Company Overview: Emeco Holdings Limited (ASX: EHL) is engaged in the business of providing open-cut mining equipment, maintenance, and project support solutions & services. The company has the following reportable segments of operations – Rental: Provides a range of earthmoving equipment solutions to customers in Australia, Workshops: Provides maintenance and component rebuild services to customers, Pit N Portal: Delivers mining services solutions and associated services to clients.

EHL Details

Capex and Business Synergy to Drive Growth: Emeco Holdings Limited (ASX: EHL) provides renting and maintaining heavy earthmoving equipment services to its clients. The market capitalisation of the company as on 27 April 2021, stood at ~$497.81 million. The company is poised for growth and expects to improve on its margins further into FY22, as it converts single shifts projects into double shifts projects. It also expects to increase its utilisation rate from a level of 85% in H1FY21, thereby increasing the fleet capacity and deliver improved rental earnings.

During H1FY21, the company reported impressive financial performance despite the impact of the COVID-19 pandemic on the economy. It delivered operating revenue growth of ~21% to ~$299 million when compared to the previous corresponding period. The increase in revenue was aided by the increase in services revenue and Pit N Portal contribution. Operating EBITDA stood at ~$118 million during the same period. There was also a significant improvement in the free cash flow of the company before capital expenditure to ~$44 million, reflecting an increase of 75% on pcp. It ended the period with a cash position of $71.8 million as of 31 December 2020. As per the recent update, the company has announced that one of its Director, Peter Kane acquired 10,288 ordinary shares via indirect interest at a consideration of $0.955 per share through on-market trade.

H1FY21 Financial Performance (Source: Company Reports)

Pit N Portal Poised for Long Term Growth: The company’s Pit N Portal business segment has witnessed increased activity and demand for its services, backed by a decent pipeline. It has been awarded a surface mining project in partnership with the rental division, supported by EOS technology. It also acquired a mining recruitment business with an eye on the goldfields region, and wants to enable itself with the skills required for growth in the space. It has a decent presence throughout Australia, as depicted in the chart below.

Pit N Portal Locations Across Australia (Source: Company Reports)

Continued Momentum in Rental and Mining Services: The company has witnessed positive momentum in the rental space in Q4FY21 in the Eastern Region, and expects Western Region to deliver decent growth over H1FY21. This is on the back of improvement in the customer demands and the start of several new projects. EHL has witnessed increased traction in the business activity of its Pit N Portal business and has seen demand for its underground mining fleet. There have been issues with project commissioning in some early-stage works, but this has been deemed to be temporary and the company has taken measures to mitigate it. It anticipates profitability to improve throughout H2FY21.

Capital Expenditure to Aid Future Revenue Streams:  EHL has announced a capital expenditure of $27 million for FY21, and has reached an in-principle agreement to acquire a package of quality underground equipment for a consideration of $14 million, and includes the expected rebuild costs. The deal gives cushion to Pit N Portal’s ability to meet customer demand for well maintained, low-cost underground equipment.

Top 10 Shareholders: The top 10 shareholders together form around 54.52% of the total shareholding, while the top 4 constitute the maximum holding. Black Diamond Capital Management, L.L.C. and Paradice Investment Management Pty. Ltd. are holding a maximum stake in the company at 24.27% and 9.67%, respectively, as also highlighted in the chart below:

Data Source: Refinitiv, Thomson Reuters, Analysis by Kalkine Group

Key Metrics: During H1FY21, the company delivered impressive gross margin performance at 44.4%, compared to 32.6% in the prior corresponding period. Net margin stood at 1.1% during the same period. It has reported an improvement in the leverage profile with debt to equity ratio at 0.59x in H1FY21, compared to 2.15x in H1FY20. Assets to equity ratio also reduced to 1.83x, from a level of 3.50x during the same period under consideration.

Growth Profile and Leverage Profile (Source: Refinitiv, Thomson Reuters, Analysis by Kalkine Group)

Key Risks: The onset of the COVID-19 pandemic has disrupted the economy and might also pose a threat to the profitability of the company. The COVID-induced disruption has the potential to impact the long-term commodity prices and hence the demand for earthmoving equipment and associated services. There is also a risk of the supply chain being impacted, thereby making it difficult for the company to delivers its products and services to its clients. EHL is also faced with credit risk, liquidity risk, and market risk from the use of its financial instruments. In order to mitigate the credit risks, the Group aims to insure the majority of rental customers who are not considered to be blue-chip customers.

Outlook:  The company continued to witness momentum in the rental and mining services business, and expects earnings for H2FY21 to be broadly in line with H1FY21. It is anticipating an operating EBITDA of $235-$238 million in FY21. It is also expecting growth in the Pit N Portal business division, on the back of capex spend of $14 million to acquire a quality second-hand equipment. The new equipment is expected to deliver decent returns with pre-tax IRR above 20%. It also expects continued growth in external revenue from the Force Workshops. Moreover, the Workshops will also support the maintenance of the new equipment to be purchased by Pit N Portal, and rebuild it before deploying to customers. This positions the company to enhance the value of the transaction and leverage the high demands from customers.

Valuation Methodology: P/E Multiple Based Relative Valuation (Illustrative)

Data Source: Refinitiv, Thomson Reuters, Analysis by Kalkine Group

*% Premium/(Discount) is based on our assessment of the company’s NTM trading multiple after considering its key growth drivers, economic moat, stock's historical trading multiples versus peer average/median, and investment risks.

Stock Recommendation: On 31 March 2021, the company has announced that its Chief Financial Officer, Neil Siford, has resigned and will remain in office till the end of September 2021. As per ASX, the stock of EHL is trading below its average 52-weeks’ levels of $0.730-$1.290. The stock of EHL gave a positive return of ~20.52% in the past six months and a negative return of ~8.99% in the past one month. We have valued the stock using a P/E multiple-based illustrative relative valuation and have arrived at a target price of low double-digit upside (in % terms). We believe that the company can trade at a slight discount to its peer average P/E (NTM trading multiple), considering the ongoing business volatility due to the impact of the COVID-19 pandemic, and commissioning issues in some early stage works in Pit N Portal business. For the purpose, we have taken peers such as Acrow Formwork and Construction Services Limited (ASX: ACF), MACA Limited (ASX: MLD), Macmahon Holdings Limited (ASX: MAH), to name a few. Considering the expected upside in valuation and current trading levels, decent financial performance in the first half of FY21, continued growth prospects in the rental and Pit N Portal business and the synergy benefits across all the verticals of business, we recommend a ‘Buy’ rating on the stock at the current market price of $0.910, down by 0.547% as on April 27, 2021.

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

Note: Investment decision should be made depending on the investors’ appetite on upside potential, risks, holding duration, and any previous holdings. Investors can consider exiting from the stock if the Target Price mentioned as per the Valuation has been achieved and subject to the factors discussed above.

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