What a great way to start the week for Downer EDI Limited (ASX: DOW)!
The share price of the engineering group has surged 5.1% to $7.07 today, which makes it the best performing stock on the S&P/ASX 200 (Index:^AXJO) (ASX:XJO) on Monday.
The stock raced higher at the open after management upgraded its FY18 earnings forecast after it completed its review of its acquisition of Spotless Group Holdings Ltd (ASX: SPO).
Here are four things you need to know about the upgrade.
The first is that the profit upgrade isn't due to the Spotless acquisition. If anything, the FY18 underlying net profit after tax and before amortisation of acquired intangible assets (NPATA) for Spotless is tipped to come in at $93 million, or $85 million on a net profit after tax (NPAT) basis.
This is at the bottom end of the range provided by the Spotless board when it was defending itself against the takeover. The guidance for Spotless includes a circa $10 million hit to reflect Downer's accounting policies, particularly in relation to non-cash based earnings.
The second is that management has uncovered one-off significant items totally $79.7 million. The key drivers include redundancies, transaction costs, work in progress, mobilisation costs, and impairment of goodwill for the Spotless Laundries business.
On the flipside, Downer believes the synergies from combining the businesses will exceed its original estimates with around $25 million identified in annualised procurement savings alone. It also believes there are significant revenue synergies from the merger and these synergies appear to be growing as Downer looks closer at the sales opportunities.
Lastly, management has upped its FY18 NPATA forecast for the standalone Downer business by $5 million to $202 million, or $195 million in NPAT. This implies a total NPATA of $295 million before minority interests.
Downer has effective control of Spotless as it controls 87.8% of the latter, just shy of the 90% which would enable Downer to compulsorily acquire all shares in Spotless.
While the profit update is positive overall, it could give ammunition to critics who believe Downer paid too much for its controlling stake in Spotless.
Given the pipeline of infrastructure work in Australia, I believe the stock will be well supported in 2018 as long as there aren't any skeletons hiding in the closet.
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