We recently analysed ALS Ltd (ASX:ALQ) after the Company issued a trading update to determine if there could be more upside in the share price. Whilst the trading update mostly referred to strong operating conditions in the 3rd and 4th quarter of the now-completed 2021 financial year (FY21), it still has important implications for the outlook for the key Life Sciences and Commodities divisions.
About ALS Ltd
ALS Ltd (ALQ) is a leading testing, inspection, certification and verification company. They have operations in over 65 countries. The Company, which has a 31 March balance date has three operating divisions:
i. The Life Sciences Division. This provides analytical testing and sampling services and remote monitoring for the Environmental, Food, Pharmaceutical, and Consumer Product markets
ii. The Commodities Division. This is a leading full-service provider of testing services for the global mining industry across Geochemistry, Metallurgy, Inspection, and Coal Quality.
iii. The Industrial Division. This is a leading provider of diagnostic testing and engineering solutions for the energy, resources, transportation and infrastructure sectors.
Key Fundamental Considerations
Improving Global Mineral Exploration Activity
Major miners and junior & intermediate miners have contributed to a continued improvement in geochemistry sample flows. This is because junior & intermediate mining equity raisings continue to recover. In particular, the major miners are generating strong cashflows which also supports exploration activity.
Major miners currently account for 80% of volumes. Juniors & intermediate miners (which account for 20% of volumes) are expected to increase their contribution to sample flow following strong equity raisings in late calendar year 2020. Industry commentary suggests that a greater level of equity funding is becoming available to junior and intermediate miners.
Potential for Margin Expansion in Commodities Division
Exploration funding raised by juniors is yet to be materially put to work given the recent Northern Hemisphere winter. However, this should start to flow more readily in the lead up to the key Northern field season over the next few months.
The significance here is that juniors typically provide higher margins due to more analytics/testing required in greenfield areas. This benefits revenues and margin, as price increases are likely to become more prevalent in FY22. Pricing is estimated to have only contributed around 3-4% in 1H21, compared to +10% seen in prior periods. As such, there is upside risk to divisional EBIT margin expectations for FY21-22 (around 26-27%). To this end, we note that previous cycles have seen margins of +30%.
Improvement in Prices for Other Commodities
An improvement in the gold and copper prices is improving CAPEX from the junior mining sector. A gold price above US$1500/oz is generally seen as a supportive for capital raising activity and the subsequent use of funds raised. These factors create a positive backdrop for sample testing.
Gold (50% of minerals exploration) has accounted for most of the recovery in exploration activity. However, the significant rally in copper price should see an uplift in copper exploration activity. In context, copper is estimated to account for ~20% of minerals exploration activity. Exploration activity levels for other base metals (nickel, platinum, lithium etc) are also supportive.
Stable Volumes and Unchanged Margin Expectations for Life Sciences Division
In the recent trading update, ALQ noted that volumes in the Life Sciences division were stable in 2H21, given the division’s highly defensive revenue stream, where around 80% of divisional revenue is derived from Environmental testing.
The stability in volumes, coupled with cost control and productivity improvements, continue to support expectations for divisional EBIT margin to remain with the Company’s 16-17% target. There is also upside risk to margin expectations for FY21 and FY22 given that the division has demonstrated operating leverage to improving volumes.
Acquisition Activity Has Recommenced
Mergers and Acquisitions (M&A) opportunities present a key upside risk to earnings for the Life Sciences division. To date, ALQ has been disciplined in regards to acquisitions. This is given that M&A multiples paid for recent transactions have been elevated and management’s recent focus has been on preserving its balance sheet and liquidity position during the COVID-19 period.
Acquisition activity recently recommenced, with the Company announcing the acquisition of Americas-based pharmaceutical testing company, Investiga. The US is a strategically significant market as it represents over a quarter of the global market.
There is still a strong pipeline of bolt-on opportunities in the Food and Pharmaceutical sector. Over the next 2-3 years, we would expect the Company to execute on some of these opportunities given that: i) ALQ remain committed to growing the revenue base for the Life Sciences division and ii) A number of the opportunities have progressed further along the due diligence path, with some considered to be in the advanced stage.
Improved Balance Sheet Position Supports Further Merger & Acquisitions
The gearing level of 1.7x (on a net debt to EBITDA basis) is at the bottom end of the range over the last three years and well below the covenant level of 3.25x. In addition, the Company has in excess of $600m of liquidity available.
ALQ is presently trading on a 1-year forward P/E multiple of ~24x, which is at a premium to the 5-year average of ~21x. However, the shares continue to trade at a discount to global peers on a P/E and EV/EBITDA basis. While there are valid reasons as to why this is the case (i.e. ALQ has a higher portion of earnings being generated from more volatile revenue streams), the above factors support a potential re-rating of the multiple over the medium term towards that of its global peers.
After falling away sharply in February, ALQ managed to track sideways for the following few weeks, forming some higher lows along the way. There seemed to be some resistance near $10.15, but ALQ broke above that recently on good volume. It therefore looks as though ALQ shares should continue to head higher again and current levels would be a buying opportunity. Naturally, there will be some resistance at the old high near $11.50.
Michael Gable is managing director of Fairmont Equities.
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