Emeco Holdings (ASX:EHL) shed half its value at the end of 2018. However, things are now looking better for the Company.
About Emeco Holdings
Emeco Holdings provides rental of original equipment manufacturer (OEM) machines for customers in the mining industry. Key macro drivers for the business include: i) High mining production volumes, supported by high A$ commodity prices, ii) Incentive for miners to retain production flexibility, ii) Normalisation in Australian mine maintenance capital expenditure following several years of underinvestment, iv) Tightening equipment supply, which in turn increases demand for rental fleet and v) Slow improvement in rental rates and conditions.
The Company listed on the ASX in July 2006 an is currently included in the S&P/ASX 200 Index.
Why We Like the Fundamentals
1. Improving Return on Capital Metrics
The mining fleet industry in Australia has generated strong production gains in the last five years without any material growth in fleet size. This is likely a result of: i) Achieved mine site efficiencies/productivity; ii) Stretching the age of existing equipment, and iii) The tightening availability of equipment.
These factors have helped improve the Company’s Return on Capital (ROC) from 13% in the previous cycle peak in FY12 to approximately 20% in FY19. This is the highest since the Company’s IPO and reflects efficient management/allocation of capital across the business.
There is further upside to ROC from: i) Increased rental sales and ii) Greater utilisation of EHL’s relatively young average fleet age, which enables the Company to extent assets lives – in turn resulting in reduced capital intensity and lower operating costs throughout machine life cycles.
Unsurprisingly, EBITDA margin has also improved progressively each year since FY16 as a result of combination of improving market conditions and better cost control. EBITDA margin es expected to improve further, as the Company has been successful in extending component life and continues to reduce its major component cost. In addition, EHL is focused on being the highest quality and lowest cost provider of assets and is currently at the bottom end of the cost curve (in terms of costs throughout an asset’s life).
2. Gearing Level is Falling
As the level of debt on the balance sheet has been elevated for an extended period, reducing the gearing level (on a net debt to EBITDA basis) is a strategic priority for EHL. To this end, the Company expects to generate strong free cashflow in FY20, which should facilitate a reduction in gearing from 2.1x as at 30 June 2019, to a target of 1.0x by 30 June 2021. The lower gearing level should also help EHL refinance its US$ notes from April 2020 on more favourable terms, which in turn is expected to lower the interest expense.
The Company has indicated that following the refinancing of its US$ notes, it will consider capital management options, such as commencing dividend payments and/or share buybacks.
Fundamental View of Emeco
EHL has re-rated since our review on the Company in June 2019. However, with the shares still trading on an attractive FY20 P/E of <7x, EHL remains a stock worth considering, in light of an improving earnings profile (supported by strong cost control, improved fleet management and improving macro conditions) and a deleveraging balance sheet.
Charting View of Emeco
Price action this year had been poor with the EHL share price heading backwards since its peak in February. We have noticed that this decline resembled that of a falling wedge, which could signify a low in the share price. In June, EHL gapped up on high volume and managed to continue pushing higher. With EHL now breaking out of this falling wedge, we are getting confident that a low is in place here and that it should continue to head higher. The initial target with these formations is the base of the wedge. That is, EHL should head up to at least $2.80. Stops should be placed just under the breakout.
Michael Gable is managing director of Fairmont Equities.
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