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Morningstar | Cimic Forecasts in the Context of Australian Infrastructure Expenditures. No Change to AUD 34.50 FVE

When combined, Australian private and public infrastructure spending is forecast to be around AUD 85 billion in 2023, or 40% below AUD 133 billion peaks reached in 2013. Our unchanged AUD 34.50 fair value estimate for no-moat Cimic assumes five-year revenue CAGR of 3.8% to AUD 17.7 billion by 2023. And that from a 2018 launch year revenue of AUD 14.7 billion, already 35% improved on the AUD 10.9 billion low plumbed in 2016. After adjusting for Cimic’s AUD 1.2 billion sale of John Holland in late 2014, our 2023 revenue target is line-ball with the 2013 revenue peak; John Holland’s revenue contribution was AUD 4.5 billion in 2013. In that light, how can we forecast Cimic revenue meeting the equivalent of China-boom peaks?

Ignoring market share gains, the answer--as is often the case--is multifold. A large piece of the puzzle is energy expenditure. This component of spending hit almost AUD 60 billion at the heights of the LNG construction boom but is forecast at less than AUD 10 billion next year with projects substantially complete. A good portion of this spending occurred offshore--think Woodside floating in modules for its Pluto LNG Train 1 from Batam--and energy is not necessarily a space in which Cimic materially operates in any case. If we exclude energy from the pie, overall expenditure is forecast to be just 10% below AUD 75 billion China-boom peaks, at AUD 70 billion, and already recovered from a sub-AUD 60 billion low in 2016.

The drivers of the recovery in expenditure excluding energy are recovery in minerals spending from an unsustainable recent sub-AUD 15 billion low, in addition to increased maintenance spending off the back of major new projects commissioned, to AUD 10 billion by 2023. Public infrastructure spending is not expected to increase materially from current AUD 40 billion levels and private industry participation in that expenditure is unlikely to increase meaningfully from already increased 60% levels.

The last piece of the Cimic revenue pie is the mop-up of UGL in 2016. This boosted revenue from an area not previously participated in by Cimic, that is, defence spending. As such, Cimic’s share of the expenditure pie effectively increased. UGL boosted Cimic’s work-in-hand, or WIH, by AUD 5 billion and annual revenue by AUD 2.6 billion. Now replacing John Holland revenue, defence spending is a growth area for government and UGL has already proven its worth for Cimic.

And how does group WIH stack up against our revenue projections? At end 2018, Cimic reported AUD 36.7 billion of WIH, up 2.0% from a year prior, and equivalent to 2.25 years of revenue. That’s a bit below the 10-year average of 2.5 years, with Cimic burning through AUD 15 billion in revenue annually, and pause for not assuming even faster revenue growth than we do. But group WIH has grown at a two-year CAGR of 3.9% since the UGL acquisition in 2016, close to our five-year assumed revenue CAGR. This includes faster growth rates of 8.5% for construction, 5.5% for mining, and 22.7% for the smaller services/UGL segment, substantially offset by run-down elsewhere including in commercial/residential. The run-downs have largely run their course, but we think growth will now slow from other divisions to a more sustainable pace.

Cimic shares have pulled-back from April’s plus AUD 50 highs, but at AUD 44.50 remain materially overvalued in our opinion. Our fair value estimate equates to an unchanged 2023 EV/EBITDA multiple of 6.6, assuming a 3% five-year EBITDA CAGR forecast to AUD 2.0 billion by 2023. We think the market prices-in an unrealistic 7.5% five-year EBITDA CAGR to AUD 2.4 billion. At 0.35, Cimic’s EV relative to its WIH is still at historically high levels, well above the 25-year average of 0.27 and the 10-year average of 0.24.