in the past and keeps its capital commitment low, we’re happy to see it trying to grow and diversify away from coal. Improving productivity is an ongoing goal, which is mainly being driven by technology upgrades and more efficient operations.