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The next ASX stock that can gift ~$500m to shareholders

Investors love capital returns and ASX companies that are in a good position to undertake such programs tend to do well in this low-rate, low-return environment.

This is one factor that’s driving the outperformance of big miners like Rio Tinto Limited (ASX: RIO) and BHP Group Ltd (ASX: BHP). The hope of a handout from Commonwealth Bank of Australia (ASX: CBA) from its asset divestment program is probably also helping the big bank outperform its peers.

There’s another S&P/ASX 200 (Index:^AXJO) (ASX:XJO) stock that could soon have excess cash to splash, according to Credit Suisse.

Divestments to fund share buyback

This is engineering and maintenance group Downer EDI Limited (ASX: DOW), which is believed to be preparing to sell the laundries business owned by Spotless Group and divest its mining contracting business.

Downer has effective control of Spotless and the laundries division is one of the country’s biggest as it services hotels, aged care facilities and convention centres.

“We estimate the combined EV of these businesses at A$1.1-1.3bn. If each business was funded with net debt at 2x EBITDA [earnings before interest, tax, depreciation and amortisation], then net proceeds could be in the range of A$640-795mn,” said Credit Suisse.

“We expect management to return the bulk of the proceeds (75%) to shareholders via an on-market share buyback.”

The total amount Downer will have for a share buyback under the broker’s assumptions is $480 million to $600 million. That would be enough to buyback up to 12% of its shares and will likely take 12 to 18 months to complete.

Sales not guaranteed

This has prompted Credit Suisse to upgrade its price target on the stock to $8.00 from $7.70 a share. There isn’t enough upside to justify the broker upgrading its recommendation on the stock and Credit Suisse is sticking to its “neutral” rating on Downer.

The Downer share price shed 1.4% on Wednesday to $7.82 but it’s still up by 17% since the start of this calendar year.

However, the sale of the laundries business isn’t a given. Spotless has tried unsuccessfully to flog the business three years ago. Talk about the sale of this division is also pure conjecture, although that hasn’t stopped Credit Suisse from estimating that the sale could fetch $300 million to $360 million (based on 5-6 times the division’s FY19 EBITDA of $60.4 million).

The spin-off of Downer’s mining business is looking a little more certain although management has yet to confirm this. Downer is officially reviewing the business.

“We estimate the mining business could be worth A$835-930mn based on 4.5-5x our FY20 EBITDA estimate,” explained Credit Suisse.

“We estimate net proceeds could be A$465-560mn but we think the proceeds from the sale are likely to be more than its book value of A$545mn (as at 30 June 2019).”

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Motley Fool contributor Brendon Lau owns shares of BHP Billiton Limited, Commonwealth Bank of Australia, and Rio Tinto Ltd. Connect with him on Twitter @brenlau.

The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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