Investors overly punish high quality ASX200 company after earnings
Missing expectations but Morningstar's Adrian Atkins thinks the market's reaction is overdone.
Mentioned: Aurizon Holdings Ltd (AZJ)
At first glance, the headlines from Aurizon’s full-year results seemed fairly positive.
Earnings from Aurizon's Central Queensland Coal Network (CQCN) railway assets were up 14%. Aurizon’s coal haulage operations earnings rose by 16%. Non-coal haulage earnings were up 6% and management announced a $150 million share buyback.
Investors weren’t impressed, though, and Aurizon (ASX: AZJ) shares have fallen by around 10% since the results were released.
Why did Aurizon shares fall?
Aurizon’s results fell slightly below investor expectations. Morningstar’s Adrian Atkins thinks investors were hoping to see a stronger recovery from Aurizon’s coal haulage operations, which had a soft second half of the fiscal year.
The company’s guidance for 2025 profits was also modestly lower than expected and Atkins thinks that investors are losing patience with the firm’s investments in non-coal bulk and containerised freight.
These investments are an attempt to diversify away from coal. But while management has targeted double-digit returns on these investments, returns on capital invested in the non-coal bulk division appear to have been closer to 5%. Meanwhile, Aurizon's nascent containerised freight operations are still running at a loss.
The longer-term view
About half of Aurizon’s pre-tax earnings come from charging haulage firms for access to the CQCN, while another third come from its own coal haulage operations. As a result, the outlook for Aurizon's business still depends most on how much metallurgical coal is produced and exported from Australia (and Queensland in particular).
Morningstar’s base case is that Australian met coal exports remain relatively flat over the medium term, even if demand from China and coal prices softens. This stems from the fact that Australia is a low-cost producer thanks to its high quality mines located nearby to ports.
As a regulated asset, the most important drivers of Aurizon’s earnings from the CQCN are the value of the asset and the return on assets that regulators allow them to make through tariffs. These tariffs are set to adjust for changes in volumes to ensure a fair return for Aurizon as owner, which means that higher tariffs could soften the blow of lower volumes in a downturn.
This makes earnings from the network relatively defensive but it is only true to a certain extent. In a severe downturn, regulators could well step in to stop tariffs from becoming painfully high for remaining miners and making Queensland coal less competitive on the global market.
In its coal haulage division, Aurizon faces stiff competition from other haulers and in-house operations set up by large mining companies. Yet Atkins notes that most of the firm’s attractive, inflation protected contracts still have many years to run. He therefore expects modest growth in this segment over the next 5 years. Over the longer term, though, increasing competition and subdued export volumes could squeeze earnings.
Aurizon’s main focus going forward is on growing its non-coal businesses.
The company’s non-coal bulk haulage operations are large but only contribute around 15% of pre-tax earnings. This division mainly transports iron ore, alumina/bauxite, metal concentrates, and grain. Atkins is cautious on the outlook for Aurizon’s iron ore customers but expects returns for the non-coal segments to improve as new services ramp up. He thinks the market is too pessimistic on this side of the business.
Share price reaction over done?
Atkins adjusted his Fair Value estimate for Aurizon down by around 4% to reflect management’s weaker forward guidance. Investors were harsher in their assessment and have sent the shares down by around 10% to a price of around $3.27 per share.
As a result, Aurizon shares now trade at a 28% discount to Atkin’s $4.50 Fair Value estimate and command a 4-star Morningstar rating. Given that the shares looked undervalued even before the latest fall, Atkins thinks that management’s decision to announce a $150m share buyback makes sense.
The balance sheet also looks fairly strong. Aurizon’s growth investments were lower in 2024 and this allowed the company’s debt to fall as a multiple of pre-tax earnings. A further tapering down in growth investments could give Aurizon room to pay out a higher percentage of its earnings as mostly franked dividends.
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