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Date : 09/03/2022

CIMIC Group

ASX :

CIM

Market Cap : $6.84 Billion

Dividend Per Share : $0.78

Dividend Yield : 3.53 %

Avoid

52 Week Range : $15.28 - $22.42

Share Price : $22.03

Cimic is amidst a scandal and has been accused of underpaying hundreds of workers, subcontractors and banks in its troubled Middle East operations by more than $500 million. This major issue could lead to criminal prosecution and drag shares down, back to its long-term bearish momentum. We recommend “Avoiding” CIM for now.

Company Analysis

CIMIC Group (ASX: CIM) is an engineering-led construction, mining, services, and public-private partnerships leader. The Company aims to integrate experience and expertise to amplify insights, develop future-ready solutions and deliver enduring value across the lifecycle of assets, infrastructure and resources projects.

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Source: Tradingview

Cimic: activity-focused businesses

Cimic’s businesses are broadly diversified by market sector, activity, geography, client type, contract type, volume and duration. The Group has activity-focused businesses in construction, mining, mineral processing, services, public and private partnerships, and engineering. The size of Cimic’s businesses creates economies of scale and strengthens each of its business positions in their respective markets.

Cimic achieved FY21 financial results within its guidance range

The Group achieved reasonable financial results, reporting a net profit after tax within its guidance range, declaring total FY21 dividends of 78 cents per share, and extending its work in hand to $33.2 billion. We have also witnessed the Company achieving many significant non-financial milestones. For instance, Cimic is well aware of the criticality of ESG. Hence, the firm committed to achieving net-zero emissions for Scope 1, which is primarily fuels, and Scope 2, for the purchased electricity by 2038, and net-zero emissions for Scope 3 by 2045. So far, Cimic continues to rank among the best-performing companies for sustainability.

Cimic shares are changing hands for $22 apiece at the time of writing.

Source: CIM

Cimic has delivered on its major new projects in terms of operations, including Melbourne’s North East Link and Sydney Metro Western Sydney Airport works, among others.

In a nutshell, the Group has made good progress despite challenges throughout FY21. Cimic reported an underlying net profit after tax (NPAT) of $405 million and a statutory NPAT of $402 million. The Group revenue expanded by 8.3% year-on-year to $14.7 billion. This allowed the Company to achieve a profit before tax and NPAT margin of 5.2% and 4.2%, respectively. Compared to FY20’s profit before tax of 4.7% and FY20’s NPAT of 3.9%, this was quite an improvement. Regarding the Company’s operating cash flow, pre-factoring improved by $603 million year-on-year. Thus, Cimic exhibits strong liquidity of $4.4 billion. The Group has a net debt of $498 million after repaying $542 million of factoring and $318 million of dividend payments.

Cimic has completed the strategic unwinding of its factoring program, reducing the FY19 balance from around $2 billion to $434 million at the end of FY21. Moreover, the Group fully repaid its supply chain finance facilities and discontinued the program. Cimic continues to optimise its capital structure by diversifying its funding sources and extending its maturity profile with a debut issue in the Eurobond market. Cimic also signed a $1.4 billion three-year syndicated performance bond facility to support its delivery on the strong tender pipeline. Cimic’s investment-grade rating was confirmed by Standard & Poor’s (BBB-/A-3/Outlook Stable) and Moody’s (Baa2/Outlook Stable).

Also, during the period, Cimic listed Ventia (ASX: VNT) on the Australian Securities Exchange and New Zealand Stock Exchange (NZX: VNT). The initial public offering (IPO) valued 100% of Ventia shares at approximately $1.45 billion and provided an improved capital structure and a public market platform to enable further growth. The IPO offer size, representing 30% of Ventia’s share capital, comprises 26% issuance of new shares and 4% sell-down by Ventia’s existing major shareholders. The listing price notionally values Cimic’s retained stake in Ventia of 32.8% at approximately $560 million, although this remains in Cimic’s financial accounts at historic, pre-IPO cost. Ventia is now positioned to benefit from the full integration of Broadspectrum, a company it acquired in 2020, and a lower level of debt, which will probably help deliver an increased contribution to CIMIC’s revenue and NPAT in the future.

