Stockbrokers Cooling On Monadelphous

This story features MONADELPHOUS GROUP LIMITED. For more info SHARE ANALYSIS: MND

By Chris Shaw

Since the beginning of October mining engineering group Monadelphous ((MND)) has been downgraded by three of the six brokers to cover the stock in the FNArena database, the latest coming today courtesy of JP Morgan.

The move to an Underweight rating from Neutral previously by JP Morgan reflects recent strong share price outperformance by Monadelphous, as on the broker's numbers the stock is now trading on a 12-month forward earnings multiple of around 16.1 times.

This puts Monadelphous on a 26% premium to its long-run average multiple according to JP Morgan, while it is also trading at a 15% premium to the ASX Industrials index at present. This compares to a longer-run average premium of just 2%.

While acknowledging the long-term outlook for Monadelphous has improved over the past 12-18 months, JP Morgan argues earnings in the near-term hinge on the timing of client investment decisions and the ability of the company to win its share of new contract work on offer.

The winning of new contracts (or the lack thereof) was a key reason behind the BA Merrill Lynch downgrade to an Underperform rating at the start of October, as the broker noted at the time Monadelphous hadn't announced any major new deals over the previous three months.

According to BA-ML, this was making the achieving of contract win targets for the half year to the end of December more difficult, as compared to $525 million in new contracts announced in 2009, by the end of the September quarter this year only $220 million of such contracts had been announced.

This was enough for BA-ML to cut its earnings forecasts to a level that put it below market consensus for the full year. BA-ML's earnings per share (EPS) estimates for Monadelphous currently stand at 95.6c in FY11 and 104c in FY12, while consensus estimates according to the FNArena database are for EPS of 100.7c this year and 111.5c in FY12.

JP Morgan has made similar comments with respect to new contract wins for Monadelphous, pointing out such contracts are essential given the average contract duration for the group is less than 18 months. With the run-rate of new contract awards currently below what was achieved in FY10, the broker continues to see downside earnings risk.

At the same time JP Morgan points out if Monadelphous is able to finalise some new contracts in coming months there is potential for a boost to earnings. This would signal some upside risk to the broker's Underweight rating.

The other issue for JP Morgan is Monadelphous is currently working through contracts signed in 2009 and 2010, which was a period when margins on new contracts were compressed. This implies the recent share price strength has gone above what can be justified on earnings potential.

This is a similar argument to that given by UBS when downgrading Monadelphous to a Sell rating earlier this month. Share price outperformance of around 10% was simply too much relative to the earnings outlook, causing UBS to lower its rating on valuation grounds.

Longer-term, Monadelphous offers some potential, JP Morgan noting its earnings forecasts imply an average of 12% annual earnings growth over the next three years. The recent acquisition of KT Pipelines should assist in this regard, while expansion plans in both the Pilbara and for the Gorgon LNG project offer scope for additional contract opportunities in coming years.

Overall, the FNArena database shows Monadelphous is rated as Buy twice, Hold once and Sell three times, with a consensus price target of $15.23. JP Morgan's revised target of $15.17, up from $14.73 is close to this, while RBS Australia is more aggressive with a price target of $16.31 and BA -ML is the low mark with a target of $14.28.

Shares in Monadelphous today are weaker and as at 11.55am the stock was down 16c at $17.25. This compares to a trading range over the past 12 months of $11.77 to $17.42 and implies downside of around 12% to the consensus price target in the FNArena database.

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