Not All Smiles For Mona?

This story features DOWNER EDI LIMITED, and other companies. For more info SHARE ANALYSIS: DOW

 – AGM commentary from Monadelphous positive
 – Earnings guidance better than expected
 – FY13 result to be strong despite growing margin pressures
 – Peak in construction cycle seen as major threat to earnings

By Chris Shaw

Expectations for solid revenue and earnings growth for resource sector service provider  Monadelphous ((MND)) for FY13 were already in place, but AGM commentary from the company yesterday still managed to surprise to the upside.

Guidance for the full year is for revenues to increase by 25%, driven by a 40% increase in the first half. This was well above the forecasts Macquarie's for 17% full year growth and 25% growth in the first half, the broker noting the better than expected guidance reflects a surge in construction activity as a large number of projects have ramped up in recent months.

The only negative in the update for Macquarie was some signs of margin pressure emerging, this as customers focus increasingly on lowering costs and tightening capex spending. Improved productivity at Monadelphous should act as an offset, so Macquarie is forecasting flattish margins for FY13.

Given increases to revenue forecasts, Macquarie has lifted earnings forecasts for Monadelphous in earnings per share (EPS) terms by almost 8% in FY13 and by nearly 9% in FY14. Others in the market have followed suit, with Goldman Sachs lifting its numbers by 5% and 3% respectively and JP Morgan by 8% and 0.3% in FY13 and FY14.

Consensus EPS forecasts for Monadelphous according to the FNArena database now stand at 170.5c for FY13 and 180.1c for FY14. Changes to earnings estimates have generated changes to price targets, the consensus target for the stock increasing modestly to $22.93 from $22.88. Targets range from JP Morgan at $18.05 to CIMB Securities (formerly RBS) at $27.86.

While currently above consensus with its forecasts for FY13, the issue for Morgan Stanley with respect to Monadelphous is as to whether the first half of FY13 proves to be the peak in growth for the company. The trend towards customers looking to lower costs is only likely to intensify in the broker's view, which has implications given in the longer-term Monadelphous's business is likely to become increasingly skewed to lower margin maintenance work. JP Morgan has similar concerns.

For Morgan Stanley this implies there is better value elsewhere in the sector, with Downer EDI ((DOW)) preferred given a more attractive earnings multiple and a market leading position in the electrical engineering market. Morgan Stanley rates Monadelphous as Equal-weight within an Attractive industry view.

BA Merrill Lynch offers a similar view with its analysis, noting while performance at present is good, Monadelphous will at some point find the going tougher when the level of construction activity peaks. BA-ML expects an earnings peak fairly soon, which means no change in Neutral rating.

JP Morgan continues with its Underweight rating on Monadelphous, as despite management's strong track record of earnings growth and a good reputation as a contractor the 16% premium to valuation at present suggests near-term earnings risks are not being factored in at present.

JP Morgan also sees better value elsewhere in the sector, with Downer, Lend Lease ((LLC)) and NRW Holdings ((NWH)) all offering more attractive combinations of earnings growth and gearing in the broker's view.

Not all agree, as both Macquarie and CIMB Securities have maintained Outperform ratings on Monadelphous. For Macquarie the combination of a strong earnings growth profile, a good track record of project delivery, a solid balance sheet and a fully franked yield of better than 6.0% continue to justify an earnings multiple premium to peers.

As well, Macquarie points out the current multiple for Monadelphous is a discount to the market and the stock's historical average, which implies value. CIMB agrees, arguing the market is too bearish on the earnings outlook for the next 18 months. Delivery of earnings should deliver share price outperformance in the broker's view.

Overall, the FNArena database shows Monadelphous is rated as Outperform twice, Hold four times and Sell once. Goldman Sachs rates the stock as Neutral.

In a weaker overall market shares in Monadelphous today are higher and as at 1.45pm the stock was up 43c at $21.94. This compares to a range over the past year of $18.81 to $24.37, the current share price implying upside of around 6% relative to the consensus price target in the FNArena database.

 
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