Third-quarter fiscal 2013 volumes fell in Pacific National (PN) Rail and terminals & logistics, but grew in both PN Coal and bulk & automotive port services. PN Rail’s intermodal business continued to experience weak volumes with the key volume metric, net tonne kilometres, down 3.4% reflecting weaker economic conditions in eastern Australia. Fortunately, volumes in PN Rail’s bulk business improved following increases in the export of grain and minerals. PN Rail provides 33% of Asciano’s AIO earnings before interest, taxes, depreciation and amortisation (EBITDA), undertaking bulk containerised rail freight activities and intermodal terminal services. The third-quarter fall in volumes confirms our thesis regarding the rail business operating in small markets with few competitors and a low degree of rivalry, but with volumes being cyclical. Terminals & logistics experienced a 4.1% fall in container lifts, which measures the movement of all container volumes handled by Asciano through key container ports and metropolitan stevedoring operations. The port business has a high level of cyclical exposure to domestic economic conditions, but operates in a concentrated market with few competitors. Historically, terminals & logistics has generated 24% of Asciano’s EBITDA.

We have lowered our fiscal 2013 net profit after tax forecast by 9% to AUD 330 million and fiscal 2014 by 15% to AUD 355.8 million on reduced future volumes. However, we have maintained our fair value of AUD 4.80 on Asciano’s forecast of significantly lower capital expenditure. Asciano has a narrow economic moat due to efficient scale in the rail and ports businesses.

In first-half fiscal 2013, PN Rail increased operating revenue by 5.3%, but EBITDA fell 1.5%. The decline in third-quarter volumes suggests second-half revenue and EBITDA will be marginally lower despite the relatively strong performance in the transportation of bulk grain and minerals. We maintain our low growth forecasts for PN Rail and we are reassured by an increase in steel tonnages transported for Bluescope Steel and recent bulk rail contract wins with construction materials manufacturer, Boral, and aggregates supplier, Holcim Australia. In first-half fiscal 2013, terminals & logistics’ revenue increased 1.1%, but EBITDA fell by 7.6%. The 4.1% fall in container lift volumes was mainly associated with weaker domestic economic conditions, resulting in lower container stevedoring revenue, particularly at Port Botany and Fremantle. Terminals & logistics previously held a 51.1% market share in domestic container volumes movements at Australian ports, but this has fallen to 47.5% during the third quarter. Asciano has implemented an operating cost reduction program for PN Rail and terminals & logistics to offset the revenue shortfalls.

Both PN Coal and bulk & automotive port services reported strong volume increases. Solid contract wins during the past two years and higher production activity at contract mines assisted PN Coal to a 22% increase in tonnes of coal transported by rail during the third quarter. PN Coal remains the second-largest coal haulage operator in Australia, carrying 60% of New South Wales export coal, but also holding strong market share in Queensland. Bulk & automotive port logistics reported a robust third quarter with vessels stevedored at bulk ports up 27.5%, vehicles transported up 20% and vehicle storage days up 78.4%. The strong third quarter was a result of a full period contribution from the Gorgon LNG Project contract, increased cargo for infrastructure construction projects and a strong push by foreign vehicle manufacturers to establish high sustainable market share in Australia.

After the lower third-quarter volumes, a capital constraint program has been implemented due to deteriorating domestic economic conditions. Fiscal 2013 capital expenditure is now expected to be between AUD 575 and AUD 625 million, down 18% to 22% and fiscal 2014 between AUD 700 and AUD 800 million, down 11% to 13%. Sustaining (maintenance) capital expenditure from fiscal 2015 is expected to be approximately AUD 300 million. We have adjusted our forecasts to the upper level of Asciano’s prudently reduced forecasts.

Ultimately, Asciano’s four operating divisions (PN Coal, PN Rail, terminals & logistics and bulk & automotive port services) have strong market positions with solid long-term fundamentals in oligopoly markets. Net debt at AUD 2.8 billion is too high, but Asciano’s businesses deliver dependable steady operating cash flows from long-term contracts with major companies requiring use of the essential rail and port assets. Volumes will always be cyclical and closely linked to global and domestic economic conditions. Our main short-term concern surrounding Asciano centres on the deteriorating economic conditions in Australia and China, resulting in our cautious approach on future earnings.