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Leighton Holdings Limited reported net profit after tax (NPAT) of $216.7 million for the first half ended 31 December 2010, down 25 percent from the previous corresponding period. The result reflected difficult local and international trading conditions and impairment charges of $103.3 million (pre-tax), offset by a net gain before tax of $259 million on the sale of 35 percent of Leighton India. NPAT margin was 2.2 percent, down from 3.2 percent. For the full June 2011 year NPAT is expected to be about $480 million on revenue of $20 billion, implying an NPAT margin in the second half of 2.6 percent. Given the challenges Leighton is facing, how confident are you of achieving the NPAT guidance and what are the expected drivers of margin improvement in the second half?

CFO Peter Gregg
The guidance is our best forecast for the full year but the usual caveats apply: no further deterioration of performance due to weather and no further underperformance on major projects like Airport Link. To that extent we’re confident we can deliver.

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The recent Queensland floods and other major weather events in Australia and Indonesia impacted Leighton’s 2011 first half result by $40 million, with a further $60 million impact estimated for the second half. What assumptions underlie this estimate and what are the risks that the final impact might be larger?

CFO Peter Gregg
The most significant risk is continuing wet weather in Queensland and other parts of Australia. The Queensland government is releasing more water from Wivenhoe Dam in anticipation of further wet weather and long range forecasts predict three more cyclones for the Queensland coast before the wet season is over. So there’s a risk of further major flooding of mines and infrastructure projects we’re working on there.

In Indonesia we’re largely through with the monsoon season, so we don’t expect much further deterioration there.

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As at the end of December 2010, Leighton had work in hand of $45.6 billion, up from $42.5 billion at the end of September 2010. New contracts, extensions and variations totalled a record $16.1 billion, up from $11.7 billion in the previous corresponding period. Given the impact of the Queensland floods and tough conditions in the Middle East, what is the outlook for new work in the nearer term and with the prospect of labour shortfalls, particularly in Australia, and rising input costs, what is the outlook for margins on the current work in hand?

CFO Peter Gregg
The outlook for new work in both Australia and the Middle East is quite strong. In January, we won $2.5 billion worth of new work, which is on top of our $45.6 billion of work in hand at December 2010. We “burn” about $1.6-1.7 billion of work a month, so we need to win new work of that order to maintain work in hand.

We’re currently the preferred bidder on about $4 billion worth of projects, and there is another $8 billion worth of work in Australia and in the Middle East we’ve tendered on that we are highly likely to win.

The margin we carry in our work in hand is in excess of 10 percent and has remained steady. We haven’t seen any forecast deterioration in that margin, but obviously maintaining our profitability comes down to how well we execute jobs.

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The $100 million pre-tax impairment charge you booked on your 45 percent stake in Habtoor Leighton Group (HLG) reflected a reduction in the recoverable amount of the investment to $845 million from the book value of $1.14 billion over the first half. To what extent does the impairment take into account HLG’s unrecovered receivables and what are the prospects for a turnaround in HLG’s performance from its first half loss of $57.9 million? What is the potential for further impairment charges on the asset?

CFO Peter Gregg
One of the reasons we took an impairment on the carrying value of our HLG investment was because of the slower than anticipated flow of new work. The risk of a further impairment on HLG depends on whether new work comes through at the anticipated rate and on our ability to recover any additional money through the settlement of outstanding claims. We continue to work on these two issues.

The amounts that are unrecovered relate to jobs that were in place prior to our investment in HLG. As part of the investment agreement, the other parties provided warranties on the performance of jobs they brought to the transaction. There’s approximately AED4 billion (A$1.1 billion) outstanding in relation to those projects, of which about AED3 billion (A$825 million) has to be immediately available to the subcontractors, who we’re not required to pay until we’ve been paid. Our increased provisioning on HLG relates to the AED1 billion (A$275 million) dollar gap between those two amounts, given our belief that problems settling the outstanding claims will persist. We believe that once these jobs are completed and the bills and warranties are settled, receivables won’t be a major ongoing issue for the Group. And I should note that we are being paid for the newer work in the Middle East, this is a legacy issue.

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For the period to the end of December, Leighton provided $114 million in interest free shareholder loans to HLG, up from $38 million six months earlier, and the total has since increased by $68 million. This is in addition to $107 million provided as collateral against HLG debt facilities. Is this the full extent of Leighton’s exposure to HLG? Do you expect to commit further funding to HLG? Do you see this as a potential risk to Leighton’s own balance sheet?

CFO Peter Gregg
As it’s been unable to collect funds from clients, HLG has had to complete jobs using working capital provided by its shareholders and banks. With work still to be completed on some of these projects, shareholders will have to continue providing finance if money can’t be recovered from clients.

Leighton is valued at around $9.5 billion and the loans we’re referring to total a few hundred million dollars. So, while we don’t know the full extent of the funding requirements as yet, we don’t believe they’ll be a drag on our balance sheet. Also, as HLG wins more new work, more profits will be retained in the business and these debts can be paid off.

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Leighton had net debt of $525.9 million as at the end of December, up from $356.7 million six months earlier. Cash and equivalents totalled $1.17 billion, down from $1.31 billion, and undrawn cash and guarantees were $1.29 billion, down from $1.32 billion. What do you see as the appropriate level of cash and gearing for the size of the Group and the opportunities it sees?

