A high Calibre float?

This company didn’t exist before 2002, although it’s not Facebook. Operating earnings are forecast to more than double between 2009 and 2013 but it’s not Apple. In fact, it’s not a technology company at all.

Instead, Perth-based Calibre Group provides engineering services to clients like Rio Tinto, BHP Billiton and Fortescue Metals. This new listing is a perfect example of the ‘two-speed economy’, with Calibre firmly in the express lane.

Essentially, Calibre is a play on the commodity that has made our big mining companies pots of money—iron ore. Your regard for the long term prospects of this float should therefore stem from your view on the commodity on which it hinges. In our case, that view is clear enough.

In Iron ore: It’s (not) different this time from 15 Nov 10, we argued that the price of iron ore, then around US$150 a tonne, was elevated and destined to fall. Today, it’s under US$130 a tonne and likely to fall further (perhaps much further).

Nevertheless, massive expansions to iron ore production are already underway. Rio has plans to move from 250 million tonnes per annum (mtpa) to more than 350mtpa by 2016, while Fortescue will almost triple production by June 2013. With plans to increase production by just 5%, only BHP Billiton has announced a go-slow this financial year. All this expansion requires infrastructure—new mines, processing facilities and rail links to get the ore from pit to port, which is where Calibre comes in.

Calibre is an engineering services company that specialises in the design and delivery of iron ore infrastructure for clients (although other parties undertake the actual construction). Many of Calibre’s staff work on-site within the clients’ operational structures.

The company’s profit forecasts are impressive, although there is a passing resemblance to a ‘hockey stick’ (see Chart 1). Essentially flat for the three years prior to the float, net profit after tax and amortisation is forecast to double between 2011 and 2013.

And yet these seemingly ambitious forecasts are probably conservative, for reasons we’ll get to. But it’s the longer-term risks that should grab your attention.

Calibre is very exposed to the resources boom, and to iron ore project expansion in particular. If the boom falters, or iron ore prices fall further, it’s likely that future expansions will be scaled back or mothballed.

Calibre’s prospectus explains that just such an event hit revenue in 2009 and 2010, with ‘key clients deferring projects, and reducing work and scopes on existing projects’ in the wake of the global financial crisis (see page 70). BHP is already considering curtailing capital expenditure plans (see BHP: Where the pigs fly high from 9 May 12 (Hold – $34.68)).

If Rio Tinto did the same—or Fortescue got into trouble—Calibre’s profitability would be at risk. The company is particularly exposed to Rio Tinto, which is likely to generate about 30% of total revenue in 2013.

To reduce this reliance on iron ore and Rio Tinto in particular, Calibre is diversifying. In fact, it’s a major reason for the float. The $75m raised will be used to repay debt taken on to acquire Brown Consulting, a civil, structural and environmental engineering consulting business operating in the eastern states.

According to page 51 of the prospectus, ‘Calibre has identified strategic acquisitions that it intends to investigate further after Listing’. The company’s bankers have provided a facility of $150m for this purpose. Debt-funded acquisitions outside a company’s core business should not fill you with excitement, so there’s another concern to add to the worry list.

Now, back to those profit forecasts. As capital expenditure projects have long lead times, a fair whack of Calibre’s forecast revenue is already in the bag; the company’s order book accounts for 60% of 2013 forecast revenue. With close client relationships, it’s reasonable to think the company has a good chance of locking in the remaining 40% of revenue not yet firm.

Two other issues make this float noteworthy. The first is that no existing shareholders are selling down; all capital raised is for debt reduction. Also unusual is that First Reserve, a private equity firm that acquired a majority stake in Calibre in 2010, has undertaken to maintain its 64% holding until after August 2013 (subject to some exceptions). There’s little incentive for the existing shareholders to issue over-ambitious forecasts, or to overprice this float, quite the opposite in fact.

Attractively priced

The second is that, compared to its peers, Calibre’s investment metrics look attractive. The stock has been priced on a forecast 2013 PER of eight, an enterprise value to earnings before interest, tax and amortisation multiple of 5.5, and a dividend yield of 7.5%.

By contrast, competitors such as Worley Parsons and Cardno are trading on PERs of 14 and 12 respectively. While Calibre arguably deserves a discount due to its less diversified business, it’s been priced attractively based on the forecast period.

Of course, it’s our job to look longer term and, beyond 2013, there are good reasons for concern. Iron ore capital expenditure remains at least partly dependent on iron ore pricing and, as previously noted, ‘it’s (not) different this time’.

With the small number of shares being issued, a supportive majority shareholder (at least in the short term) and superficially attractive pricing, there’s potential for Calibre to list above its $1.63 issue price. Of course, there are no guarantees, particularly with Mr Market’s current worried attitude towards resource-related stocks.

If you can’t obtain shares in Calibre’s float (see box: Who can apply for shares?), we recommend you avoid the stock after listing. If you’re a resources boom believer, there are less risky ways to hitch your wagon to the locomotive. In this case, proceed with caution. AVOID, but as we will not be covering the stock after listing, our ongoing recommendation is NO VIEW.