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Treasure Chest: Value Emerges For Macmahon

Treasure Chest | Apr 23 2018

FNArena's Treasure Chest reports on money making ideas from stockbrokers and other experts. Macmahon Holdings has narrowed mine contracting to Australia and Indonesia and Moelis initiates coverage of the stock.

-Significant contract at the Batu Hijau copper-gold mine
-Strong growth forecast underpinned by existing contracts
-Discount to peers considered unwarranted


By Eva Brocklehurst

Mining contractor Macmahon Holdings ((MAH)) has changed tack in recent years. The company, having departed Mongolia and Nigeria, has a narrower focus on Australia and Indonesia.

Moreover, recently-acquired TMM, a civil construction services provider in the Queensland coal mining industry, now enables Macmahon to become involved earlier in the project.

The company also entered an important agreement in 2017 with AMNT, operator of the Batu Hijau copper-gold mine in Indonesia. Macmahon has an alliance-style contract, with the initial scope of work to the value of US$2.9bn over the 14-year mine life.

The company will also acquire US$145.6m in mining equipment in exchange for 900 MAH shares, resulting in AMNT nominee, AMC, becoming the larger shareholder at 44.3%. AMNT and its main shareholders will support Macmahon's growth in Indonesia, and Asia, including first right of refusal to provide mining services to AMNT.

Moelis initiates with a Buy rating and 28c target and takes a conservative approach, estimating revenue will grow by 80% to $648m in FY18 and further 56% to over $1bn in FY19, underpinned by existing contracts.

The broker's FY18 estimate for operating earnings (EBIT) of $40.7m is at the low end of management's guidance of $40-50m. Moelis believes 6.5x is an appropriate multiple to apply to its FY19 operating earnings estimate of $77.8m.

Estimates exclude new growth from existing contracts as well as new contracts, although the broker assumes margins will improve in the second half of FY18. This is considered possible from an improved performance at Newcrest's ((NCM)) Telfer mine and the benefits of the gain-sharing mechanism at Batu Hijau. Moelis assumes EBIT margins stabilise at around 8%, in line with management's target.

The stock currently trades at a material discount to peers, in part, Moelis believes, because of relative scale/liquidity and capital structure, as well as concerns around customer concentration and political risk.

The discount is considered unwarranted, particularly because most of the forecast growth is underpinned by existing contracts. The broker acknowledges that any underperformance from Batu Hijau is likely to be a material risk.

However, risk management mechanisms exist, including payments to Macmahon which include a charge for equipment depreciation regardless of usage, a nil margin floor for any cost over-runs, and the AMNT shares to be held in escrow for 30 months with the potential to be bought back if mining services contracts are terminated.

The company is estimated to generate over 40% of earnings in Indonesia and is therefore also exposed to any political changes or regulatory reviews in that country. Still, the broker points out, the company has been operating in Indonesia since 2008.

Other key risks includes any delay in the turnaround at Telfer as well as general risks such as inclement weather, competitive pressure and a decline in mining activity. As background, CIMIC ((CIM)) made a hostile takeover bid at 14.5c per share in early 2017 and then subsequently sold down its 23.6% stake at 16.5c a share.

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