Company Overview: Emeco Holdings Limited (ASX: EHL) is engaged in selling, renting, and maintaining heavy earthmoving equipment to customers in the mining industry in Australia and overseas. The company provides EOS, equipment productivity and management tool, and generates earnings from the provision of equipment rental and maintenance solutions to the earthmoving industry. The group supplies safe, reliable, and maintained equipment rental solutions to its customers and also offers repair and maintenance and component and machine rebuild services for its customers’ equipment.

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Expansion in Capacity and Decent Increase in Operating EBIT: Emeco Holdings Limited (ASX: EHL) is engaged in the selling, renting, and maintaining heavy earthmoving equipment for customers in the mining industry in Australia and overseas. As on 5 May 2020, the market capitalization of the company stood at ~$388.82 million. During FY19, the company delivered well on its growth strategy and witnessed a growth in group operating revenue from continuing operations to $464.5 million in FY19. This was mainly due to growing equipment utilization, asset fleet, and tight control on costs. Recent acquisitions increased utilization of the fleet by customers, increased rental rates and additional cost management measures implemented over the year resulted in an increase of 50.7% in operating EBIT on FY18 to $125.4 million and a growth of 39.9% on FY18 in EBITDA to $214.0 million. In the same time span, the company reported higher profitability, with an increase in operating NPAT by 213.9% to $63.1 million, representing shareholder value creation. On the back of strong profitability, the company generated operating free cash flow of $90.1 million. This enabled EHL to repay its debt and further helped to invest in strategic growth assets for future earnings. During the year, expansion in capacity throughout Australia and increased retail work on Emeco’s rental fleet resulted in continued growth in activity in the workshops business. By extending asset lives and being cost-effective, the company maximized the returns of the shareholders as evidenced by a strong FY19 return on capital of 21%. The company also reported a strong balance sheet with a reduction of $16.6 million in debt and achieved a significant milestone in its deleveraging strategy by reducing its Net Debt/Operating EBITDA multiple to below 2x at the end of FY19. 

The company has also released its interim results for the period ended 31 December 2019 wherein it reported strong growth in earnings. The company has further diversified its commodity exposure which will help to expand its margins and has also entered hard rock underground equipment and mining services, which will double its exposure in gold.

As customers remain disciplined, the company anticipates continued demand for metallurgical coal and is focused on diversifying Eastern Region exposure to gold and copper. It also expects increasing growth in revenue and earnings in the coming years, with an increased focus on earnings in the second half of the year.


FY19 Financial and Operating Highlights (Source: Company Reports)

Details of Top 10 Shareholders: The following table provides an overview of the top 10 shareholders of Emeco Holdings Limited. Black Diamond Capital Management, L.L.C. is the largest shareholder in the company, with a percentage holding of 20.46%. 


Top 10 Shareholders (Source: Refinitiv, Thomson Reuters)

Increasing Returns to Shareholders: Over the past two years, the company witnessed an improvement in gross margin which stood at 32.6% in 1H20, up from 30.4% in 1H18. During 1H20, net margin of the company also increased and stood at 11%, from 9.1% in 2H19. The improvement in gross and net margin indicates that the company is managing its costs well and can convert its revenue into profits. In the same time span, the company reported increased profitability with an improvement in EBITDA margin from 41.8% in 2H19 to 47.2% in 1H20. During 1H20, current ratio of the company stood at 1.70x as compared to 1.29x in 2H19. This indicates that the company is liquid enough to pay its current liabilities using its current assets. In the same time span, Return on Equity went up to 12.5% from 11.9% in 2H19. This suggests that the company is well managing the capital of its shareholders and can generate profits internally. During 1H20, Debt/Equity ratio of the company was 2.15x, and Assets/Equity ratio of the company stood at 3.50x, lower than the previous half ratio of 3.88x. This indicates that the business is financed with a significant proportion of investor funding and a small amount of debt, resulting in a financially stable balance sheet.


Key Margins (Source: Refinitiv, Thomson Reuters)

Decent Increase in Earnings and Financially Stable Balance Sheet: The company has recently released its half-year results for the period ending 31 December 2019 wherein it delivered on its strategy and reported strong growth in earnings with operating EBITDA in line with management guidance. During 1H20, the company reported an improvement in leverage to 1.77x, down from 2.0x at 30 June 2019 and witnessed an increase of 10% in revenue to $246.5 million. In the same time span, operating EBITDA witnessed a growth of 16% to $119.1 million, resulting in an increase in operating EBITDA margin to 48.3%, up from 46.2% in 2H19. During the half-year, the company won new gold and iron ore projects, which will further diversify the commodity exposure of the company and will result in increased earnings and reduced risk. In the same time span, operating cash flows of the company witnessed continued growth and stood at $75.3 million, up by 19% on the pcp. This was mainly due to continued growth in the scale of the business.


1H20 Operational and Financial Highlights (Source: Company Reports)
 
Vesting Under FY17 and FY18 Employee Incentive Plans: The company has recently stated that equity incentives granted to eligible employees have vested in full, as a result of which 19,003,059 ordinary fully paid shares have now been transferred from the Emeco Employee Share Ownership Trust to the eligible employees. The company also noted that Fitch Ratings had upgraded its long-term issuer default rating to “B+”, reflecting a stable outlook. 

Future Expectations and Growth Opportunities: EHL is focused on improving its utilization and is aiming to expand its margins, setting itself for further growth in the coming years. The company will integrate the Pit N Portal business into its operations, which will facilitate further growth. The company delivered EBITDA CAGR of ~15% from FY17–FY19 and is expecting similar levels of growth for four months of earnings in FY20 and FY21. EHL expects a significant increase in its free cash flow in the second half of FY20, ensuring that it deleverages down to 1.5x for FY20 and 1.0x for FY21. The company is planning to pay a dividend once it reaches its target leverage range. The company will continue its workshop activity with a focus on internal works to support the Rental fleet and is anticipating an increase in the rental margins. It will improve quality and efficiency through continuous improvement in projects and will work to widen its customer value proposition and provide customers with additional services. 


Key Valuation Metrics (Source: Refinitiv, Thomson Reuters)

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

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

Note: All the forecasted figures are taken from Thomson Reuters, NTM: Next Twelve Months

Stock Recommendation: As per ASX, the stock of EHL gave a return of 17.22% in the past one month and is inclined towards its 52-weeks’ low level of $0.485. Over the span of 4 years from FY15 to FY19, the company witnessed a CAGR of 17.78% in revenue and a CAGR of 25.03% in gross profit, reflecting continued improvement in EHL’s financial and operating performance. Considering the returns in the past one month, trading levels, CAGR in gross profit, and decent outlook for the medium and long term, we have valued the stock using Price to Earnings multiple based illustrative relative valuation approach and have arrived at a target price with an upside of lower double-digit (in percentage terms). Hence, we recommend a ‘Buy’ rating on the stock at the current market price of $1.020, down by 3.318% on 5 May 2020. 
 
 
EHL Daily Comparative Chart (Source: Refinitiv, Thomson Reuters)

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