Finally, Cimic completed a full year with a co-investor in Thiess. This co-investment in Thiess could be a positive outlook for the Company as it will bring diversity and growth in its offering in the mining sector, with wins during the year, including mining services at the Anthill Copper Project in Queensland. Moreover, Cimic has strengthened its UGL’s service offering with the acquisition and integration of Innovative Asset Solutions, a specialist provider of asset life extension and critical repair solutions in the resources, infrastructure and industrial sectors. Cimic also completed the acquisition of Devine, simplifying the Group’s structure.

With performance in line with its guidance during FY21, Cimic could declare a final, unfranked dividend of 36 cents per share, with total FY21 dividends of 78 cents per share representing a payout ratio of 60% on the FY21 result. Despite a payout ratio of 60%, dividend payouts have continued to decline over the last few years. This represents a substantial decrease of -40.46% year-on-year.

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Since FY18, Cimic has experienced a consistent earnings decline at a negative CAGR of -12.98%. NPAT remains relatively unchanged. For FY22 guidance, Cimic targets an NPAT in the range of $425 million to $460 million. This represents a limited NPAT growth of just 4.9% to 13.5%, remaining below the FY18 level.

Company Updates

Cimic’s recent wins and work in progress

Cimic has recently been awarded $20.4 billion of new work, substantially increasing its work in hand to $33.2 billion as of December 2021. This strong growth results from government investment in infrastructure to stimulate economic growth. Cimic’s tender and operational teams allowed the Company to achieve solid results for clients who benefit from the delivered infrastructure and services. The Group’s order book is well diversified across:

  • Construction, with CPB Contractors, Broad and Leighton Asia
  • Services, with UGL and Sedgman, and
  • Investments, with Ventia and Thiess segments.

Cimic’s key wins during the period included:

  • The North East Link Primary Package public-private partnership: A tunnelling project in Victoria that will generate $3.8 billion in revenue.
  • The delivery of the M6 Motorway Stage 1 in NSW: Which will bring in revenue of $1.95 billion.
  • The operation of rail infrastructure for the Country Regional Network in NSW: A potential earnings of $1.5 billion.
  • The delivery of the Sydney Metro, Western Sydney Airport Station Boxes and Tunnelling work: A prospective revenue of $1.35 billion.
  • The continuation of mining services at Mount Pleasant in NSW: A potential revenue of $920 million.
  • The delivery of an upgrade for the Warringah Freeway in NSW: Expected revenue of $800 million
  • The operation of the Auckland passenger rail network in New Zealand: revenue of NZ$600 million
  • The rollout of fibre for NBN Co in NSW, Victoria and Queensland: revenue of $400 million
  • The delivery of Inland Rail’s southern civil works programs in NSW: Which Cimic has been chosen as part of a joint venture.

In all, new work is now well ahead of pre-COVID-19 levels and has shown recovery from 2020.

FY22 Outlook: Cimic exhibits an extensive pipeline, although the Company is facing significant risk due to a costly employees underpayment scandal in its Middle East operations

In 2022, Cimic’s objectives will remain consistent with those of previous years. Hence, the Company have an unwavering focus on sustainable growth and returns, effective management of costs, working capital, and the generation of cash-backed profits from its core operations. We believe that Cimic has a strong position with its work in hand, providing relative stability for its future earnings. New projects are being awarded, and the outlook remains attractive across its core markets, underpinned by numerous stimulus packages announced by governments with additional opportunities through a strong public-private partnership pipeline. As of the end of FY21, the total future pipeline of relevant tenders could be more than $480 billion, including $115 billion of public-private partnership opportunities.

