Labour Pressures Weigh On NRW Holdings

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Alleviation of labour cost pressures, as projects shift from iron ore to new projects, plus a growing order book bode well for NRW Holdings, but broker’s note labour market tightness lingers

-NRW trades at a major discount to peers
-Increased wage & equipment costs could weigh on near-term margins
-Earning guidance points to a recovery in margins across civil division
-Shift in contract mix and geography to alleviate labour pressure

By Mark Story

Given that the covid pandemic significantly impacted NRW Holding’s ((NWH)) throughout the financial year, the market was quick to show its recognition of what was a stronger-than-expected FY21 by nudging the share price over 13% higher.

What was particularly pleasing to the market, notes Canaccord Genuity, who maintains a Buy rating on NRW, was the company’s ability to retain margins in the face of resource availability and labour cost pressures. While margins were a shade lower than expected due to the integration process, the minerals, energy & technologies (MET) segment was boosted by the Primero acquisition which has hit the ground running.

A key takeaway from NRW’s financial performance metrics, notes Canaccord, is the expectation for gross cash conversion, which was soft in FY21, to recover close to 100% in FY22. NRW is carrying $68m in claims, however, the company noted that claims currently submitted are much higher.

Interestingly, the broker believes this implies that the company booked the costs but less revenue than it intended in FY21. What this essentially means, adds Canaccord, is that margins were potentially artificially lowered.  While $75m of claims were agreed and paid in FY21, the broker expects some claims to unwind, and notes growth will still require some working capital investment.

Despite the challenges NRW faced during the year, the diversified contracting service provider posted FY21 revenue and earnings up 11.5% and 6.7% on FY20 respectively. Operating cash flow of $147.4m was 9% ahead of Macquarie’s forecasts which delivered a 17% beat in free cash flow of $69.5m in the period.

Equally encouraging, NRW provided FY22 revenue guidance of $2.4-2.5bn, and earnings guidance of $145-155m –excluding the Primero uplift — which Macquarie notes imply earnings margins of around 6.0% in FY22, above FY21, and highlighting alleviation of some cost pressures.

After incorporating the FY21 result and FY22 guidance, Macquarie has modestly decreased earnings per share forecasts -2-4% for FY22 and beyond. Macquarie’s earnings forecasts are below consensus for FY21-23. The broker expects lower margins due to increased wage and equipment costs over the next three-year period.

But based on bullish margin indications and guidance above Canaccord’s estimates, the broker has increased earnings forecast by 14% in FY22/FY23.

Labour constraints

Equally important, UBS, which has a Buy rating on NRW (target price $2.40), believes FY22 earnings guidance of $145-155m confirms the recovery in margins across civil, which experienced a sharper-than-expected decline, as labour headwinds reduce.

Due to border restrictions, the access to workforce was severely constrained, with 30% of its WA personal typically sourced from the east coast or overseas. As a result, the company witnessed the highest level of staff turnover in first half FY21 than it has seen at any time historically.

On project rollover, the Pilbara workforce has declined from 3,000 to 900 year-on-year. Due to these wage and cost pressures, earnings margins decreased from 6.8% in FY20 to 5.2% in FY21.

While labour challenges haven’t gone away, Moelis, which has a Buy rating on NRW (target price $3.10), believes a shift in contract mix and geography should alleviate some pressure.

The broker notes NRW’s mix of work and labour requirements is shifting away from hotspots like the Pilbara – due to iron ore project completions – and more towards new projects (like Strandline), and mining work with more stable workforces (like Karara) and alliance-style contracts.

Given that reported labour and mobility challenges have arguably deteriorated since Moelis last published estimates in February, the broker views last week’s result as a strong outcome. The broker notes despite the recent share price reaction, NRW is still trading on 6.5x EV/FY22 earnings, a 28% discount to its peer average of 9x.

Strong pipeline

Overall, Macquarie believes the company’s acquisition of Primero Group in March, and the installation of pit crushing and conveying solutions – to reduce its carbon emissions by at least 75% – add to the positive outlook for the company.

NRW’s order book at the end of FY21 totalled $3.4bn, and the broker expects this to grow to at least $4.4bn on conversion of the Curragh extension letter of intent valued at $1.0-1.4bn, to work to at least 2026.

NRW has also stated that its tender pipeline of $14.5bn, up from $12.9bn in the previous period, remains strong and the recent conversion of tender to orders has been 50%.      

While NRW is highly leveraged to iron ore capital spend and infrastructure spend – both of which have significant current tailwinds – UBS expects this to be offset by increased civil infrastructure capability and a healthy level of replacement capex projects from both Rio Tinto ((RIO)) and BHP Group ((BHP)).

Canaccord also expects the next phase of iron ore sustaining capex to provide a boost during 2022.

On the mining front, NRW has stated that the $700m, 5-year Karara project will require $170m in capex – $140m in FY22 and $30m in FY23. The Karara contract is scheduled to commence in March 2022 and the broker expects it to provide $40m revenue in FY22 before an even bigger boost to FY23.

The Karara project is owned by Gindalbie Metals ((GBG)) and China’s AnSteel.

Meanwhile, given that the outlook for the civil business is less clear at this stage, Jarden believes winning a greater share of this business underpins future earnings revisions. Given the longer-term nature of these projects, the broker which retains an Overweight rating on NRW (price target $2.90), suspects this may take time.

In the interim, Jarden thinks contract repricing and rise/fall clauses might be enough to offset higher wage costs, provided labour churn rates stay in line with expectations and industry labour supply experiences no further contraction.

Key risks to Jarden’s positive investment view on NRW include sustained cost pressures due to labour market tightness/churn beyond contracted rates, slowing contract wins for mining or the Primero business, and industry activity moderating or civil infrastructure investment delays.

However, the broker notes NRW is confident mining earnings margins, which improved half-on-half in second half FY21, can be held into FY22.

Jarden is encouraged by the deleveraging of NRW’s balance sheet and forecasts the company to move to "net cash" by FY24, provided the broker’s earnings forecasts are accurate.

NRW returned a fully franked dividend of 9.0cps in FY21, and Jarden expects this to grow 37% to 12.3c in FY22 and 13.5c in FY23.

FNArena's database has two Buy ratings, and the consensus target is $2.30, suggesting a 25% upside to the last share price. The dividend yield on FY22 and FY23 forecasts is 4.9% and 5.4%.

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