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Aggreko announces turnaround plan

Steve Clayton | 6 August 2015 | A A A
Aggreko announces turnaround plan

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Aggreko plc 4 329/395p

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Aggreko's half year results have been impacted by the slowdown in the North American oil and gas sector, lower than expected pricing on the Bangladesh contract extension and lower production levels in Yemen due to on-going security challenges. Underlying revenue was down 2% year-on-year, but margins fell sharply, resulting in a 21% decline in profit before tax. The interim dividend has been held at 9.38p and full year profit guidance remains unchanged from that given on 24 July (profit before tax of £250-£270m at current exchange rates). The shares were 1% lower in morning trading.

Our view:
Market conditions are conspiring against Aggreko. Growth in emerging markets has slowed significantly, which has reduced demand for its temporary power solutions. Intensifying competition is leading to pricing pressure as the industry adjusts to the lower demand environment, resulting in falling margins in the Power Projects business. Margins in the Local division are also under pressure as collapsing commodity prices reduce demand for Aggreko’s equipment from the oil and gas and mining sectors.

The turnaround plan is designed to make Aggreko more competitive against local operators. Costs will be cut back and part of the savings will be reinvested in technology and service. By making its equipment more energy efficient, for example, Aggreko hopes to reduce electricity costs for its customers, making it less likely they will switch to a cheaper local operator. In the near term, this extra investment will depress profitability and returns to shareholders.

The long term prospects for Aggreko still look appealing. The power shortfall in emerging markets is forecast to grow at around 6% per annum, albeit more slowly in 2015 and 2016, according to the company. Aggreko remains confident of out-growing its markets, whilst delivering margins and returns of around 20%, once conditions improve.

The share price already reflects a lot of bad news, but analysts' earnings forecasts continue to fall. Early indications suggest that earnings expectations for next year (FY16) will come in at around 0.73p, which is a 13.5% discount to the current consensus. On that basis, the shares trade on a price to earnings ratio (P/E) in the order of 15.5x  for FY16, which represents around a 15% discount to Aggreko's long run average rating.

Business performance: 
The Local business grew underlying revenue by 3%, with a strong performance from EMEA; partially offset by a 2% decrease in the Americas due to a slowdown in the oil and gas sector and strong prior year comparatives. Trading profit decreased by 14% and trading margin reduced from 13% to 11%, mainly driven by pricing pressures stemming from the mining and oil and gas sector slowdowns.

Power Projects saw underlying revenue decreasing by 9% and trading profit falling by 27% in the first half. Reported trading margin decreased to 22% (2014: 27%). The main reasons for the margin decline were higher mobilisation costs driven by higher levels of new work in EMEA and pricing pressure in Bangladesh, as well as reduced volumes in Indonesia. Order intake for the first half was 422MW (30 June 2014: 488MW).

Business priorities:
  • Chris Weston (appointed CEO in January 2015) has completed a comprehensive review, with the aim of returning Aggreko to growth. The group will be re-organised into two business lines:
  • Aggreko Rental Solutions - incorporates Local businesses in developed markets. The main focus here will be on improving efficiency and customer service to drive higher fleet utilisation and profitability.
  • Aggreko Power Solutions - includes the existing Power Projects business and Local businesses in developing markets. Historic high growth rates have led to cost inflation so the main priority will be to reduce the cost base, through better procurement, and efficiency savings, for example. Aggreko will also step up investment in fleet technology, with a particular focus on improving the fuel efficiency of its equipment, as well as investing to improve the customer offer.
  • Aggreko expects to generate savings of £80 million by 2017. There will be a one-off cost of circa £30 million, which will largely be incurred in the current year. Capital investment is expected to increase in the short term, with utilisation and returns likely to be lower for a period. The group has guided for annual maintenance capex of around £200 million. Acquisitions will also be considered.
 
Dividend cover will remain at around three times in order to maintain leverage at around one times net debt to EBITDA (currently 0.8x).This makes it less likely that surplus capital will be returned to shareholders in the short term.
 
The group commented:
"The market environment has changed, but Aggreko has a unique business model. There are good opportunities for growth in each of our markets. To capture these, management is focusing on three business priorities: Customer; Technology and Efficiency. As a result, we expect to grow faster than our markets whilst delivering margins and returns of around 20% in the medium term. There will be significant change in the business in 2016 and the market environment remains difficult, so we anticipate that margins and returns will be lower in the short term."

Read more share research from Hargreaves Lansdown

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