We think that Cimic’s core markets in construction, public-private partnership (PPP), mining, mineral processing, operations, maintenance services, and engineering continue to offer many opportunities. Hence, Cimic’s work in hand and a substantial pipeline of future projects support the Company’s positive outlook. Onward 2022, Cimic has an opportunity pipeline of approximately $180 billion. The Group expects to bid for, is currently bidding on, or has been shortlisted for projects, including these 20 opportunities:

  1. Sydney Metro West – Westmead to the Bays Central Package, Transport for NSW, New South Wales;
  2. Sydney Metro West-Eastern Tunnelling Package, New South Wales;
  3. Copper String 2.0 for CuString Pty Ltd, Queensland;
  4. Western Harbour Tunnel – Northern and Southern Tunnel, immersed tube tunnel & project-wide civil, mechanical and electrical fit-out for the Roads and Maritime Services, New South Wales;
  5. Westmead Paediatric Services Building, Department of Health Infrastructure, New South Wales;
  6. Pacific Highway, Coffs Harbour Bypass, Roads and Maritime Services, New South Wales;
  7. Coomera Connector – Stage 1 Central, Department of Transport and Main Roads, Queensland;
  8. Redevelopment of Prince of Wales Hospital Phase 2 (Stage 1) (Superstructure), Hong Kong;
  9. Redevelopment of Our Lady of Maryknoll Hospital (Superstructure), Hong Kong;
  10. Construction of New Territories East Cultural Centre, Hong Kong;
  11. Manila International Airport Terminal, Philippines;
  12. North-South Railway Project (South Line) – Various Packages, Philippines;
  13. Cross Island Line – P103 (Riviera Station), Singapore;
  14. Rio Tinto – Winu Copper Gold Concentrator and Mining Support Project, Western Australia;
  15. Yuen Long Barrage Scheme, Hong Kong;
  16. Cactus Mine Project – Copper Project, United States of America;
  17. Greensbushes – Lithium project, Western Australia;
  18. Various opportunities for ‘Centinela’ – Copper Projects, Chile;
  19. PT Position – Nickel Mine Project, Indonesia; and
  20. Various other mining and mineral processing opportunities across Australia.

As you can see, the Group has an extensive pipeline. This represents more than $480 billion of tenders for Cimic to bid for 2022 onward. The Group also has a prospect to bid for $115 billion worth of private-public partnership projects. Cimic continues to consider opportunities to diversify and expand into new regions and markets by leveraging its existing capabilities. The Group has quite a positive mid-term outlook founded on a strong balance sheet, generating cash, and a rigorous approach to tendering and project delivery. We believe that this focus, combined with the Group’s strong competitive position and the range of opportunities across its core markets, could provide a solid base for generating sustainable returns. However, Cimic has been recently found itself in the middle of a scandal and has been accused of underpaying hundreds of workers in its troubled Middle East operations by more than $500 million. This major issue could lead to criminal prosecution and significantly weigh on the Company’s long-term performance.

Industry Analysis

Construction Market and public-private partnership (PPP)

Across Cimic’s core geographies, the construction markets have remained resilient throughout the year, as its clients maintained and built on their infrastructure investment plans and commitments. We think that these investments will underpin the economic outlook and support Cimic’s construction market. Major transport and social infrastructure programs were outlined in the latest four-year budget statements from the Australian Federal, State and Territory Governments, which increased infrastructure commitments to $225 billion.

In NSW, the 2021-22 State Budget outlined a $108.5 billion infrastructure investment program over the coming four years. The program includes funding for the $12 billion Sydney Metro West, the $8 billion Sydney Metro, Western Sydney Airport, and the $6.3 billion Western Harbour Tunnel and Beaches Link Program. Part of the Government’s Budget includes the Warringah Freeway Upgrade, the $2.7 billion M6 Extension Stage 1 and the $2 billion Great Western Highway Upgrade. The Budget also outlines the State Government’s commitment to undertake early works and site preparation for Sydney’s third city, Bradfield, to be built adjacent to the Western Sydney International Airport and connecting with the Sydney Metro, both of which are currently under construction.

In Victoria, the State Government’s Big Build program forms the backbone of the Group’s opportunities across the State. This program includes the $15.4 billion North East Link, the one-billion-dollar Monash Freeway Upgrade – Stage 2, the $2.2 billion Suburban Roads Upgrade – Northern Roads Upgrade and South-Eastern Roads Upgrade, $12.3 billion Metro Tunnel, $6.3 billion West Gate Tunnel, $10 billion Melbourne Airport Rail and the $6.6 billion project for the removal of 75 level crossings by 2025. This works program forms part of the Victorian Government’s broader $90.2 billion infrastructure investment program over the coming four years.

