ALQ getting cheaper, but not cheap enough

Does recent weakness in the ALS Ltd (ASX:ALQ) share price make it cheap enough to buy, and is there further downside based on the technicals?

The Company is a provider of professional technical services. These are primarily in the areas of testing, measurement and inspection across a wide range of sectors, supporting environmental monitoring, food & pharmaceutical quality assurance, mining and mineral exploration, commodity certification, equipment maintenance and asset care operations. There are three divisions: Life Sciences (49% of group 1H19 revenue), Commodities (38% of 1H19 revenue) and Industrials.

Key Observations From Recent Results

ALQ’s results for the six months to 30 September 2018 (1H19) were ahead of expectations. This is a result of a strong performance from the Commodities division. However, as has been the case for some time, divisional performance was mixed. The Life Sciences and Industrial divisions are continuing to underperform.

i. Margin expansion in the Life Sciences division has been a key area of focus for investors after a long period of sustained declines. While the EBIT margin for 1H19 bounded off their disappointing 2H18 lows as guided, the division continues to face ongoing competitive and volume pressures. This was particularly in key Environmental markets in the US, due to overcapacity/competition and apparent political impediments to new project approvals. These ongoing competitive pressures are expected to outweigh the benefit from cost rationalisation and contribution from acquisitions.

ii. The Commodities division was the standout performer in 1H19, generating revenue growth of 25% to $314m and 36% EBITDA growth to $95m. Both revenue and EBITDA results were ahead of expectations. The outlook for the division is for EBITDA margin expansion, supported by factors such as price increases of +7-8% in Geochemistry, strong activity levels in metallurgy and increased demand for coal services.

Balance Sheet Provides Capital Management Options

ALQ continues to flag complementary bolt-on acquisitions in Life Sciences (in particular Food & Pharmaceuticals). They also noted there is a pipeline of opportunities worth $60-70m that the Board is considering in the current half (2H19). Following the recent refinancing of its banking facilities, there is enough balance sheet capacity to pursue further acquisitions in Life Sciences.

Having said that, the Life Sciences space is highly competitive. There is always the risk that the Company overpays for acquisitions. To this end, the three recent acquisitions, while represent a strong strategic fit, were minor in the context of overall earnings contribution. Furthermore, specific financials (i.e. acquisitions multiples, expected/historical earnings) were not disclosed.

Fundamental View of ALQ

With the shares now trading on a 1-year forward P/E multiple of ~18x, we struggle to see value from a fundamental perspective. This is given that group earnings remain largely reliant on the Commodities division. In particular, competitive conditions are leading to margin pressure in the Life Sciences division. Geochemistry sample volume growth (a key driver of the Commodities division) continues to slow. ALQ is expecting to see 8-10% sample volume growth in its Geochemistry business in 2H19, compared to +14% growth in 1H19.

Technical View of ALQ

ALQ had spent much of the last year trading in an ascending triangle. It made an upside break in August, but it has since fallen back and is now trading underneath it. So far it has failed to get above the diagonal lines. The stock is therefore vulnerable to fall back towards the 2018 low near $6.50.

ALS Ltd (ASX:ALQ) weekly chart
ALS Ltd (ASX:ALQ) weekly chart


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Michael Gable is managing director of Fairmont Equities.

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