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Morningstar | No-Moat Monadelphous Reports 1H EBITDA Decline to Likely Nadir. No Change to AUD 10.50 FVE.

Our AUD 10.50 fair value estimate for no-moat Monadelphous stands. The company reported an 18% decline in first-half fiscal 2019 NPAT to AUD 31.0 million, close to our AUD 32.0 million expectation. Revenue of AUD 830.5 million was slightly higher than anticipated, down 5% on first-half fiscal 2018. But EBITDA margin was softer than expected, down to 6.5% from 7.0%. There was a significant increase in maintenance revenue, up 25% on the previous corresponding period, or pcp, to AUD 503 million as on- and off-shore oil and gas maintenance contracts ramped-up; and margins on maintenance are often lower than for new construction. The engineering construction segment, however, recorded a sharp 30% decline in revenue to AUD 332 million, with the Ichthys onshore LNG facilities finished. Ichthys’ run-off is forecast to result in lower construction revenue in fiscal 2019 and 10% less group revenue for the fiscal year. Our little changed AUD 1.61 billion fiscal 2019 group revenue forecast is in line with this guidance.

Monadelphous says it has secured AUD 770 million of new contracts since the beginning of the financial year. This is less than the first-half revenue required to be replaced. Despite this, we stick with our optimistic enough 4.8% 5-year EBITDA CAGR forecast to AUD 150 million by fiscal 2023. Monadelphous says the resources sector continues to strengthen, with energy to follow. It expects opportunities to generate significant new construction revenue in fiscal 2020 and beyond. The sentiment is in line with our own which anticipates an increase in sustaining capital works in the resources sector following an unsustainable period of deferment. That said, we continue to be less optimistic than the market. At AUD 17, Monadelphous shares remain at a substantial premium to our fair value. We think the share price implies an unrealistic five-year EBITDA CAGR of 13.5% to AUD 225 million.

We acknowledge that in a smaller contractor like Monadelphous, with a market capitalisation of just AUD 1.6 billion to Cimic Group’s AUD 16 billion, winning one particularly large contract could radically alter the earnings trajectory; this elevated leverage feeding into our very high fair value uncertainty rating. But we think it would be reckless on our part to credit this potential, particularly given the relative rise in importance of maintenance activity, with its more pedestrian-like growth, albeit with useful annuity-like persistence. Further, a key driver for engineering construction is likely to be iron ore projects. We are considerably less optimistic than the market in this regard, including anticipated pull-back in iron ore prices to a midcycle USD 40 per tonne versus recent USD 90 per tonne spot pricing. If realised, that could tame enthusiasm for several major iron ore projects in early development.

Our fair value estimate equates to an unchanged 2023 EV/EBITDA multiple of 7.9. We assume a midcycle EBITDA margin of 8.3%, ahead of the current half’s 6.5% anticipating re-energised growth in higher-margin engineering construction. Our midcycle EBITDA margin forecast is in line with the 8.3% three-year average to fiscal 2017, though down from 10% plus China-boom peaks in fiscal 2011 and fiscal 2012. Our forecast for a near-4.0% fully franked yield (based on the current share price) has some appeal, though on a high plus 80% payout ratio.

Monadelphous retains a healthy AUD 166 million net cash position, although this has somewhat declined for the past three halves from AUD 228 million at end June 2017. Maintaining a high dividend payout ratio largely accounts for the decline, and the as expected AUD 25 cent first-half fiscal 2019 dividend equates to another AUD 33 million outgoing. Assuming maintenance of the 80% payout going forward, our forecasts don’t envisage a change in trend to the declining net cash position, though the fall is modest to a still healthy AUD 145 million by fiscal 2023. We think it advisable for contractors to retain a net cash position, given the everpresent danger of a contract turning sour.