In Queensland, the State Government’s capital investment program will deliver $52.2 billion of infrastructure over the coming four years, including investments into schools, hospitals, roads, rail and renewable energy infrastructure. This includes funding for the $6.9 billion Cross River Rail, an effective program of works on the M1 Pacific Motorway, $1 billion for the Gold Coast Light Rail – Stage Three and continued work on the $13.3 billion upgrades of the 1,700 kilometres, Bruce Highway – which includes the Rockhampton Ring Road. In a bid to stimulate the renewable energy sector, the Queensland State Budget also allocated $2 billion to the Queensland Renewable Energy and Hydrogen Jobs Fund to invest in renewable energy projects across the State In Western Australia; the 2021-22 State Budget outlines a record $30.7 billion commitment to infrastructure over the next four years, which includes components of the $7.9 billion METRONET project.

The other State and Territory governments have major transport and social infrastructure programs in their own right, as outlined in their most recent budgets. For instance, the South Australian, Australian Capital Territory, Tasmanian, and Northern Territory governments have respectively committed to infrastructure investments of $17.9 billion, $5 billion, $4.6 billion, and $4.4 billion over the coming budget period, the bulk of which are in transport and social infrastructure, and could provide Cimic with a broad range of construction opportunities across the country. Supporting the State and Territory Government investments across the country is the Australian Federal Government’s commitment to invest $110 billion in infrastructure over the coming decade. This investment includes funding for the $14.5 billion Inland Rail project – which will see the creation of a 1,700 kilometres freight rail corridor from Melbourne to Brisbane, the $4 billion Geelong Fast Rail in Victoria, the $14.5 billion North-South Corridor in South Australia, $565 million Midland Highway Upgrade in Tasmania and the $4.4 billion Western Sydney Infrastructure Plan and $1 billion M80 in Sydney. These numerous public sector infrastructure investment programs support a positive outlook for the Australian construction market over the coming years. They are expected to be supplemented by the ongoing investment by the private sector, largely in the form of public-private partnership projects.

In Cimic’s overseas markets, the construction outlook has continued to improve over the year. New Zealand’s Government outlined a record NZ$57.3 billion infrastructure investment program over the coming five years in the most recent 2021-22 Budget, with substantial investments in roads and rail, schools, hospitals, housing and energy generation. This investment program included $300 million of additional capital for Green Investment Finance to support climate change mitigation. In Hong Kong, the Government has committed to an infrastructure investment program of over HK$100 billion and expects the region’s total construction output to grow to approximately HK$300 billion.

Mining and mineral processing market

Cimic’s exposure to the mining and mineral processing market is principally through its business, Sedgman and its 50% equity interest in Thiess, with expertise spanning most of the world’s key commodities. We think that the robust global demand for the Group’s core commodity exposures and strong structural tailwinds supports the Company’s mining and mineral processing market outlook. In addition, Cimic’s key commodity exposures are central to new and low emission technologies, which are set to gain momentum over the coming decades. These trends include sustained population growth, increasing urbanisation and industrialisation, rising global living standards, and limited substitutes for the major commodities mined and processed by the Group.

The global transition to low carbon energy systems is expected to be metals intensive, with some metals facing demand increases of nearly fivefold by 2050. This is due to the higher mineral intensity of renewable technologies, like offshore wind turbines, which are thirteen times more mineral intensive than an equivalent gas-fired power plant. The demand for metals is robust because the whole electricity generation, transmission, and storage system are undergoing rapid transformation.

In the shorter term, Australian resource and energy exports are expected to grow to a record $379 billion onward 2022, representing a 22% increase in the prior year. According to the Australian Department of Industry, Science, Energy and Resources, resource and energy export volumes are expected to show further growth over the coming years, driven by economic growth and industrial production in the country’s major trading partners, as well as further production of electric vehicles and new energy technologies.

Australian exports, by volume, of copper, gold, aluminium, nickel, zinc, lithium, metallurgical coal, thermal coal and iron ore are expected to grow by a compound annual growth rate of 2%, 15.4%, 3.4%, 22.5%, 0.6%, 21.1%, 2.8%, 2.9%, and 3.0% per annum, respectively, from 2021 until 2023.