CFO Peter Gregg
We see an appropriate level of gearing (net debt/net debt plus net equity, including off balance sheet financing) between 35 to 40 percent. At 39 percent at the end of December, we’re at the top end of that range and wouldn’t like to see debt levels increase much further. In that context, we’re tightly controlling our capex, and reviewing the returns generated by some of our assets and whether we’ll continue to hold those assets or move to release capital back into the business.

Historically we’ve tried to hold a cash buffer of between $600 million to $1 billion. Much of this represents prepayment for jobs currently underway. But our gearing target is the most important thing, and making sure we maintain our ability to repay and refinance our long term debt.

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In Australia, earnings were impacted by a significant profit write-back reflecting increased projected costs for the $4.2 billion Airport Link project in Brisbane. Your other major project in Australia is the $3.5 billion Victorian Desalination Plant. What are the risks around the completion of both the Airport Link project and the desalination plant?

CFO Peter Gregg
The main risk on Airport Link is around the cost of completion. The cost of completion has gone up from what was originally anticipated because of design issues, overruns, bad weather and additional scope that wasn’t anticipated. There remains a risk of further increases in the cost of completion. On any of our projects, including major infrastructure projects, we have to control costs as tightly as we can.

In the case of the Victorian Desalination Plant, the biggest issue is getting first water in the time frame dictated by the Victorian government. While we’ve had some impact from severe weather around the site, parts of the project, such as the underwater tunnelling, are well ahead of schedule. At this stage we’re not anticipating any problems in meeting the project deadline.

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With government spending priorities changing post the recent east coast weather events and looming skills shortages, what is the outlook for further major projects in Australia and how is Leighton positioned to respond?

CFO Peter Gregg
The Australian economy is quite strong, driven by demand for energy and mineral resources and that demand should continue to drive major investment, including in related infrastructure.

There’s been a relative shift away from government sector infrastructure to private sector infrastructure given major private sector projects such as the Gorgon gas field development, coal seam gas developments in Queensland and the Curtis Island LNG project. Government investment has moved away from the traditional private-public partnerships to the building of social infrastructure like hospitals and desalination plants. There’s no shortage of work available, but our priority is to ensure we deliver growth with the margins we require.

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Leighton Asia earned pre-tax profit of $32.1 million in the first half, down 28 percent from the previous corresponding period, on revenue of $457.9 million, down 11 percent. To what extent was the earnings decline due to one-off factors? What is Leighton’s strategy to capitalise on growth prospects in emerging Asian markets?

CFO Peter Gregg
The biggest driver of Leighton Asia’s drop in profitability was the wet weather in Indonesia which had a significant impact on a number of mines. Of course the currency also had an impact on revenue.

The Hong Kong Government’s enormous level of spending on infrastructure presents opportunities Leighton Asia intends to participate in. The company is doing a large amount of work on the high speed rail connection between Hong Kong, Shenzhen and Guangzhou and we expect these sorts of projects to be ongoing. In Hong Kong, we were awarded a number of new projects that geared up during the period.

With the wet weather in Australia, we’ll also look to capitalise on increasing demand for thermal coal out of our operations in Mongolia, where we’ve continued to win new contract mining work. We’ll be committing further capex into projects there.

While the contribution from Southeast Asia was slightly below expectations in the first half, we believe it will be a very important part of Leighton Asia’s growth going forward.

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Leighton International’s December 2010 sale of its 35 percent of Leighton India to Welspun Infra Projects was followed in January by an agreement to sell its stakes in two Indian toll roads to its Indian equity partner OSE. You also plan to restructure the reporting lines for the business. To what extent has your experience with HLG affected your strategy in relation to your international operations? With a new CEO now in place, are you considering further strategic changes across the Group?

CFO Peter Gregg
The sale of the 35 percent stake in our Indian operations to Welspun involved another entity buying into our operations and means we’re now involved in India with an established local partner. It differs from the situation with HLG, where we bought into an entity operated by another party.

David Stewart, Bill Wild or I now sit on the boards of all our major operating companies to keep a close eye on developments across the Group. Bill and I are on the board of the joint venture in India to ensure it meets expectations and delivers our planned growth forecast. This means the Indian joint venture has not only a stronger platform than we had in the Middle East but also a higher level of scrutiny than in the past.

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Leighton announced a fully franked interim dividend of 60 cents per share which represents a payout ratio of 83 percent. This compares with 65 cents per share fully franked and a payout ratio of 67 percent last year. With continuing difficult conditions how do you expect Leighton’s dividend payout ratio to trend going forward?

CFO Peter Gregg
Historically the group has paid out between 60 and 70 percent of its profits in the form of dividends. The higher than normal payout ratio is intended to provide confidence to our investor base and signal our belief that the drop in profitability is short term only.

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Thank you Peter.
 

For more information on Leighton Holdings, visit www.leighton.com.au or call Justin Grogan, Executive General Manager, Corporate Affairs, on (+61 2) 9925 6628 or Matt Sullivan, Manager Investor Relations on (+61 2) 9925 6121

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