Australia | Aug 27 2021
This story features MONADELPHOUS GROUP LIMITED, and other companies. For more info SHARE ANALYSIS: MND
Soaring labour costs and reduced productivity are currently hampering Monadelphous, yet LNG projects and the clean energy transition represent new catalysts
-Productivity hit by labour shortages in Western Australia
-Newly-secured contracts include elevated pricing
-LNG projects and clean energy transition the new catalysts
By Eva Brocklehurst
Challenges besetting Monadelphous Group ((MND)) are likely to stick around for several months despite the company being a strong services operator in the resources industry in Western Australia.
Labour challenges are affecting costs and productivity. While earnings growth of 18% was delivered in FY21 the company has run up against border restrictions and strong demand for labour in Western Australia's iron ore sector.
This has resulted in labour cost inflation and difficulties with recruitment, with a resultant drop in project productivity. Operating margins have been hit, with the second half EBITDA margin declining -90 basis points to 5.1%, a record low. Monadelphous expects revenues will be lower in FY22 as major iron ore construction projects are completed and before new contract are awarded into FY23.
Morgan Stanley suspects a timing issue is a major reason FY22 revenue is likely to be lower than FY21, as the macro environment remains supportive of longer-term growth. Investors are likely to focus on FY23 metrics in terms of valuation and set targets using this year. One of the risks is the recent pull-back in iron ore prices may start to impact activity over the medium term.
Yet, at this stage, the broker does not believe this will occur, although considers the issue worth putting on a "watch". On the other hand, activity in oil & gas is likely to gradually increase. Revenue from the oil & gas sector was subdued in FY21, albeit more than offset by the contribution from iron ore. Management provided no specific guidance other than highlighting the persistent uncertainty.
A rebound in the share price is expected, amid a clearer understanding of the step-up in FY23, back towards historical averages, at which Monadelphous has traded at a premium to peers because of a niche service offering and robust balance sheet.
UBS remains attracted to the company's leading position in the resource construction market in Western Australia yet finds the outlook subdued, and unprecedented labour shortages are resulting in uncertainty. Still, these factors appear largely priced into the stock.
Credit Suisse agrees the stock captures the near-term uncertainty around earnings and points out Monadelphous sources 40-50% of its workforce from outside Western Australia. As it is not clear when borders could re-open sustainably, higher prices have been secured for contracts, which provides some relief from rising labour costs.
The broker expects cost pressures will continue as long as traffic to and from Western Australia is impeded. On the positive side, the newly-secured contracts with elevated pricing could translate to margin expansion from the second half of FY22.
Credit Suisse factors in 40 basis points of earnings (EBIT) margin improvement in FY22 with momentum accelerating in the second half. As the operating environment normalises, Ord Minnett, too, finds no reasons why Monadelphous would not be able to expand margins and profitability, at which point it will trade at a higher price.
The broker has upgraded to Buy from Hold following the sell-off on the release of the results and assumes no margin improvement in FY22 along with a -16% decline in construction revenues, but believes the market is pricing in a much more negative scenario where management would be unable to recover margins.
The completion of work, priced before the pandemic, remains the impetus for more normal margins, Bell Potter asserts. Once these construction projects are completed in the first half the order book should be significantly de-risked. Subsequently, the broker forecasts a return to operating earnings (EBITDA) margins above 6% in the second half.
Still, a difficult first half is likely and the broker, not one of the seven stockbrokers monitored daily on the FNArena database, maintains a Hold rating and $11.00 target.
To Jarden there is only upside potential from what is priced into the stock currently. The broker forecasts EBITDA margins to trough in the first half, then expand to 6.2% along with cash conversion improving to 95.4% over the course of FY22.
Jarden does not envisage any difficulties for Monadelphous to cover its dividend and, also not one of the seven, retains an Overweight rating and $11.80 target.
The company is notably talking up oil & gas opportunities for the first time in some years, Macquarie observes. For example, the broker notes Scarborough is a US$12bn potential project for which Woodside Petroleum ((WPL)) will make a final investment decision later this year.
While Monadelphous has been a clear "loser" from the pandemic, Macquarie suggests the incorporation of elevated costs in new contracts represents a catalyst. There is also Australia's transition to clean energy as new wind farms are coming onto the market in the next few years, particularly as electrical grid access improves in NSW and Victoria.
There are also opportunities for the company in the hydrogen sector. Even though iron ore construction work will come off peak levels there is still enough expenditure in the broker's view to sustain high levels of work.
In June, Monadelphous announced $250m in work across the resources construction and maintenance business. New contracts include Olympic Dam smelter maintenance for BHP Group ((BHP)) and Gudai-Darri iron ore services and construction as well as new contracts in Chile for Rio Tinto ((RIO)). Heavy lifting and haulage services were also picked up from Fortescue Metals ((FMG)) at Iron Bridge.
On the negative side in the results, Monadelphous has noted a large volume of construction work is in the final stage of completion so the measure of outstanding claims has gone up. Macquarie suggests this is largely because of timing. FY21 net profit of $47m was below the broker's estimates, yet largely related to tax.
The Australian Taxation Office has notified the company that amended assessments required to facilitate a refund for R&D incentives will not be issued, and the company has lodged an objection. On the positive side, there is a substantial improvement in safety performance, Macquarie notes, while the Buildtek business in Chile is performing well.
The database has two Buy ratings and three Hold. The consensus target is $10.97, signalling 3.1% upside to the last share price. The dividend yield on FY22 and FY23 forecasts is 4.2% and 5.2%, respectively.
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