Monadelphous Falling From Favour

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

– Sell ratings dominate
– Analysts spooked by mining capex slowdown
– CLSA sees little near term hope

By Andrew Nelson

The company's interim profit report back in February marked a distinct turning point for engineering and construction services provider Monadelphous ((MND)). It’s not that it was a bad result. In fact, the numbers were in-line with most broker forecasts and even ahead of a few. It still wasn’t enough to keep three FNArena database brokers from downgrading their recommendations on what were then creeping fears about the slowdown in mining capex and the cancellation and/or deferral of projects.

Macquarie, who used the opportunity to downgrade its recommendation to Neutral from Outperform, summed up the broader broker stance back in February. While Macquarie admitted it was another guidance-beating result and FY13 revenue guidance was lifted, it still saw the need for more caution. Margins had slipped and earnings growth was already fading, the broker noted. Macquarie did think management was being cautious about new awards in FY14, warning a period of consolidation is at hand. Yet while Macquarie suggested this may be somewhat conservative, the broker nevertheless saw little chance for outperformance in the short term.

The result was also in line with Deutsche Bank, who lifted FY13 revenue forecasts on the result, which fed through to a 2% increase to net profit forecasts. The broker also noted competition was starting to bite, margins were under pressure and uncertainty remained around new project approvals. Deutsche Bank said back in February it expects the pipeline to keep shrinking, which would put FY14 revenue growth in doubt. BA-Merrill Lynch was of the opinion back then that revenue had peaked for the cycle and despite the company’s oil and gas opportunities, new work will be harder and harder to come by. That was the reason both brokers downgraded to Sell.

Citi and UBS didn’t downgrade their calls at the time, but that’s because they were both already at Sell (or equivalent). In a report this month, Citi was unsurprisingly concerned about the fact that Australian non-residential and engineering work has fallen off so sharply since late last year. What’s worse, so have forward indicators. This caused Citi to push out its recovery forecasts and revise its growth expectations.

UBS also updated its view this month and is also of the belief that end markets are continuing to deteriorate. The broker is also now thinking we’ll see an earlier than previously expected decline in earnings. Probably as soon as FY14 rather than FY16. The broker lifted its FY13 earnings forecasts by 1.5%, reduced FY14-15 by 18% and cut its price target by around the same amount.

Regional broker CLSA Asia-Pacific Markets was on the fence, at least until this week. The broker actually lifted its call a notch back in March on the belief that increasing work in the LNG market would be enough to offset softness in iron ore. Not so, unfortunately, and once the broker came to this view it downgraded back to Sell.

Switching from mildly optimistic back to a Sell call yesterday, the broker now expects a cocktail of the issues mentioned by various brokers above. CLSA sees group revenues dropping 12%, with margins shrinking by 100bps in FY14. This saw CLSA’s FY14 EPS forecast cut by 21%. With the broker now forecasting declining earnings growth for the next two years, it feels the stock simply does not justify any premium to the market and this is despite the quality of this business.

The broker explained that even the highest quality company in mining services cannot remain immune to a commodities slowdown. In fact, with BHP Billiton ((BHP)) and Rio Tinto ((RIO)) both increasing their focus on costs and savings, shelving plans for expansion, CLSA thinks margins for all mining services companies will remain under pressure. The broker sees this continuing to play out over the next twelve months, at least.

Why will margins fall 100bps in FY14? CLSA has laid out a hit list, which includes an increasing maintenance contribution to the revenue stream, fewer positive contract variations, lower headline margins, less shutdown work and the inability to use Sinostruct in LNG.

There is just one true believers in Monadelphous still standing: CIMB. Although it must be noted the last sign of support was back with the first half result in February. The broker said back then that is still saw further growth ahead from cost cutting in the business. This was despite management's assessment that FY14 would be a year of consolidation. CIMB also thought the share price reaction to that admission was too excessive. In fact, the broker saw it as a great buying opportunity and upgraded to Outperform. Back then.

The FNArena Database shows there is currently 25.3% upside to the consensus price target. Broker sentiment for the stock is negative, the database showing a Buy/Hold/Sell ratio of 1/2/5.
 

Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" – Warning this story contains unashamedly positive feedback on the service provided.

Click to view our Glossary of Financial Terms