Eco Investor July 2015

Core Securities

Movement at Qube's Rail Development in Sydney

Two medium term factors will affect Qube Holdings' performance with the company downgrading its expected underlying earnings from its Ports & Bulk division for 2015-16, and on a positive note signing conditional contracts for the development of the Moorebank Intermodal Terminal Project in Sydney. The latter is good news for environmental investors as the rail freight terminal will reduce heavy truck journeys in Sydney and Qube Holdings says it offers outstanding long-term growth potential for its business.

The contract is between Moorebank Intermodal Company owned by the Federal Government and Sydney Intermodal Terminal Alliance (SIMTA) which is owned 67 per cent by Qube and 33 per cent by Aurizon.

Moorebank will be Australia's largest intermodal precinct. SIMTA has a 99 year lease over 243 hectares of land and Qube will operate the import-export (IMEX) freight terminal and the interstate freight terminals. When fully developed these will handle up to 1.5 million twenty-foot equivalent containers per year of which up to 1.05 million containers will be international freight and up to 500,000 will be interstate freight. The precinct will include up to 850,000 square metres of warehousing for Qube, importers, wholesalers and retailers.

Stage 1 will see 250,000 containers each per year through the IMEX facility and the interstate terminal, with later stages to be developed when needed.

On the financial side, Qube's total capital expenditure will be around $450 million, with $252 million of this spread over the first five years and the balance as needed. The numbers are not huge for a company of Qube's size, but they do not include Qube's capital for rail shuttle operations and its own warehousing needs.

Qube also has development, property and asset management rights over the precinct for the lease period and these will all add to its revenue. It will earn revenue from the IMEX and Interstate Terminal operations; property management; as construction manager; ground rent; warehousing development, lease and or sale; and logistics through port shuttle rail services, regional rail services, warehousing and other container services.

Qube has not put any public numbers to anticipated earnings but the internal rate of return is attractive as it exceeds its target of above 12 per cent.

There is some business risk in Qube being able to attract users and tenants at Moorebank, but all the partners including the Commonwealth see the service as attractive.

On the environmental side, the terminal has a direct rail link to Port Botany and to the north/south and east/west interstate rail corridors, and is close to the M5 and M7 Motorways which connect to the national highways. The terminal will enable more shipping containers to travel by rail, and so reduce the distance traveled by freight trucks in Sydney and on highways around Australia. It will reduce truck movements between Port Botany and Moorebank by 2,700 to 3,000 per day and Qube's managing director, Maurice James, says it will ultimately reduce the total distance traveled by import-export freight trucks in Sydney by more than 60,000 kilometres each day.

The net reduction in greenhouse gas emissions from the use of rail rather than trucks is 40,000 tonnes per year, he said.

Paul White of Qube said the terminal is expected to save importers and exporters about 20 to 25 per cent on current costs due to the great reduction in truck movements.

At present, containers are shipped by heavy trucks from Port Botany to the importer's warehouse for unloading and the trucks leave empty. The containers are emptied and another truck takes them to a container park. When the containers are needed, another truck brings them to be loaded. And when full another truck takes them to Port Botany.

The Moorebank Intermodal Terminal removes the need for so many truck movements as the containers can be taken by rail from Port Botany to Moorebank and the goods taken by local trucks to where there are required. The containers need not leave Moorebank until they are refilled and railed to Port Botany.

Combining land owned by the Commonwealth and SIMTA will reduce the rail track footprint and preserve more open space along the Georges River as it will connect to the main freight rail line at the southern end of the precinct, rather than through the public park next to the river.

Qube's partner, Aurizon, is Australia's largest rail freight operator with a 2,670 kilometre rail network handling coal, iron ore, intermodal and bulk freight, although most of this is in Queensland and Western Australia.

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How the Moorebank Rail Terminal will look.

Dr Kerry Schott, the chair of MIC, said "The terminal is critical infrastructure that will help unlock Sydney's transport gridlock and get more interstate freight on rail. The terminal will be open access for transport operators to increase competition in the freight market, it will support Federal and New South Wales targets to get more freight on rail, and the cost to government will be small."

The Commonwealth will invest around $370 million in the development, including funding the rail connection between the terminal and the Southern Sydney Freight Line and land preparation works. The investment will attract a low-risk return and is significantly lower than the amount anticipated when MIC was established in 2012, she said.

SIMTA will build and operate the terminals and has development rights for associated warehousing at a total project cost of approximately $1.5 billion over ten years. The contractual structure allows the Government to sell its revenue stream from the terminal at some time in the future, but the operating requirements for the terminal including the open access rules will continue for the term of the lease.

The next steps for MIC and SIMTA are to obtain the planning and environmental approvals for the precinct and if initial approvals are obtained it is hoped construction of the first stage will start in the second half of 2015. The IMEX terminal is expected to start operations in late 2017 and the interstate terminal in about 2019.

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Meanwhile, in a trading update, Qube said despite Atlas Iron temporarily suspending its operations, the two companies have extended their contract for another seven years. The new contract has interim arrangements for up to 24 months during which Qube has reduced its base charges but there is an upside sharing arrangement where Qube can earn additional revenue depending on the iron ore price received by Atlas and the free cash flow Atlas generates. At the end of the interim arrangements, contract pricing will revert to a set rate per tonne linked to volume.

Despite the issues at Atlas, challenging market conditions with lower volumes and rate pressures in other areas of its business, and severe weather in NSW in April that impacted its rail operations there, Qube said it expects continued growth in underlying earnings per share in 2014-15 compared to 2013-14.

However, Qube does not expect trading and economic conditions to improve in 2015-16.

Volumes at Atlas are expected to remain below previous levels until at least the December 2015 quarter. The earnings in Qube's Ports & Bulk division in 2015-16 will also be affected by the completion of some contracts in the second half of 2014-15 including the Yara contract at Dampier, project work at Roy Hill, and the previously announced end of the Arrium contract.

Despite the contribution of new contracts for Ports & Bulk in 2014-15 and the full year impact of acquisitions and growth capital expenditure, Qube expects underlying earnings from the Ports & Bulk division will be lower in 2015-16 than in 2014-15.

When asked by Eco Investor, Qube would not say if the lower earnings from Ports & Bulk would translate into lower earnings for the whole company. It said only that the forecast is meant to draw attention to the soft conditions in the iron ore business. So investors have to wait for the next full year results in August to get a clearer picture.

Qube has been a growth stock and the news saw its share price fall 40 cents to around $2.50. This would have been driven by the expected fall in earnings which has the potential to halt many years of growth. And while the Moorebank terminal is great news for Qube, it also means more capital expenditure in a weak market before the terminal can contribute to earnings.

The poor market for at least the next year and the two years for the terminal to begin operating put a medium term time frame on Qube's future performance. But the combination of when the economy recovers and when the terminal is up and running should mean that the growth is strong. (ASX: QUB)

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