Aggreko is the global leader in the rental of temporary power generators, air conditioners, dehumidifiers and oil-free air compressors. Its equipment is usually loaned for short periods to music festivals, sporting events, offices, factories, and even to whole cities at times of power shortage or emergencies.
Aggreko (LSE: AGK), rated a BUY by Dresdner Kleinwort
In August, the group reported impressive second-half figures. Revenue rose 28.4% to £407.7m, pushing earnings per share up 44.7% to 17.13p. This was followed by “stronger than expected” results in the third quarter. The strong performance has been driven by the Beijing Olympics, the European 2008 football tournament and record demand from developing countries, which tend to be afflicted by blackouts or poor infrastructure. For example, India and China don’t have stable electricity networks. Power cuts are an everyday occurrence, damaging these country’s hopes of establishing local high-tech industries; even call centres need resilient power sources. The big advantage of hiring Aggreko’s products is that their power stations can be established in five to ten weeks, whereas a permanent one takes five to ten years to construct.
Aggreko operates in a late-cycle industry that is still having a field-day, despite the troubling economic backdrop. But investors should remember that renting power equipment is a ‘feast or famine’ sector, with very high fixed costs and dangerous operational gearing. During 2002-2004, after the fallout from the dotcom crash, Aggreko’s earnings tanked due to lower usage rates and falling sales.
Could this happen again? Absolutely. The City is giving it the benefit of the doubt, but I suspect that 2009-2010 could be dreadful for the industry. Aggreko’s performance is closely tied to emerging markets, which deliver its juiciest margins and contributed 71% of second-half profits. Although not disclosed, the firm is exposed to the volatile mining, oil and gas and shipping sectors. It has also spent £19.5m buying Power Plus Rentals in August to beef up its presence in the Canadian oil sands power rental market. This looks like poor timing – this space is very competitive, suffering from low barriers to entry and price elasticity.
In fact, it may even be hit worse than before. Aggreko has earmarked £250m to update its fleet this year, increasing its debt burden to £310m. That represents gearing of about 90%. But about £145m of its loans need to be renegotiated over the next 18 months, which is a worry if the group does get into financial difficulties due, say, to cancelled contracts.
So what is the stock worth? As a cyclical business where there are ongoing price pressures, I would value Aggreko on a 12 times through-cycle p/e ratio, or around 300p a share. Hence, on pure valuation grounds, I would suggest shareholders take profits and recycle the proceeds into other more attractive areas. In fact, several directors, including the CEO, have been doing just this over the past six months by selling chunky stakes at prices between 487p and 674p. It’s time to turn the lights out.
Recommendation: follow the directors’ lead and SELL at 469p (market cap £1.2bn)
• Paul Hill also writes a weekly share-tipping newsletter, Precision Guided Investments.