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Better Times Ahead For Contractors

Australia | Sep 10 2021

This story features CIMIC GROUP LIMITED, and other companies. For more info SHARE ANALYSIS: CIM

Contractors hampered by border closures and disruptions to supply chains should be in line for a boost, given accelerating mining exploration and infrastructure expenditure

-Mining & construction job vacancies reach highest level in current cycle
-Increasing optimism regarding infrastructure opportunities being crystalised
-ESG opportunities for contractors increasingly in focus

 

By Eva Brocklehurst

Exploration expenditure is accelerating. Contractors which have been hampered by the border closures, disruptions to supply chains and constrained labour markets created by the pandemic should now be feeling some relief is in sight.

Payrolls and job advertisement data also signal mineral exploration employment is increasing at a rapid pace. Expenditure rose to $912m in the fourth quarter of FY21, up 24.1% on the prior quarter and approaching levels that were last witnessed in the previous mining super cycle.

Bell Potter notes $1.22bn in contracts is estimated to have been awarded during August, with Cimic Group ((CIM)) securing $655m and Monadelphous ((MND)) $200m in E&C (engineering & contracting).

Larger companies have borne the brunt of the constraints, too, having to manage thousands of employees across major projects, experiencing the greatest margin pressure. This includes Monadelphous and NRW Holdings ((NWH)), the broker points out.

Others that were more successful in riding out labour shortages include smaller operations such as GR Engineering ((GNG)) and Civmec ((CVL)). The former has benefited from the buoyant environment for junior/mid-tier gold projects in Western Australia and is currently Bell Potter's top pick in the E&C sector.

The rise in vacancies in mining and construction has reached the highest level in the current cycle, attributed to strong demand because of higher commodity prices, and a shortage of labour flows because of border closures.

Jarden points out, even before the latest lockdowns, airport movements at Western Australia's Karatha hub were only 82% of pre-pandemic levels, revealing constrained FIFO (fly in fly out) capacity into the Pilbara.

Jarden assesses stocks in mining services, with the exception of NRW Holdings, are trading a material discount is to valuation. Emeco Holdings ((EHL)), trading at a discount to NTA (net tangible assets), is assessed to have the most attractive outlook in the sector.

Credit Suisse is now cautiously optimistic about infrastructure opportunities being crystalised, noting the average price/earnings ratio across the sector is at 13.7x and a material -25-30% discount to the market.

Bell Potter agrees low valuations are presenting opportunities and retains Buy ratings on GR Engineering, Lycopodium ((LYL)) and Service Stream ((SSM)).

The broker is mindful that a re-rating may not eventuate for the latter until there is clear evidence of the integration of the Lendlease ((LLC)) services business. Lycopodium has also proven it can successfully deliver on African projects and remains leveraged to a global re-opening.

Beneficiaries should also include the ALS ((ALQ)) commodities division and Jarden is expecting 21.1% growth in FY22 revenue for that division. The broker has assessed exploration expenditure has an 88% forward correlation with total industry expenditure over 18 months, so this reinforces the view that the peak in the cycle is still ahead.

Oil & Gas

On the other hand, those servicing the oil & gas (O&G) sector are less likely to receive a substantial boost as there is weakness in employment, which remains below pre-pandemic levels while new projects and some maintenance operations are deferred.

Monadelphous has identified pandemic-related interruptions to rigs as a headwind to its maintenance and industrial earnings, although believes the situation is slowly improving since the FY21 result.

O&G accounted for 34% of the company's maintenance and industrial revenue in FY19. The main opportunity in the O&G sector, Jarden asserts, is Woodside Petroleum's ((WPL)) Scarborough project.

Monadelphous has made recent gains in terms of contracts, which Macquarie notes total $420m in value, with better pricing that is more reflective of the current high cost environment.

The broker considers the second half operating earnings (EBITDA) margin of 5.1% is likely to be a trough. Monadelphous is bidding on the $2bn Covalent lithium project in Western Australia along with wind farms and other lithium opportunities.

Macquarie believes, while being disadvantaged by the border closures, the business stands to be a key beneficiary once these are open. Meanwhile, Worley's ((WOR)) revenue remains subdued although staff numbers are expected to increase in the second half.

Infrastructure

The impact of the pandemic and pressures on labour costs are a continuing thorn in the side of infrastructure contractors. Yet Macquarie notes, in urban services, Downer EDI ((DOW)) has improved its cash conversion and has no problem contracts besetting the business this time around.

Earnings growth remains strong and some of the gap to global support services peers has been closed. Macquarie allows for higher multiples for the services business and believes the stock will be supported by buybacks.

The broker expects lockdowns should ease in coming months as vaccination rates improve and this will provide an uplift, particularly for Downer EDI, which is also impacted by the restrictions in Auckland.

ESG (environment, social & governance) opportunities are in focus, too, as the sale of company's mining and laundry businesses supports the company's decarbonisation strategy. Downer continues to grow its Reconophalt business. Macquarie notes local councils are slowly changing recycled content and the company's position in recycled road base appears well ahead of competitors.

Seven Group ((SVW)) has a strong outlook for its Coates division and Macquarie considers the stock a quality exposure to infrastructure/construction and resources. Although guidance for WesTrac was disappointing compared to expectations, Seven Group is a top pick for Credit Suisse, as demand remains strong in maintenance and replacement, and the commodities market remains supportive.

The broker acknowledges risks around the margin because of two successive part price reductions by Caterpillar, largely on the back of adverse FX moves. East coast infrastructure intentions are likely to underpin Coates and provide additional upside to guidance, which is for high single-digit earnings growth.

At the small end of the contractor sector, Credit Suisse prefers Alliance Aviation ((AQZ)), as accelerated deployment of E190 aircraft should provide substantial benefits, amid additional dry lease opportunities as border restrictions ease.

GenusPlus ((GNP)) should also be well placed for opportunities in electricity and the telecommunications sector, Jarden believes, although revenue is currently centred on Western Australia and the smaller divisions have struggled to achieve profitability.

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CHARTS

ALQ AQZ CIM CVL DOW EHL GNG GNP LLC LYL MND NWH SSM SVW WOR WPL

For more info SHARE ANALYSIS: ALQ - ALS LIMITED

For more info SHARE ANALYSIS: AQZ - ALLIANCE AVIATION SERVICES LIMITED

For more info SHARE ANALYSIS: CIM - CIMIC GROUP LIMITED

For more info SHARE ANALYSIS: CVL - CIVMEC LIMITED

For more info SHARE ANALYSIS: DOW - DOWNER EDI LIMITED

For more info SHARE ANALYSIS: EHL - EMECO HOLDINGS LIMITED

For more info SHARE ANALYSIS: GNG - GR ENGINEERING SERVICES LIMITED

For more info SHARE ANALYSIS: GNP - GENUSPLUS GROUP LIMITED

For more info SHARE ANALYSIS: LLC - LENDLEASE GROUP

For more info SHARE ANALYSIS: LYL - LYCOPODIUM LIMITED

For more info SHARE ANALYSIS: MND - MONADELPHOUS GROUP LIMITED

For more info SHARE ANALYSIS: NWH - NRW HOLDINGS LIMITED

For more info SHARE ANALYSIS: SSM - SERVICE STREAM LIMITED

For more info SHARE ANALYSIS: SVW - SEVEN GROUP HOLDINGS LIMITED

For more info SHARE ANALYSIS: WOR - WORLEY LIMITED

For more info SHARE ANALYSIS: WPL - WOODSIDE PETROLEUM LIMITED