Is it time to buy Leighton?

Leighton Holdings (ASX: LEI) is one of Australia’s largest infrastructure construction and contract mining companies with a proven ability to win medium to large projects domestically and overseas.

The company has traditionally had a strong balance sheet and a good reputation for delivering on time and budget, however the company has struggled in recent times due to two poorly executed projects during FY11-12. Cost overruns during Leighton’s construction of the Brisbane Airport Link and Victorian Desalination Plant severely damaged the company’s reputation and share price.

Prior to the cost overruns, Leighton’s share price hovered around the $30 mark but has recently hit a five-year low of $14.94, with today’s price of just above $16, representing a fall of around 50%. The cost overruns and desire to maintain the majority of its dividend payments in recent years have resulted in gearing rising to 48% at March 2013, traditionally high for the company and industry. Company CEO Hamish Tyrwhitt stated at the time that he intends to reduce gearing to between 25%-35% by the end of 2013 via the sale of assets and perhaps dividend reductions.

Leighton recently completed the 70% divestment of its telecommunications assets, with the $500 million in net cash proceeds to be directed to lowering gearing (by an estimated 10%). While this is seen as a positive by most brokers, some have expressed concern that the sale reduces exposure to the high-margin industry. Leighton expects the remaining 30% holding to appreciate in value due to the new ownership structure and expanded free cash flow.

The construction and mining services sector has been hard hit in recent months due to the anticipated slowdown in China growth, corresponding to the end of the mining investment boom, and poor consumer and business sentiment heading into the election. Amazingly, Leighton continues to win major contracts, with last week’s announcement of the $1.3 billion contract awarded by Fortescue (ASX: FMG) to service the Kings deposit at Solomon Hub in the Pilbara. The company also recently re-affirmed its profit guidance for 2013 for between $520 and $600 million on in-progress projects worth around $19 billion.

Leighton has diversified its earnings by generating significant exposure to overseas markets. Leighton operates in over 25 countries in Asia, the Middle East and Southern Africa but transparency to investors of individual projects is low. Its Middle East operations, however, under the Habtoor Leighton joint venture, has experienced problems winning projects and receiving payment of late and has been written down with no guidance on the likelihood of further writedowns.

Key risks include a major slowdown in mining construction and increased pressure from major shareholder Hochtief (54% owned) to change company direction.

Foolish takeaway

Leighton appears to be a good option for investors seeking exposure to the mining sector through a more defensive company. The diversification of profits between markets and locations means that profit downgrades due to slowing mining construction activity in Australia may be less severe than competitors, and Leighton has room to grow should demand allow. Investors should consider Leighton for a medium-term investment as company gearing and dividend payout will improve over time.

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Motley Fool contributor Andrew Mudie does not own shares of any companies mentioned in this article.

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