MARKETS SPECTATOR: Leighton's governance discount

The fallout of last month’s resignation of three Leighton Holdings directors, including former chairman Stephen Johns and former Reserve Bank of Australia governor Ian Macfarlane, is having more of an effect than even the bears on the stock could have foreseen.

Leighton shares, especially in March, should have been propelled higher after the company announced a string of deals including the $619.5 million sale of a majority of its stake in its telecommunication business, a $656 million rail contract in Hong Kong, a $NZ220 million Auckland road contract with a partner and a $212 million LNG contract in Western Australia.

But when a board chairman and fellow directors resign, any good news announced by the company is likely to be overshadowed. Specifically in Leighton’s case there are investor suspicions that Actividades Construccion y Servicios, which has a 54.5 per cent stake in the company, may repatriate cash from the company and influence more strongly its strategic direction, which is having a detrimental effect on Leighton’s stock. The company is trading at a discount to the market, about 10-times forecast 2013 earnings versus the broad market’s 14.5 times.

It is the second time in three years that a Leighton chairman has quit. This is raising questions of what is going on at the company’s board and what is the relationship between board members and its controlling shareholder who, of course, have board representation. Moreover, Leighton’s business units faces a series of headwinds that may cause the stock to slide further.

Australia, which essentially accounted for 84 per cent of Leighton’s 2012 revenue of $18.95 billion, has an uncertain commercial construction outlook. The forecast for mining contracting, which accounts for 28 per cent of Leighton’s sales, is similarly bleak. Mine owners such as BHP Billiton want to do such work themselves. Contract miners such as Leighton may be asked to forgo termination payments. Some new contracts may penalise contractor margins if productivity goals are not met.

Moreover, there is skepticism that Leighton can consistently win business in Asia.

Chief executive Hamish Tyrwhitt boasts of an extensive experience in the region. However, Leighton is competing against the world’s premier construction companies including Korea’s Hyundai Engineering and Construction Co, responsible for helping to build Singapore’s Changi airport, Samsung C&T Corp., who helped construct the world’s tallest building, as well as companies from China, which has the world’s three largest construction companies by revenue including the biggest, China State Construction and Engineering.