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Morningstar | We Temper Monadelphous’ Near-Term Earnings Expectations but our Long-Term Outlook Stands. See Updated Analyst Note from 05 Dec 2018

We cut our fiscal 2019 and fiscal 2020 EPS forecasts by 23% and 14% to AUD 0.69 and AUD 0.74, respectively, but our AUD 10.50 fair value estimate for no-moat Monadelphous stands. We reassess with a more hawkish eye, Monadelphous’ ability in the near term to make up for finished Ichthys LNG construction revenue. Further, we now forecast little to no revenue growth to fiscal 2023 but at an improved midcycle EBITDA margin of 8.3%. That contrasts with our prior forecast for still only modest revenue growth but at a lower 7.6% EBITDA margin. We think revenue will be a bit harder to come by but there will be cost benefits with a focus on efficiency. Consequently, our midcycle fiscal 2023 EBITDA forecast is little changed at around AUD 150 million.

Monadelphous shares have pulled-back almost 25% from AUD 18.75 high of just over a year ago, but at AUD 14.25 remain materially overvalued. We think too much is anticipated from resources and Australia’s east coast construction boom. Disappointment could be met in further share price retreat.

Published data projects total Australian energy capital expenditure falling sharply again in 2019, with the nadir not before 2020, as the tail end of LNG construction boom rolls off. After more than five years’ construction, the Ichthys LNG project--a revenue insulating core for Monadelphous--began production in July. Monadelphous consequently forecasts lower construction revenue in fiscal 2019 and group first-half revenue around 10% below the previous corresponding half. Our forecasts now agree with this guidance.

But Monadelphous says the longer-term outlook for resources and energy sectors is positive and maintenance activity is forecast to grow. It points to major resources construction projects expected to generate revenue opportunities in fiscal 2020 and beyond. We are less optimistic and our outlook for resources is more tempered.

We anticipate 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.

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. While positive, annual maintenance revenues can be small compared with the substantial upfront construction revenue.

Our fair value estimate equates to a 2023 EV/EBITDA multiple of 7.9. But the market is valuing Monadelphous on a 2023 EV/EBITDA of 10.8, P/E of 22 and a dividend yield of 3.8%, discounted at WACC. This is too generous in our opinion. Our forecast for a near-4.0% fully franked yield from fiscal 2019 (based on the current share price) has some appeal, though on a high plus 80% payout ratio. Yield notwithstanding, we think the price optimistic implying an unrealistic five-year EBITDA CAGR of 10.3% at a midcycle EBITDA margin of 10.9%, versus 7.6% EBITDA margin actual for the three years to fiscal 2018, and our 4.5% five-year EBITDA CAGR forecast.

Monadelphous has a 55% interest in the Zenviron joint venture with ZEM Energy, a wind farm engineering specialist which has won multiple projects in 2018, including a second contract at Moorabool wind farm taking total contract works to AUD 130 million. Most recently in November, Zenviron won an AUD 100 million contract at Dundonnell wind farm. But these, and Monadelphous being awarded an AUD 240 million three-year maintenance services contract at BHP’s iron ore mines, will struggle to make up for Ichthys’ almost AUD 700 million contract value. Monadelphous earned AUD 1.8 billion in revenue in fiscal 2018, and almost AUD 1.0 billion came from engineering construction activities. It’s a tall order sustaining these levels and we now project group revenue down 10% to AUD 1.6 billion in fiscal 2019.