Henry Walker's debt pile

But, as Warren Buffett says, it's far better to buy a good company at a fair price than a fair company at a good price. Unfortunately, Henry Walker Eltin falls into the latter category.

It's the country's largest listed underground mining contractor and the biggest contractor in Australian iron ore mining, with these activities contributing over 50% of revenue.

The rest comes from international operations in the same business, civil and heavy engineering and construction, through Simon Engineering.

Competitive

These businesses are highly competitive, low-margin and capital intensive. Those who've been following our Investor's College articles will appreciate the following numbers.

For 2001, Henry Walker Eltin's asset turnover ratio was 1.35. That, combined with a lowly EBIT margin of 4.2%, made for an unimpressive return on assets (ROA) of 5.7%.

The last time we mentioned this stock was way back in issue 73/Feb 01 (Sell and Stop Losses - $1.03). At that time the company had just issued a profit warning. Now, over 12 months later, it's at it again.

Management has downgraded its public profit target for this year to $18m from $24m-$26m. This time around the announcement has claimed the scalp of CEO Richard Ryan. He will depart once a replacement is found.

A successor was to have been named by the end of March but it appears the board is a little behind schedule.

Now we're left wondering if the company is having trouble getting someone to accept what many perceive as a poisoned chalice.

Although the balance sheet at 31 December 2001 showed $106m in cash, there was also $313m in debt on the other side, leaving the company's net debt-to-equity ratio at a reasonably high 79%. Applicants would no doubt be very well aware of the figure.

Dividend cut

Management also knows it must ensure that figure doesn't get out of control. In a business requiring big outlays on plant and machinery, that's a fearsome task.

The half-year dividend was cut to 3.5 cents from 5.25 cents last year and, although the full year dividend will fall, the payout ratio is expected to be 70% (i.e. 70% of profits paid out as dividends). A long-term target ratio of 45-55% has been flagged.

What does that mean? Well, if profits don't rebound, there may be further dividend cuts next year.

And while management is talking up prospects of a 2003 recovery, the fact is that the order book has weakened over the last six months from $1.94bn at 1 July 2001 to $1.55bn at 31 December. While a recovery is quite likely, if it doesn't eventuate the share price would come under further pressure.

This is quite the opposite to our 'Rolls Royce' stocks. The shares are cheap but they deserve to be.

Unless this company's performance improves markedly, the only reason the share price would rise markedly is by virtue of a takeover. We can't rule that possibility out but it's not something we'd like to bet on at this stage.

At absolute bargain basement levels we'd be tempted. At the moment, though, we don't see the upside as sufficient compensation for the risks.

We think you'll do far better with the dominant player in the sector. If you're still holding this stock we suggest you SELL and SWITCH to Leighton Holdings.