Company Overview: Aurizon Holdings Limited (ASX: AZJ) is Australia’s leading rail freight operator that offers large-scale supply chain solutions to various types of customers. The company is also involved in the maintenance of private infrastructure, external design, and construction works. The company operates three main segments – Network, Coal and Bulk. Notably, the company’s Coal business provides a critical supply chain link for the majority of Australia’s coal producers. The company’s vision is to be the first choice for bulk commodity transport solutions, and its purpose is to grow regional Australia by delivering bulk commodities to the world.

AZJ Details

Focussed on Operational Efficiency Improvements: Aurizon Holdings Limited (ASX: AZJ) is Australia’s leading rail freight operator that provides customers with integrated freight and logistics solutions across an extensive national rail and road network, traversing Australia. As of 5 November 2020, the company’s market capitalisation stood at ~$7.09 billion. The company generates the majority of its revenue through the provision of access to, and operation of, the Central Queensland Coal Network (CQCN). The company also derives revenue through other operations including maintenance of private infrastructure, external design and construction works, customer funded infrastructure charges and other services. From 2016 to 2020, the company’s NPAT grew at a CAGR of ~71%. Further, the company has a track record of paying regular and decent dividends to its shareholders.

5-Year Financial Summary (Source: Company Report, Thomson Reuters)

Looking ahead, the company is focused on continuing its operational efficiency improvements, supporting contracted volume growth. In order to drive continuous improvement in its operations, the company is making targeted investments in technology. From the funding perspective, the company seems well placed with a robust balance sheet.  Although the COVID-19 pandemic has created an uncertainty around the company’s operations and has impacted its recent performance,  the company seems well placed to benefit from the continued long-term growth in demand for coal and iron ore, particularly from fast growing Asian economies such as Japan, China and India.               

FY20 Results Highlights: For the year ended 30 June 2020, AZJ posted total revenue of $3,064.6 million, up 5% on the previous year, reflecting the approved UT5 Undertaking in the Network segment and new contracts in the Bulk segment. The company reported underlying EBIT of $909 million, up 10% on the previous year, driven by the increase in the revenue of Bulk and Network segment. Further, the company reported statutory NPAT of $605 million, up 28% on FY19.

The company’s Bulk segment reported revenue of $609 million in FY20, up 21% on the previous year, due to new contract growth and improved revenue quality. From the Coal segment, the company reported total revenue of $1,775 million and EBIT of $411 million. Due to the increase in track access revenue and other revenue growth from higher external construction works, the company’s network segment reported YoY growth of 6% in its total revenue which stood at $1,189 million.

During the year, the company completed the refinancing of Aurizon Network’s bank facilities, extending the maturity to 2023- 2025 and increasing the facility size by $420 million to $1.3 billion. For FY20, the company reported a free cash flow of $715 million, which includes proceeds from the sale of Rail Grinding business offset by working capital movements. As of 30 June 2020, the company had a gearing of 45.1%.

FY20 Results (Source: Company Reports)

Top 10 Shareholders: The top 10 shareholders have been highlighted in the table, which together form around 20.12% of the shareholding. BlackRock Institutional Trust Company, N.A. and Vanguard Investments Australia Ltd. hold the maximum interest in the company at 3.80% and 3.19%, respectively.

Top 10 Shareholders (Source: Refinitiv, Thomson Reuters)

A Quick look at Key Margins: For FY20, the company’s gross margin stood at 74.5%, higher than the industry median of 39.2%. For the same period, the company reported net margin of 19.8% in FY20, higher than the industry median of 13.3%. The company’s current ratio stood at 0.49x in FY20.

Key Metrics (Source: Refinitiv, Thomson Reuters)

Dividend History:  For FY20, the company paid a final dividend of 13.7 cents per share (70% franked), taking the total dividend for the full year to 27.4 cents per share, up 15% on the previous year. Over the past five years, the company has distributed 70%-100% of its underlying net profit after tax in the form of dividends. Notably, over the last five years, the company has delivered $3.5 billion in shareholder distributions, underpinned by consistent free cash flow generation.

5-Year Shareholder Return (Source: Company report)

September Quarter Update: For the quarter ending 30 September 2020, the company reporting total coal volumes of 50.0mt, down by 5% on the previous corresponding period, mainly due to the impact of COVID-19 on coal demand. For the same period, the Bulk volumes stood at 13.1mt, up 13% on pcp, driven by iron ore, principally the commencement of railings for Mineral Resources (January 2020). Total Above Rail Volumes for the quarter stood at 63.2mt.

Quarterly Above Rail Volumes (Source: Company Reports)

$300 million Buy-back: The company recently announced a $300 million on-market share buy-back which is expected to be completed in FY2021. As per the recent share buy-back notice, the company has bought back ~40.2 million shares under the on-market buy-back program for a total consideration of ~$166.8 million.

Pricing of Medium Term Notes: On 27 August 2020, the company announced that it has successfully priced another issuance under its Aurizon Network Pty Ltd (Aurizon Network) A$ Debt Issuance Program, under which, it will issue A$500 million 10-year notes (Notes) at a fixed coupon of 2.9% per annum, pricing at 210 basis points over the 10-year swap rate. The company intends to use the proceeds from these notes to repay its existing bank debt facilities.

Key Risks: AZJ is exposed to the risks and uncertainties of COVID-19 pandemic as it could impact the demand of coal across different countries and create supply chain issues. The company may face competition from parties willing to compete at reduced margins and accept lower returns and greater risk positions than AZJ. The company may experience business interruption and consequential financial impact from a range of circumstances including, road vehicle incident, process safety incident, illegal protest activity, cyber security incidents, technology incidents and adverse weather events.

What to Expect:  The company’s future success is dependent on key demand drivers of the Australian resources sector in global markets. AZJ expects the demand for coal to remain soft in the first half of FY2021 but is expected to grow in the long term. Over the next decade, the demand for Australian coal export is expected to grow by 1-2% per annum, supported by infrastructure development and energy demand in Asia. 

Looking ahead, the company expects operational efficiency improvements to remain a key driver in the business. The FY21 EBIT is expected to be in between $830 million – $880 million. In the second half of FY21, the company expects Railings to improve as steel capacity comes back online in key export markets. The total coal volume in FY21 is expected to be in between 210mt - 220mt. The company expects its FY21 capital expenditure to be in the range of $500 million - $550 million.

Key Valuation Metrics (Source: Refinitiv, Thomson Reuters)

Valuation Methodology: Price to Earnings Multiple Based Relative Valuation (Illustrative)

Price to Earnings Multiple Based Relative Valuation (Source: Refinitiv, Thomson Reuters)

Note: All forecasted figures have been taken from Thomson Reuters, NTM: Next Twelve Months

Stock Recommendation: Over the last six months, the stock of AZJ has corrected by 17.9% and is currently inclined towards its 52-weeks low price of $3.380, offering a decent opportunity for accumulation. On the technical analysis front, the stock has a support level of ~$3.375 and a resistance level of ~$4.399. The company is trading at a PE multiple of 12.2x with an annual dividend yield of 7.28%. We have valued the stock using the P/E multiple based illustrative relative valuation method and arrived at a target price with an upside of low double-digit (in % terms). Considering the company’s improving bottom-line, its decent FY20 financial and operations performance, expected long-term growth in coal demand, history of paying decent dividend, current trading level, and valuation, we suggest a “Buy” recommendation on the stock at the current market price of $3.760, on 5 November 2020.

 

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

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