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Aggreko - relief rally

Charles Huggins | 9 November 2015 | A A A
Aggreko - relief rally

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Aggreko plc 4 329/395p

Sell: 825.60 | Buy: 827.00 | Change 4.20 (0.51%)
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Underlying revenue fell by 7%, with reported revenue down 6% in Aggreko's third quarter. Market conditions remain "challenging", but actions to return the group to sustainable growth are said to be progressing well. In July, Aggreko lowered its full year profit expectations to between £250 and £270m, and the group still expects to meet this guidance. The news has reassured investors - the shares rose by 6% in early morning trading.

Trading review (constant currency):

Rental Solutions, which incorporates Local businesses in developed markets, experienced a 1% decline in revenue. Weakness in the oil and gas and mining sectors has been largely offset by growth in other sectors, such as petrochemical and refining. Aggreko also saw a strong temperature control season in North America and Continental Europe.

Power Solutions, which includes the Power Projects business and Local businesses in developing markets, experienced an 11% decline in revenue. Solid growth in Industrial, Russian and African businesses was offset by weakness in Brazil. Utility revenue in Power Solutions was 21% lower than last year, driven by the previously announced price reduction on the Bangladesh contract extension and the off-hiring of the Panama contract. Order intake year to date is 561MW (2014: 697MW), although the prior year figure included 170MW of "one-off" work. The closing order book has the equivalent of 14 months of forward revenue cover, reflecting a number of contract extensions secured this year.

Outlook:

Aggreko's business model allows it to flex capital expenditure (capex) in response to prevailing market conditions. The group now anticipates spending around £250m on fleet, down from previous guidance of £270m . Capex for the first half of 2016 is guided to be £120m (2015: £138m).

Aggreko still expects the underlying revenue trend in the second half to be similar to that in the first half, reflecting the on-going challenging market conditions. Full year profit before tax guidance is unchanged at £250-£270m at average exchange rates.

Chris Weston, Chief Executive, commented:

"Aggreko continues to demonstrate its resilience against a challenging market backdrop... Whilst we are at an early stage in delivering the specific actions identified at our business review in August, I am encouraged with the progress we are making which, regardless of the prevailing market conditions, will strengthen Aggreko and position it well for the future."

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.

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.

While market conditions are expected to remain challenging in the near term, the share price already reflects a lot of bad news. The shares trade on a forward price to earnings ratio (P/E) of 13.6x, which is a c. 30% discount to Aggreko's long run average rating.

This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research disclosure for more information.