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, for both Emeco and customer-owned fleet 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 offers repair and maintenance and component and machine rebuild services for its customers’ equipment.


EHL Details

Higher Profitability and Decent Balance Sheet: Emeco Holdings Limited (ASX: EHL) is engaged in the selling, renting, and maintenance of heavy earthmoving equipment to customers in the mining industry in Australia and overseas. As on 7 July 2020, the market capitalization of the company stood at ~$351.97 million. During FY19, the company executed its growth strategy and witnessed an increase in group operating revenue from continuing operations to $464.5 million in FY19. This was mainly due to increased 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% 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 an operating free cash flow of $90.1 million. This enabled EHL to repay its debt and further helped the company to invest in strategic growth assets for future earnings.

During the year, expansion in capacity throughout Australia and increased retail work on Emeco 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, evident in a strong FY19 ROC of 21%. The company also reported a decent balance sheet with a reduction of $16.6 million in debt and reduced its Net Debt/Operating EBITDA multiple to below 2x at the end of FY19. 

During 1H20, EHL reported strong growth in earnings. The company has further diversified its commodity exposure which will help it expand its margins and has also entered hard rock underground equipment and mining services, which will double its exposure in gold.

With disciplined growth in customers, the company expects continued demand for metallurgical coal and is focused on diversifying Eastern Region exposure to gold and copper. It also expects a decent rise in revenue and earnings in the coming years.


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 17.94%. 


Top 10 Shareholders (Source: Refinitiv, Thomson Reuters)

Well Management of Costs and 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 the 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 2.36x and 3.88x, respectively. 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: During 1H20, the company 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 hence will increase earnings and reduce 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 the continued growth in the scale of the business. The company also noted that Fitch Ratings had upgraded its long-term issuer default rating to “B+”, reflecting a stable outlook.


1H20 Operational and Financial Highlights (Source: Company Reports)

Key Risks: The onset of COVID-19 has impacted the earnings in 2H20 because of some additional costs and the fall in coal price, resulting in a reduction in utilization in the Eastern Region. The preparation of the consolidated financial statements requires management to make judgements, estimates and assumptions. These estimates and judgements may have a material impact on the financials. The group is also exposed to credit risk, liquidity risk, and market risk.

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 Pit N Portal business into its operations and hence, will facilitate growth.  The company is expecting four months of earnings with CAGR of approximately 15% in FY20 and FY21. EHL expects a decent rise 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. It also expects operating EBITDA for FY20 to be in the range of $244 million to $247 million.

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: EV/Sales Multiple Based Relative Valuation Approach (Illustrative)

EV/Sales 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: The company has expanded the business by securing a five-year contract with Mincor Resources NL through Pit N Portal, executing on its strategic objective of diversifying its commodity exposure. As per ASX, the stock of EHL gave a return of 6.11% in the past three months and is trading close to its 52-weeks’ low level of $0.485. We have valued the stock using EV/Sales multiple based illustrative relative valuation approach and have arrived at a target upside of low double-digit (in percentage terms). Considering the attractive trading levels, decent returns in the past three months, positive outlook in the long term, and decent financial performance, we recommend a ‘Buy’ rating on the stock at the current market price of $0.915, down by 4.188% on 7 July 2020. 

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

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