Downer Enhances NZ Capability

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

Engineering & construction services company Downer EDI has expanded its network in New Zealand with the acquisition of Hawkins. Brokers assess the prospects.

-Enhances NZ capability and bridges the reduction in Oz oil & gas work
-Downer EDI screens more positively than Monadelphous for Macquarie
-Deutsche Bank envisages revenue downside for Hawkins as Christchurch activity ebbs
 

By Eva Brocklehurst

Engineering & construction services company Downer EDI ((DOW)) has added another construction business with the acquisition of Hawkins in New Zealand. The private company is a bolt-on acquisition, which will make Downer the number two integrated construction player in New Zealand behind Fletcher Building ((FBU)).

Macquarie observes that while construction is higher risk than services or maintenance, Downer has large experience in managing the risks across its mechanical/electrical engineering, as well as in its wind farms/solar utilities segment. In addition to enhancing NZ capability, the acquisition should bridge a drop-off in Australian oil & gas work.

Macquarie estimates over NZ$50bn will be invested in the non-residential construction market over the next five years. The broker expects the NZ construction market to undergo large changes, with a regional shift in activity away from Christchurch to Auckland. This year becomes a general election year in the country and government expenditure is expected to support volume growth.

Downer is estimated to still have over $300m in potential capacity for further acquisitions and/or buy-backs and the most prospective targets are in the services/recurring revenue areas of unlisted businesses. Macquarie compares Downer EDI favourably to Monadelphous ((MND)) in that it is less exposed to the resources capital expenditure cycle.

Downer's EC&M (engineering construction & mining) revenue is 25% of its total versus 56% for Monadelphous. Downer's mining exposure comprises 27% of Macquarie's FY17 revenue estimates but the broker believes this is less about capital expenditure and more about volume/production. Downer EDI also has more diversity among its end markets in the services business.

Citi remains attracted to the high-quality balance sheet, which is not only linked to the defensive aspects of the business but also future growth options. The broker believes the ability to deliver growth via acquisitions offsets the risks to growth, as the company continues to transition to public/private infrastructure work from resources.

Citi estimates New Zealand will account for roughly 20% of Downer's revenue post the transaction. The broker assumes the three-month contribution from Hawkins in FY17 is fully offset by transaction and other integration costs but assumes a contribution in FY18, which enhances earnings per share by around 3-4%. The acquisition adds to capabilities and increases the company's penetration of the NZ non-residential construction sector.

While the share price has run hard, the broker believes management is skillfully re-positioning the business and this should mean a continuation of strong support. Citi remains a holder of the stock because of the robust fundamentals and attractive outlook for growth.

Deutsche Bank calculates the acquisition will be around 2% accretive in FY18-19, but suspects there are minimal synergies. While the medium term outlook for non-residential construction activity looks positive, the broker is cautious about the longer term as current activity is being buoyed by the re-building of Christchurch.

Deutsche Bank assumes the acquired revenues are maintained at peak levels until FY19 before declining. The Hawkins acquisition will help mitigate the roll-off in resources construction revenues in FY18-19, but the broker expects it to experience revenue reductions in FY20 and FY21 which suggests the acquisition is likely to be neutral to earnings per share in FY21.

Morgan Stanley is also more cautious. The broker expects a small uplift to FY18 earnings and notes a minimal impact on gearing, but questions the strategic aspect of the acquisition – in vertical construction – given Downer's historical move away from this exposure. The broker agrees there is limited ability to generate synergies with Downer's existing NZ business.

Hawkins

Hawkins is a well-known business for Downer, which is only acquiring the NZ arm, not the offshore business. Downer did not disclose the acquisition price but indicated it was in the range of $50-100m. Assuming the mid point of that range Morgan Stanley estimates the deal to be 2% accretive in FY18 and lifts gearing marginally to around 4%.

Hawkins is involved in the non-residential and civil construction space and has a number of projects in the re-building of Christchurch, as well as the SH16 Lincoln to Westgate upgrade, the construction of Auckland's Park Hyatt hotel and the Pier B extension at Auckland Airport. Citi assumes a acquisition cost of $75m for Hawkins, which suggests an acquisition multiple of 6-7 times, broadly in line with other recent transactions in New Zealand.

There are one Buy (Macquarie), three Hold and one Sell (Credit Suisse, yet to update on the acquisition) on FNArena's database. The consensus target is $6.26, signalling -13.4% downside to the last share price. Targets range from $4.01 (Morgan Stanley) to $7.60 (Macquarie).
 

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