Henry Walker v Downer EDI

Towards the back, with the commercial equivalents of Woody Allen (and several of our own staff members), would be Downer EDI. And then, finally, Henry Walker Eltin would stumble in among the very last of the tail-enders.

Both companies operate in the extremely tough engineering and contract mining industries. Profit margins are low and returns on shareholders' funds are lucky to make it into positive territory, let alone double figures.

But, while both face similar problems, we have had very different views on each. Downer EDI has rated a positive mention for just over a year now, most recently in issue 108/Jul 02 (Long Term Buy - $2.04).

Meanwhile, we've had a negative view of Henry Walker Eltin for more than two years, with issue 117/Nov 02 (Sell/Switch to Leighton - $0.86) our most current. Why is that?

Even in bad industries, some companies produce reasonable results. In fact Leighton Holdings produces outstanding returns by playing smarter and tougher than everyone else in the game, which is why we've been keen on it for a long time.

Downer EDI is much further down the spectrum. It produces positive, if unspectacular, returns while Henry Walker lies at the bottom of a rough heap. The company's recent results slumped to a loss of $29m for the six months to 31 December 2002 and investors were justifiably upset, selling the stock down heavily.

Henry Walker's management had flagged a small expected loss for the first-half last November but the actual result was far worse than anticipated. The bad news was mostly accounted for by writedowns on overseas operations (a recurring theme on the ASX of late) but that is far from the end of the nightmare.

The deteriorating financial results put the company in technical breach of three loan covenants – rules and limitations imposed by lenders to protect the money they have provided to the company. The consequences of such breaches can be serious.

CEO Bruce James will no doubt have been working hard to calm lenders' nerves.

Indeed, given Henry Walker's reliance on debt funding, we suspect such a task was part of his job description. But that doesn't make the company any more attractive.

The shares continue to trade at a large discount to their net tangible asset backing of $1.01 per share but, given the company's falling work-in-hand balance and accident-prone history, we aren't tempted to upgrade our recommendation. SELL and SWITCH to Leighton Holdings.

Downer EDI shares trade at a modest premium to their net tangible asset backing of 41 cents and we have been happy to recommend the stock given its huge balance of work-in-hand, which stood at $5bn at 31 December.

A couple of rail and road contracts announced since 31 December should keep this balance bubbling along and the company is doing a good job of cementing its place as the leading rail expert in the country.

It now covers everything from manufacturing locomotives and wagons to maintenance and upgrades of rail lines.

The company's market capitalisation of $482m is about four times that of Henry Walker's $114m but Downer's revenue is only a little more than double Henry's. In other words, investors are placing a lot more faith in Downer than they are in Henry. Is that justified?

Stable record

It's a tough question to answer. Downer has a more stable record of profitability and a history of increasing its work-in-hand – the lifeblood of companies of this ilk. And on a PER of 8.6 the current price is far from exorbitant.

Downer is certainly not a 'Rolls Royce' stock and not one we'd encourage you to hold forever.

But at these prices there is the potential for reasonable capital gains plus an unfranked dividend yield of 4.8% to tide you over while you wait. We don't think that's at all bad.

Still, if you are keen to add an engineering and construction company to your portfolio we think Leighton is a better long-term bet. It's exceptionally well managed and has an outstanding track record.

But if you bought Downer EDI on one of our previous positive recommendations, we can't seen any reason to sell. HOLD FOR THE UPSIDE.