Aurizon Holdings (AZJ)
BUY

Upside earnings risks emerge

 4 Jul 2023
Sector: Industrials

COMPANY ANALYSIS

Need To Know

  • Final regulatory outcome for UT5 is due by the end of July 2023
  • We see upside risk from 8.18% to ~8.40%, driven by higher bond yields, which could add $20m to earnings per year 
  • AZJ improved earnings outlook being driven by higher interest rates and improving (drier) weather outlook. Maintain the Buy Rating

AZJ’s below rail pricing regime for the FY24-27 period, known as UT5, is expected to be finalised by the Queensland Competition Authority (QCA) in July 2023. The pricing mechanism known as WACC is currently fixed at 6.3% (which is applied to AZJ below rail asset base), with AZJ in May suggesting 8.18% could be the new rate.

Given higher realised bond yields through June, there is the possibility that the WACC moves higher again to ~8.40%. This would equate to a further ~$20m of EBIT for AZJ’s below rail business. There are other influences on the final WACC decision including forecast inflation and the agreed value of the below rail assets.

Market consensus for EBIT in FY24 is between $899m and $1,020m, with a mean of $960m. We see some risks the bottom end of consensus will need to move upwards.

Next catalyst: 18-19 July: Investor Day. Before 31 July 2023. A final decision on UT5 WACC is expected.

Investment View

We believe the market is too bearish on AZJ and is capitalising on the soft weather-induced volumes of 2022/23 into the future. Poor operational performance has been coupled with much higher bond yields and ESG concerns. We see the prospects of >25% earnings growth and 30% dividend growth in FY24E. The dividend will remain a key attraction for investors in the medium term.

To be sure, AZJ faces a long-term existential crisis in coal volumes declining over the long term. We don’t see coal volumes declining this decade. ESG concerns overhang AZJ with coal-linked revenues and is part of the reason AZJ trades on a depressed multiple.

We rate AZJ Buy. The key short-term catalyst is the first guidance on FY24 volumes expected in August where we look for a strong rebound to ~205Mt. A peaking of global interest rates over the next 6 months should begin to remove the valuation headwind that AZJ has faced from rising long bond yields.

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Stock Overview

Share Price

Company Overview

AZJ is a rail freight operator in Australia. It operates in three segments: Network, Coal, and Bulk. 

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