EUR 850.00 For Business Accounts Only

Morningstar | Cimic Reports a Run of New Contracts, but This Is Needed in Support of Our Unchanged Thesis

Our 2018 EPS forecast of AUD 2.34 is unchanged following Cimic’s third-quarter 2018 earnings results. Nine-month year-on-year revenue, EBIT, and NPAT increases of 11%, 15%, and 13% to AUD 10.7 billion, AUD 825 million and AUD 564 million, respectively, are all in line with our expectations. No prizes though, with our expectations simply following Cimic’s characteristically timely and detailed guidance. The firm has confirmed 2018 NPAT guidance of AUD 720-780 million, an increase of 3%-11%, subject to market conditions. Our midrange AUD 760 million forecast stands.

Despite this purely confirmatory near-term data, we increase our fair value estimate by 10% to AUD 32.00. Approximately one third is due to time value of money, with the balance reflecting minor favourable adjustments to commodity prices, and a slightly improved resource expenditure outlook. Further, we lifted Cimic’s CPB Contractors midcycle EBITDA margin expectations to 9.5% from 9.0%, reflecting the outlook for a potential shortage of contractor capacity to meet demand for substantial public infrastructure works into the medium term. This segment contributed 45.7% of group EBITDA in 2017.

Despite the fair value upgrade, we keep a weather eye on the level of work-in-hand, which Cimic reports at AUD 35.0 billion, lower than the AUD 35.7 billion of this time a year ago. We aren’t overly concerned given characteristic volatility in timing of new contracts, and the AUD 35.0 billion doesn’t include AUD 1.0 billion in Metro Tunnel Works for which Cimic is the preferred contractor. Still our fair value estimate, which equates to an unchanged 2022 EV/EBITDA multiple of 6.8, does assume 5-year EBITDA CAGR of 3.2% to AUD 1.8 billion by fiscal 2022. This assumed earnings growth demands work-in-hand growth in order to be sustained. At our 12.0% midcycle EBITDA margin assumption for the group, Cimic needs to add approximately AUD 3.5 billion in new contracts per quarter just to stand still in a revenue sense.

Cimic shares have softened 20% from September AUD 51.60 highs, but remain overvalued. We estimate the AUD 42 share price has the market anticipating a reduced but still-high 8% five-year EBITDA CAGR to AUD 2.2 billion by 2022. This when we are apparently just a year away from an anticipated annual around AUD 16 billion peak in major transport infrastructure spending in Australia, from a low of around AUD 6.0 billion in 2016 and an estimated approximately AUD 13 billion in 2018. We still see little reason to become aggressively more bullish in our more tempered outlook at this stage which forecasts a plateau from peak spending rates.

But our grievance, if any remains, is with the share price, not the underlying company performance which remains impressive. We project net operating cash flow to remain above AUD 1.3 billion per year and growing, and for Cimic to sustain growing net cash including maintenance of a 60% payout ratio. This may facilitate payment of special dividends or initiation of buybacks at some stage in the future. We project ordinary dividends to grow at 5% CAGR to AUD 1.70 per share by 2022 versus 2017’s AUD 1.44. Our fair value estimate equates to a discounted 4.1% fully franked 2022 dividend yield, or 6.4% in nominal terms.
Key upside risks to our below-market fair value estimate could include Cimic leveraging high-priced scrip in an acquisition--though the price/fair value premium is nothing on the likes of WorleyParsons’ and its majority scrip bid for Jacobs ECR. That or majority 73% shareholder Hochtief announcing a clean-up takeover bid for Cimic which could be attractively priced given only a quarter of the shares remain in independent hands--our fair value estimate necessarily assumes a stand-alone Cimic. Further, if the shares sufficiently weaken, Cimic could deploy its growing net cash position to accretive buybacks, though these would unlikely be tax-effective given the limited AUD 225 million franking account.