The share price of temporary power supply hire group Aggreko (AGK) recently ticked up in the wake of a note published by BoA/Merrill Lynch, which suggested that group revenues would return to growth in 2017, as power demand in emerging markets caught up with cheaper oil (a key cost in running temporary power generators) - a lagged effect we've certainly witnessed before. The BoA/Merrill Lynch analysts also raised the prospect that the market, seemingly "accustomed to Aggreko disappointing" may have missed an inflection point in the fortunes of its utilities business, as market assumptions remain downcast with regard to operating margins and organic growth rates.
- Inflection point for key market
- Operational gearing
- Turnaround in emerging markets
- Strong new business pipeline
- Institutional short positions
- Problems in Venezuela and Yemen
Does the IC concur? Most certainly; following a strong first quarter, the idea that trading performance in this key segment of the business has bottomed out is no longer at odds with prevailing trends given a 486 megawatt (MW) order intake compared with 388MW the same time last year. True, until recently trading had been resolutely bearish and the group has said it is cautious about its ability to convert more work from its strong pipeline into firm orders. Nevertheless, we think the group's recent performance provides good grounds for optimism.
Indeed, bearishness seems to be easing, with institutional short positions seeming to have peaked midway through March after rising sharply since the fourth quarter of 2015. Nevertheless, Aggreko remains one of the most heavily-shorted plays within Castellain Capital's Short Interest Tracker, so we recognise that investors buying at this juncture may well be taking a contrarian stance.
But there could be significant upside. Aggreko has been trading well below its historic earnings average, which is a reflection of a prolonged cyclical downtrend. But the group's largely fixed cost base, coupled with the sensitivity of hire rates and utilitisation to changes in demand, means profits and sentiment could improve rapidly if trading continues to impress. BoA/Merrill Lynch's optimism is based on its forecast that there's "substantial scope to regain market share" with "higher utilisation and stable pricing" accelerating organic growth to 10 per cent and raising margins by 300 basis points in 2017, against consensus expectation of 1 per cent and 60 basis points.
| AGGREKO (AGK) | ||||
|---|---|---|---|---|
| ORD PRICE: | 1,167p | MARKET VALUE: | £2.99bn | |
| TOUCH: | 1,166-1,167p | 12-MONTHHIGH: | 1,642p | LOW: 763p |
| FORWARD DIVIDEND YIELD: | 2.4% | FORWARD PE RATIO: | 16 | |
| NET ASSET VALUE: | 435p | NET DEBT: | 44% | |
| Year to 31 Dec | Turnover (£bn) | Pre-tax profit (£m)* | Earnings per share (p)* | Dividend per share (p) |
|---|---|---|---|---|
| 2013 | 1.57 | 333 | 93.3 | 24.74 |
| 2014 | 1.58 | 289 | 83.3 | 26.57 |
| 2015 | 1.56 | 226 | 69.7 | 27.12 |
| 2016* | 1.60 | 240 | 68.0 | 27.66 |
| 2017* | 1.65 | 263 | 74.7 | 28.21 |
| % change | +3 | +10 | +10 | +2 |
Normal market size: 2,000 Matched bargain trading Beta: 1.29 *JPMorgan Cazenove forecasts, adjusted PTP and EPS | ||||
We believe there was enough evidence in Aggreko's 2015 full-year figures coupled with the recent first-quarter trading to suggest that markets may have bottomed out and a re-rating could follow. Management's warning on "slightly lower" first-half profits in 2016 fell short of investors' worst-case scenario. For the rest of 2016, particular focus will be on Aggreko's Utility segment, which operates large-scale temporary power plants in emerging markets, and has been in a downtrend since the final quarter of 2012. It generates nearly half of the group's adjusted profits. An improving growth profile for emerging markets economies coupled with ongoing energy generation deficits offer serious potential for growth. That said, the group still face many challenges, and in the first quarter made a $10m (£6.8m) increase in debtor provisions linked to its Venezuelan assets, and there are lingering problems in Yemen linked to the security situation.
