Leighton surges despite tunnel woes
Leighton owns 6 per cent of Cross City Tunnel, which was placed into voluntary administration on Friday and was supposed to sign an agreement to appoint KordaMentha as receiver at 3pm on Tuesday.
Behind-the-scenes discussions are taking place between various parties as part of an effort to avert receivership.
Leighton's exposure to Cross City Tunnel is an estimated $18 million, which in the scheme of things is relatively small.
For Leighton's investors, a string of project wins tallying up to $6 billion over the past few weeks dwarfs any negativity from its exposure to a toll road that has been down the path of administration before.
To put it into context, Leighton's share price has jumped 21 per cent to $19.23 in the past four weeks.
The surge is partly due to factors unique to itself and partly due to a rebound in the engineering and contracting sector, which was bludgeoned earlier this year as mining investment fell, causing a number of projects to be either cancelled or downsized and contracts renegotiated downwards.
Over a similar time period, Downer EDI's shares have jumped 28 per cent to $4.75, Transfield's shares have soared 41 per cent to $1.23 and UGL is up 11 per cent.
The rebound was helped by the release of a string of statistics that suggest the Chinese economy might not be slowing as dramatically as originally believed. These green shoots of optimism lifted iron ore prices and other commodities, which, in turn, resulted in a few coal maintenance work tenders, LNG projects going ahead, and Gina Rinehart's Roy Hill iron ore project announcing a few contract awards, including one to Leighton.
The brutal reality is mining has propped up the economy for the past few years and when this started to falter, the mining services and construction companies got caught in the crossfire with their work cut back and margins squeezed.
A hot-off-the-press, 38-page report by Deutsche Bank into the sector shows 2013 profit margins were at their lowest point since the global financial crisis, "due to underperforming contracts, a sharp contraction in revenues and restructuring costs". It expects profit margins will improve in 2014, driven by benefits from "cost out initiatives, lower employee churn, roll-off of underperforming contracts and fewer contract cancellations/scope reductions".
While things might be looking up, it does not mean the mining party is back. Quite the contrary. Clients are taking longer to pay bills and there has been a marked increase in variation claims as clients scrutinise contracts.
According to Deutsche, Leighton and one other company, Monadelphous, are most exposed to variation claim writeoffs.
In its latest results, Leighton reported a $1 billion increase in net working capital (including a $630 million increase in receivables, mainly related to underclaims). While Leighton says it expects to recover $500 million of underclaims in the second half of the year, that is yet to be seen.
In Indonesia, Leighton stopped working in May at two coal mines controlled by Bumi Resources over a payment dispute. The mines accounted for $345 million of Leighton's revenue in 2012.
The company is trying to claw back underclaims in Australia and the Middle East.
At its interim results announcement in August, Leighton boss Hamish Tyrwhitt reiterated full-year guidance for $520 million to $600 million underlying net profit.
Against this backdrop, Leighton's major shareholder Hochtief lifted its stake to 56.39 per cent. In the past few months, Hochtief has bought the equivalent of 3 per cent of Leighton, complying with the creep rules allowing companies that don't want to launch a takeover bid to creep 3 per cent up the register every six months. The move was significant because it breached a long-standing agreement with Leighton that it would not go above 55 per cent.
The speculation is that Hochtief is being steered by its major shareholder, Spain's ACS, to build a big enough stake in Leighton that allows it to take more board positions and, ultimately, merge Leighton, Hochtief and ACS into a global construction giant and relist the new entity in all or one of the following countries: Germany, Spain, London and Australia. But for now, it remains speculation.
Frequently Asked Questions about this Article…
Leighton’s share price jumped about 21% to $19.23 over four weeks largely because the company landed a string of project wins totalling roughly $6 billion, Hochtief increased its stake in Leighton, and a broader rebound in the engineering and contracting sector (helped by upbeat Chinese data and higher commodity prices) boosted investor sentiment.
Leighton owns about 6% of the Cross City Tunnel, with its exposure estimated at roughly $18 million. The tunnel was placed into voluntary administration, but Leighton’s exposure is relatively small compared with its recent $6 billion in project wins, so it isn’t portrayed in the article as a major company-level risk.
Hochtief has increased its stake to about 56.39% by using the 3% ‘creep’ allowance. That breached a prior agreement not to go above 55%, which has prompted market speculation (reported in the article) that Hochtief — possibly guided by its own major shareholder ACS — may be positioning for greater board influence or, ultimately, a larger corporate combination. The article stresses this is speculation for now.
Key risks highlighted include rising underclaims and receivables (Leighton reported a $1 billion increase in net working capital, including a $630 million rise in receivables related to underclaims), exposure to variation claim write‑offs (Deutsche Bank named Leighton among the most exposed), clients taking longer to pay, and disputes like the stoppage at two Bumi Resources coal mines in Indonesia (which accounted for $345 million of 2012 revenue). Leighton says it expects to recover about $500 million of underclaims in H2, but that recovery is not guaranteed.
Sector peers have also rallied: Downer EDI rose about 28% to $4.75, Transfield about 41% to $1.23, and UGL about 11% over the same period. The sector rebound matters because improved commodity prices and signs of stabilising demand (for example, some coal maintenance tenders and LNG projects progressing) can lift contract activity and margins across the industry, benefiting firms like Leighton.
Deutsche Bank’s report noted that 2013 profit margins were at their lowest since the global financial crisis — driven by underperforming contracts, a sharp revenue contraction and restructuring costs. It expects margins to improve in 2014 due to cost‑out initiatives, lower employee churn, the roll‑off of underperforming contracts and fewer contract cancellations or scope reductions.
At its interim results, Leighton’s CEO Hamish Tyrwhitt reiterated full‑year underlying net profit guidance in a range of $520 million to $600 million.
The article reports market speculation that Hochtief — possibly influenced by Spain’s ACS — might be building a large enough stake to secure more board positions and potentially merge Leighton, Hochtief and ACS into a larger global construction group and relist the combined entity. However, the article makes clear this is speculation and not a confirmed takeover plan.
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