EUR 850.00 For Business Accounts Only

Morningstar | Cimic’s 1H Cash Flows Impress but Growth in New Work Remains Elusive. No Change to FVE

Our AUD 29.00 fair value estimate for Cimic stands. No-moat Cimic reported a 12.4% increase in first-half fiscal 2018 NPAT to AUD 363 million, only marginally below our AUD 380 million expectation. Company guidance for fiscal 2018 NPAT of AUD 720-780 million is unchanged but our forecast softens slightly to AUD 759 million from 768 million, given the first-half result. At AUD 42.80, Cimic shares are 17% down from AUD 52.00 December 2017 peaks, but remain materially overvalued. We continue to think the market overenthused by the implication of high-profile public infrastructure spending.

The important metric from our perspective remains Cimic's work-in-hand, or WIH. At end June 2018, the company had AUD 34.8 billion, down marginally from December's AUD 36.0 billion print, and equivalent to 2.5 years' current revenue. While a notoriously lumpy metric, the fact that like-for-like WIH has not materially changed in dollar terms in more than two years, and in fact has fallen in revenue terms, from 3.0 years' worth in first-half 2016, should concern. Our AUD 29 fair value anticipates five-year EBITDA CAGR of just 1.5%, to AUD 1.6 billion by fiscal 2022. At the current share price, the market appears to be pricing-in 8.5% five-year EBITDA CAGR to AUD 2.3 billion. That would be an extraordinarily impressive feat, requiring growth in WIH that at least for now remains non-evident. Worth considering again, despite retreat since December, Cimic's diluted share price is still above 2010's AUD 39 mining boom highs, yet WIH of AUD 107 per share is more than 20% lower.

But these arguments are with the share price, not the underlying company performance which remains impressive. The quality of first-half 2018 earnings improvement was high, as EBITDA margin held ground at 11.3% with no significant one-off items. First-half EBITDA margin particularly impressed, given revenue growth from the services segment, a lower 7.5% margin business.

Construction EBITDA margin improved to 10.1% from the previous corresponding period's 9.5% and mining margin held at 21%. From this context, Cimic's lack of WIH growth might be viewed as evidence of creditable discipline in bidding for new contracts.

First-half net operating cash flow increased 20% to AUD 636 million, slightly ahead of our expectations. Free cash flow also impressed, up 70% to AUD 384 million and well ahead, with lower-than-anticipated capital expenditure of just AUD 253 million. This allowed the net cash position to improve by 43% versus December to AUD 1.3 billion, a commendable position for a business in a highly cyclical industry.

We project net operating cash flow to remain above AUD 1.2 billion per year and growing, and for Cimic to remain in growing net cash including maintenance of a 60% payout ratio. This may facilitate payment of specials or initiation of buybacks at some stage in the future. The trick will remain to avoid repeating mistakes of the past--too aggressively chasing work when pools shrink and underpricing for the risk.

Our fair value estimate equates to a little-changed 2022 EV/EBITDA multiple of 6.8. But at AUD 42.80, the market values Cimic on a 2022 P/E of 21 and a price/cashflow multiple of 16, discounted at WACC. We think this far too generous, with the implied 2.8% yield discounted at WACC underwhelming. Cimic will pay a fully franked AUD 0.70 first-half fiscal 2018 dividend, and our full-year expectation is for AUD 1.43, a 3.3% yield at the current price.