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

Strong Earnings and Returns in FY20: Emeco Holdings Limited (ASX: EHL) is engaged in the selling, renting, and maintaining heavy earthmoving equipment to customers in the mining industry in Australia and overseas. As on 29 September 2020, the market capitalization of the company stood at ~$451.57 million. Despite the increased outspread of COVID-19 and the subsequent restrictions, EHL witnessed a continued increase in its earnings driven by the large fleet of in-demand assets and the acquisition of Pit N Portal. The company emerged as a more resilient and sustainable business with a stronger customer value proposition, stable commodity mix and a more diverse customer base. The company is judiciously allocating capital to generate healthy returns and drive solid free cash flow.

During FY20, the company reported operating revenue from continuing operations of $540.4 million, up from $464.5 million in FY19 and saw improved profitability with operating EBITDA of $246.1 million, reflecting an increase of 15% on FY19. This was mainly due to enhanced utilization of the rental fleet and increases in rental rates on new and renewed contracts.

Notes: 1. Refer to Statutory to Operating reconciliations in Appendix B 2. Total Workshops segment revenue including inter-segment revenues 3. Net debt / Operating EBITDA, before the impact of AASB16 Leases 4. Weighted average cost of capital 5. Gold and iron ore revenue. Annualised Q4 FY20 compared to FY19

FY20 Financial Highlights (Source: Company Reports)

Increased earnings and decent generation of cash flows in FY20 resulted in the reduction in the net debt and leverage ratio fell to 1.46x from 2.0x in FY19. The company is focused on a stronger and more resilient balance sheet, which will provide more flexibility to capital deployment. During FY20, the company reported an increased cash balance to $198.2 million, primarily due to the conversion of EBITDA to net operating free cash flow.

FY20 Financial 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 24.27%.

Top 10 Shareholders (Source: Refinitiv, Thomson Reuters)

Key Margins: During FY20, gross margin of the company stood at 25.1%, while the EBITDA margin of the company was 44.5%, higher than the industry median of 21.1%, indicating better profitability. During the year, net margin of the company witnessed an improvement over the previous year (12.2%, up from 7.2% in FY19). This indicates that the company is well managing its costs. The return on equity stood at 23.8%, as compared to the industry median of 8.3%, suggesting that the company is well managing the capital of its shareholders.

Looking into the balance sheet, the current ratio of the company stood at 1.43x, up from 1.29x. This shows that the company retains a decent liquidity position. During FY20, debt-to-equity ratio of the company was 1.74x, and assets-to-equity ratio of the company stood at 3.05x, lower than the previous year ratio of 3.88x and 2.36x, respectively. This indicates that the business is financed with a larger proportion of investor funding and a small proportion of debt, resulting in a financially stable balance sheet.

Key Margins (Source: Refinitiv, Thomson Reuters)

Segment Highlights: The business operations of EHL are comprised of three segments: Rental, Pit N Portal and Workshops. During FY20, revenue in the Rental segment increased by 5.9% to $425.1 million with operating EBITDA margins increasing from 58.3% in FY19 to 61.0% in FY20. Total Workshops activity increased from $114.7 million in FY19 to $163.8 million in FY20, reflecting a significant growth of 43% on YoY. Together with mid-life equipment model of EHL, the workshops reduced its costs and has facilitated a strong return on capital at 21.0%. Pit N Portal was established via the acquisition on 28 February 2020, which provides a range of mining services solutions, and associated services to customers in Australia. During FY20, Pit N Portal reported operating EBITDA of $9.0 million in four months at a margin of 25.5%.

Rental Division Financial Highlights (Source: Company Reports)

Completion of Retail Entitlement Offer: The company has recently completed its retail entitlement offer wherein it raised $38 million at a price of $0.85 per share, along with $111 million from the institutional component of the entitlement offer. The company has also refinanced its US$180 million notes with the extension in maturity from March 2022 to March 2024. Post the completion, the pro-forma net debt of the company will be $224 million along with net leverage of 0.9x.

Commencement of Mincor Underground Mining Services Contract: The company has received a notice to start its five-year contract with Mincor Resources NL. This contract is likely to expand the service offering of EHL and will support its strategic objective of securing long-tenured projects.

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 group is also exposed to supply chain risks, the likelihood of disruption to the operations, fluctuation in long term commodity prices, reduced demand for earthmoving equipment, credit risk, liquidity risk, and market risk. 

Future Expectations and Growth Opportunities: The company expects to report another solid year in FY21, with a focus on new longer tenure, fully maintained contracts that are likely to offer additional commodity diversification. EHL seems well placed to service market demand and is confident in its ability to redeploy fleet into new projects. The company may see strong demand in gold and iron ore, which will support its growth in earnings in the Western Region.

The price decline in coal may limit short term growth, but the group expects strong bidding activity across all Rental regions and in Pit N Portal. The company is the widening the value proposition with an increased focus on improving quality, cost effectiveness and efficiency through continuous improvement projects and technology-based systems and processes.

Key Valuation Metrics (Source: 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: EHL is executing its strategic objective of diversifying its commodity exposure. It aims to be the lowest cost, highest quality provider of mining equipment, and is focused on continued diversifying commodity exposure. As per ASX, the stock price of EHL is inclined towards its 52-week’s low level of $0.457, proffering a decent opportunity for the investors to enter the market. On a technical analysis front, the stock price of EHL has a support level of ~$0.7289 and a resistance level of ~$1.2921. We have valued the stock using EV/Sales multiple based illustrative relative valuation approach and have arrived at a target upside of lower double-digit (in percentage terms). Considering the attractive trading levels,  positive outlook for the long-term, and modest financial performance, we recommend a ‘Buy’ rating on the stock at the current market price of $0.845, up by 1.807% on 29 September 2020.

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

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