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Morningstar | Monadelphous Meets Fiscal 2018 Earnings Expectations and Sees More Infrastructure in its Future. See Updated Analyst Note from 21 Aug 2018

Our AUD 10.50 fair value for no-moat Monadelphous stands. The company reported fiscal 2018 NPAT of AUD 71.5 million, only marginally below our AUD 72.7 million expectations. Our long-term assumptions remain substantially unchanged. An element of the result that did surprise was its being achieved on higher than anticipated revenue, up 41% to AUD 1.78 billion. But this was negated by a commensurate increase in operating costs, EBITDA margin falling 120 basis points to 6.6%, and 60 basis points below our 7.2% forecast. We don't see long-term consequence and our midcycle EBITDA margin assumption remains 7.6%. The market appears little perturbed either, the shares up some 6% to around AUD 15.80 upon release of the result, and considerably overvalued in our opinion. We think too much is anticipated from resources and Australia's east coast construction boom. Disappointment could be met in share price retreat.

Our fair value estimate equates to a 2023 EV/EBITDA multiple of 7.5. But the market is valuing Monadelphous on a 2023 EV/EBITDA of 11.3, a P/E of 22, and a price/cashflow of 12.8, discounted at WACC. Our forecast for a near 5.0% fully franked yield from fiscal 2019 (based on current share price) has some appeal, though on a high plus 80% payout ratio. Yield notwithstanding, we think the price still too generous implying an unrealistic five-year revenue CAGR of 3.2% at a midcycle EBITDA margin of 11.4%, versus 7.6% actual for the three years to fiscal 2018, and our 7.6% forecast.

Monadelphous says there is strong demand for its services in resources and energy and there is a surge in oil and gas construction revenue. This is at odds with published data showing total Australian energy capital expenditure changed little in fiscal 2018 at approximately AUD 26 billion, before an expected precipitous fall in fiscal 2019. And after more than five years' construction, the Ichthys LNG project--a revenue insulating core for Monadelphous--began production in July.

Monadelphous expects lower construction revenue in fiscal 2019 due to project timing and Ichthys run off. We are less bearish, anticipating similar levels to fiscal 2018, with higher operating and sustaining capital expenditure levels to add support. Offshore Ichthys maintenance services will be added to Monadelphous' maintenance contracts for Chevron at Barrow Island, for Shell at Prelude FLNG, and for Woodside at Karratha. Annual maintenance revenue can be small compared with the substantial upfront construction revenue. But overall, we project group fiscal 2019 group revenue to increase by 3.5% to AUD 1.85 billion.
Monadelphous' strong balance sheet has it well positioned to participate in new projects as and when they arise. Fiscal 2018 net operating cash flow halved to AUD 51.6 million, missing our AUD 63 million target. But the balance sheet regardless remains in a healthy and appropriate net cash position of approximately AUD 200 million or AUD 2.15 per share. Priorities are to continue to grow water and irrigation in Australia and New Zealand, deliver renewable energy projects through Zenviron, and progress options to enter other Australian infrastructure markets. We agree with the diversification. Despite Monadelphous predicting major resources construction opportunities in fiscal 2020 and beyond, Morningstar's outlook for resources is more tempered, including anticipated pull-back in iron ore prices to a midcycle USD 38 per tonne by fiscal 2020 versus recent USD 68 per tonne spot pricing. If realised, that could tame enthusiasm for several major iron ore projects in early development. But overall a quibble is with Monadelphous' share price, not the earnings direction. Our fair value estimate projects 4.8% five-year group EBITDA CAGR to AUD 153 million by fiscal 2023.