FN ARENA NEWS - 25/11/2008
At its AGM earlier in the month, construction leader Leighton Holdings' (LEI) management maintained an upbeat view of the company's ongoing prospects, implying a level of immunity to the global economic downturn. Management noted that the Australian government is set to pour money into infrastructure, that rumours of the local mining industry's demise are exaggerated, and that the Middle East is still offering golden opportunities for further extravagant construction.
Analysts were not so blindly optimistic however, and considered Leighton's 15% earnings growth expectation in FY09 might mask the potential for a disappointing FY10. After all, most of FY09's contracts were already sown up. FY09 might prove a year when new contracts quickly dry up. Moreover, write-downs on local toll road contracts had a feeling of "this might just be the beginning" about them. (See "Leighton's Rose-Tinted Glasses"; Australia; 07/11/08).
In their report at the time, JP Morgan's analysts noted "we remain comfortable with our current FY09 profit growth forecast of 14%" but suggested consensus estimates were too high. They were right, as their peers took the opportunity to slash earnings forecasts and subsequently target prices from an average of $47.29 to $37.53. This figure is still artificial, as Deutsche Bank is yet to come back with a promised review and so its target remains at an outlying $51.50.
JPM nevertheless left its target at $44.41, given its "comfort".
One or two brokers did make note of Leighton's booming business in Dubai, but were happy with management's claim that for every Dubai there is an Abu Dhabi or Qatar waiting in the wings. That left most of the concern around Leighton's local contracts and whether or not there would indeed be a downturn in mining sector construction, and as to whether toll road write-downs may not become more severe. All up, analysts were happy to just be cautious.
I also made the following comment in the previous article:
"I've been reliably informed by a source close to the action that markets tend to believe Dubai is a fantasy world built on petrodollars, but that's a misconception because Dubai actually has no oil. The spectacular "city in the sand" is really a city based entirely on debt".
It is thus interesting to note JP Morgan's comments this morning:
"Dubai's rapid modernisation has been built on cheap debt. With debt markets closed, there are now serious questions being asked about the ability of companies linked to the Dubai government to raise new debt to refinance their existing obligations and continue to pay for the emirate's rapid development."
This comment forms the basis of JP Morgan's rethink on Leighton in a report this morning. Having been comfortable with their earnings forecasts earlier in the month, the analysts are now not so comfortable with the Middle East. They have slashed their target from $41.44 to $23.20 - just like that.
While making no reference to Leighton's suggestion that other Emirates would make up for any downturn in Dubai, the analysts suggest that any inability of Dubai government entities to refinance their debt will cast doubt over further construction development. A material downturn in Leighton's Gulf operations will have a meaningful impact on the company, they note.
If Dubai is about to struggle you wouldn't know about it. Last weekend saw a $30m party thrown for the opening of the $2.32bn Atlantis hotel on Dubai's artificial Palm Island. Kylie reportedly pocketed $4m for 45 minutes work and the firework display was said to be seven times larger than the one at the Beijing opening ceremony. The CEO of the company that built the hotel was reportedly embarrassed by the excess in a time of global economic hardship.
Pride comes before a fall.
Apart from JPM's sudden concern over Dubai, the analysts also aired their belief this morning that many Australian resources expansion projects will be put on hold until demand recovers. And they also expect further impairment charges on ConnectEast ((CEU)) and RiverCity ((RCY)). In general, the analysts suggest "the global financial crisis appears likely to trigger a synchronised global economic recession".
Not so comfortable after all.
JPM has responded to its new fears by downgrading Leighton to Underweight, introducing the first Sell rating into a B/H/S ratio which is now 5/3/1 in the FNArena database.