Published in the June 2008 Australia’s Mining Monthly

For investors in Emeco Holdings, Australia’s biggest earthmoving equipment rental company, good news has been as rare as Melbourne wins in the AFL this year.

Just as long-suffering Demons supporters have had little to cheer about, it has been a tumultuous 12 months for Emeco shareholders as the stock fell out of favour.

Late in January, Emeco shares tumbled to a historical low of 71c after the company reported a fall in interim profit caused by disappointing results in the US and Indonesia.

The low point was well off the $1.90 a share that investors forked out when the company was floated almost two years ago.

The bullish predictions that flowed freely from the private equity owners in the lead-up to the float had well and truly dissipated.

The slide in the share price and the earnings downgrading led to many analysts dropping the stock.

Former JPMorgan analyst Richard Amland was among them. “We believe there are easier and better ways to gain exposure to a resource-aligned stock,” he said late last year.

Even long-time supporter Citigroup, one of three joint lead managers of the initial public offering, lost patience, lambasting senior management.

The bad news did not stop there. In another embarrassment, Emeco director Stuart Fitton was forced to step down after it was revealed he had sold shares in the company contrary to its trading policy.

As with many victims of the fallout of the sub-prime mortgage collapse in the US, Fitton sold the shares to cover a call on a margin loan. The ensuing publicity did little for investor confidence.

Emeco’s poor performance led to many analysts questioning its business model. Others were concerned about delays in sourcing machinery to supply to the big miners, which affected cash flow.

As with all big rental companies which spend lumps of cash upfront and then slowly earn it back through rental over the asset’s lifetime, cash flow is a perennial headache.

Emeco is not solely a rental company, although it generates most of its turnover from that sector.

It also derives income from machinery sales and maintenance services, the ratio varying greatly in different countries. Apart from Australia, the US and Indonesia, Emeco also operates in Canada and the Netherlands.

Despite the market bruising, Emeco managing director Laurie Freedman remains optimistic that the US, where the primary focus is coal, ultimately will prove to be a significant contributor to group earnings.

Since the share price nadir, Emeco has rallied in the recent weeks, rising as high as $1.17 as Australia’s Mining Monthly went to press.

The rally early in May sparked a “please explain” from the Australian Securities Exchange. In a letter to the ASX, Emeco executive director Robin Adair was not able to shed any light on the increase or higher trading volumes.

However, it seems sharp investors realised that Emeco’s fortunes are closely aligned to the coal sector. As thermal and metallurgical coal prices soared, interest in Emeco grew.

But it is not solely a rental company. Emeco sells more than 800 earthmoving machines annually in the global used equipment market. Machinery is sourced from Japan, North and South America, Europe, South Africa, New Zealand and Asia.

It also specialises in supplying parts and components for Caterpillar machinery and has a big procurement team that maintains an extensive inventory.

Despite those other strings to its bow, it is the rental business to the mining and civil engineering industries that accounts for about 90% of earnings before interest, tax and amortisation.

Emeco has a fleet of more than 1000 earthmoving machines. In Australia, it is dominant with about 30% market share in rentals to the mining industry. In Indonesia, its grip is even tighter, with 55% market share.

The renewed interest in the stock led to UBS Securities Limited changing its rating last month from neutral to buy. UBS was a lead manager in the Emeco float.

UBS said the change primarily was due to an increase in medium-term earnings forecasts. It noted that coal accounts for nearly half the group’s rental business.

“Over the past month we have increased pricing assumptions for export coal from Australia and Indonesia,” UBS researchers said.

“We have also significantly increased our US price assumptions. As a consequence, 2009-2011 earnings forecasts for EHL have risen by 5–7.5 percent.”

UBS reported the increased earnings forecasts had resulted in improved return on investment capital metrics. It said that although Emeco had struggled to generate adequate returns in the past 12 months, it believes returns over the next two to three years will be more than adequate.

In upgrading its rating to a buy, UBS raised its 12-month target for Emeco to $1.15.