Is it worth buying Aurizon for the dividend?

We recently researched Aurizon Holdings (ASX:AZJ) in The Dynamic Investor. Following the interim results release for 1H24 in mid-February, the shares enjoyed momentary gains. However, this has largely reversed despite no obvious catalyst for such a move. Accordingly, we consider whether the recent weakness presents a more attractive entry opportunity for the given yield.

About Aurizon Holdings

Aurizon Holdings is an Australian rail freight operator that operated three divisions: i) Network, which manages the 2,670km Central Queensland Coal Network (CQCN) which is governed by a regulated return agreed with customers; 2) Coal, which has contracts to haul coal in Central Queensland and the Hunter Valley from mines to export terminals; and 3) Bulk, which encompasses the group’s non coal rail haulage activities, including bulk mineral commodities (including iron ore), agricultural products, and mining and industrial inputs.

AZJ’s asset base is classified as either ‘Above Rail’ or ‘Below Rail’. ‘Above Rail’ comprises the Coal and Bulk businesses, while ‘Below Rail’ refers to the regulated Network business.

Key Fundamental Drivers

Can Aurizon Coal Earnings Surprise on the Upside?

EBITDA for the Aurizon Coal segment in 1H24 was well ahead of expectations. Revenue yield more than offset softer volumes with better-than-expected customer/corridor mix. Coal contract utilisation remained flat at 82%. The Company has reiterated the target of 90%, which is likely to be achieved in FY25/FY26. We consider that there are upside risks to earnings growth expectations for Aurizon Coal in the short- and medium-term from several factors:

i. The expectation for falling revenue yields has caused some market concern that underlying EBITDA growth for Aurizon Coal will slow. The latter expectation is not being driven by lower volume growth, with consensus Coal haulage estimates indicating the reverse.
ii. The fleet composition within Aurizon Coal has increased from 311 active locomotives in 2H23 to 321 as at 1H24.
iii. While broader quarterly coal guidance by producers has been flat, the recent change of mine owners is boosting medium-term production expectations. In addition, new mines are coming on line.
iv. The thermal coal outlook is positive as energy transition takes longer. This suggests that demand will last for longer. Metallurgical coal demand is also robust.

Challenging Outlook for Aurizon Bulk

The performance of the Aurizon Bulk segment has concerned the market. Underlying EBIT was ~15% below consensus estimates and continued the string of weaker performance relative to market estimates. The 1H24 period represented the 3rd half in a row of below-expectation results. While AZJ is successfully winning contracts, headwinds from a permanent loss of NSW/Queensland grain volumes and specific customer results have limited growth.

Overall, the outlook for the Aurizon Bulk segment is likely to be under budget, given that the 3Q24 period was heavily affected by the weather. In addition, the high-value Northern Iron contract has also had construction delays due to weather, such that first volumes are now in FY25. Weather is also likely to impact FY25 earnings as WA again appears to have a very dry season, with volumes at one-third 2023.

Further, iron ore volumes are lower. In context, iron ore is considered the most significant segment for AZJ; accounting for ~25% of the EBITDA of the Bulk group.

Capital Management Appeal Increasing

Gearing (on a net debt to EBITDA basis) as at FY24 is expected to be ~3.1x, which is only slight elevated in comparison to recent levels. Accordingly, AZJ has flagged a capital position that allows for more ‘flexibility’ to increase capital returns. The potential scale, duration, and nature of capital management (dividends or buyback) remain unclear. This is partly because the Company is early in its container strategy and is increasing growth investment in its Bulk segment.

Having said that, the more likely capital management option in the near term is increasing dividend payments. The dividend payout ratio (which was 75% In FY23) is not expected to return to the top end of the 70-100% range for at least two years. To this end, it is worth noting that gearing has still not returned to pre-One Rail levels when the dividend payout ratio was ~100%.

It is worth noting that there are two alternative avenues of capital management. Aside from increasing the dividend, AZJ can implement on-market share buyback, given the limited franking credits available. Alternatively, it can re-investing surplus capital back into the business. The Company benefits from lower tax payments as a result of a portion of the CAPEX qualifying for the instant asset write off.

Fundamental View

At current levels, the shares are trading on a 1-year forward P/E multiple of ~13x, which broadly in line with the trading range over the last two years. Against this multiple, AZJ has an attractive medium-term earnings profile, as evidenced by an EPS growth profile of +9% over FY24-26 on a CAGR basis.

The more imminent capital management has improved AZJ’s yield appeal (6%). Notwithstanding, the key factor limiting further upside in the shares is the continued underperformance of the Bulk segment. It still remains unclear as to whether the Company can generate a sufficient return on invested capital for the Bulk segment.

Charting View

AZJ remains range-bound and right now it is in the middle of that range. Investors can therefore be patient and wait for the stock to retrace back towards lower levels under $3.50. Otherwise, an upside break beyond $4.10 would be the other possible buy signal.

Aurizon Holdings (ASX:AZJ) weekly chart
Aurizon Holdings (ASX:AZJ) weekly chart


Michael Gable is managing director of Fairmont Equities.


Current share prices available here.

You can learn more about technical analysis in this article.

 An 8-week FREE TRIAL to The Dynamic Investor can be found HERE.

Would you like us to call you when we have a great idea? Check out our services.

Disclaimer: The information in this article is general advice only. Read our full disclaimer HERE.

Like this article? Share it now on Facebook and Twitter!