Investment Thesis

Cimic caught in underpayment scandal could lead to criminal prosecution

Broken promises, financial hardship and millions of dollars in unpaid wages are just a few of the accusations being levelled to Cimic. Hence, a wage scandal has emerged over Cimic’s ethical obligations and claims by more than 150 employees in the Middle East. These employees stated that they had not been paid wages and other entitlements. The brewing unpaid wages scandal dates back to Cimic’s announced sale of its troubled Middle East investment, the BICC Group, in February to a privately owned United Arab Emirates investment company. Cimic is desperate to get rid of the Middle East business and therefore had entered a Sale and Purchase Agreement with SALD Investment to offload its 45% stake in the business for a nominal sum. The deal’s completion was subject to certain conditions being met and that Cimic would contribute a certain amount of funds into BICC. According to Cimic, the contribution amount would not increase the Company’s financial exposure to its Middle East operations. The announcement lacked details about how much money Cimic would have to inject in and the conditions needed to be met. For investors, the key was CIMIC would exit a business that had negatively affected CIM share price for a while.

Over the years, Cimic has been caught up in a series of high-profile international bribery and corruption scandals, corporate governance issues and shareholder class actions. The Group’s Middle East business has caused it the most headaches. Hence, Cimic has been accused of underpaying hundreds of workers, subcontractors and banks by more than $500 million. This scandal could lead Cimic to criminal prosecution.

Yet ten months on, questions are being raised about the status of the sale of the Middle East investment after more than 100 employees went public on LinkedIn claiming they had not been paid wages, leave, end of service benefits and compensation. This critical issue revealed Cimic’s poor ethics in how the Company tried to distance itself from the plight of its employees. Some of whom had worked for the Company for as long as 15 years. This has also sparked speculation that Cimic’s exodus would not be as clean as the Company could expect. At least a hundred of those employees decided to take action after failing to get answers from the Company. They decided to write to Cimic’s CEO on LinkedIn for help. They were disappointed when some of their comments were deleted, no doubt in the hope the problem would stay buried. They then decided to amplify their messages. An estimated 150 employees put their names in a few letters to ASIC, the Fair Work Ombudsman and the Australian Ambassador to the United Arab Emirates, outlining their financial stress and the untenable situation of not getting paid. At the same time, they continued to write to senior executives and directors of Cimic and its German parent Hochtief which is part of the ASC empire.

According to the Company’s first half of FY21 accounts, BICC was still 45% owned by Cimic. But the sale of the Middle East operations to SALD raises some important questions. What are Cimic’s obligations to the workers, regardless of the sale status?

Over the last 12 months, the Cimic share price has gained roughly 10%. It is also up 30% year to date. However, recently, CIM share prices have been on a wild ride since CIMIC shares reached a 52-week high of $22.42 in Late February following a takeover approach by Hochtief Australia, which proposed a $22 per share final cash offer. We believe the market’s reaction has been exaggerated and that CIM price action may fall back to its earlier valuation below $19 per share.

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Source: Tradingview

Since the end of April 2019, Cimic’s share prices have been on a consistent decline. The recent year-to-date 30% gained is, in our opinion, an overaction from the market following the takeover approach by Hochtief. Technically, CIM price action has been over-extended on the upside. This could be confirmed by the Relative Strength indicator on the weekly timeframe, which signals that CIM has entered the overbought territory. We believe that positive momentum is quite limited as CIM exhibits strong resistance around the $24 level. The trend remains bearish in the long-term, as attested by a pretty bearish reading of the 200 daily moving average. CIM price action also reflects the Company’s weak fundamentals:

  • Elevated Debt: CIM’s total liabilities represent more than 87% of the Company’s Capital Structure.
  • EBITDA Margin on the decline: The EBITDA margin is expected to decline from 9.42% in FY21 to 7.88% in FY24.
  • Weak net profit margin: Cimic has a very weak profit margin of 4%, which is expected to remain consistent in the next three-year period.
  • Operating income is projected to be capped under $440 million from FY21 to FY24

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Recommendation

Over the last 12 months, the Cimic share price has gained roughly 10%. It is also up 30% year to date. However, since reaching a 52-week high of $22.42 in late February, the CIM share price has been on a wild ride following a takeover approach by Hochtief Australia, which proposed a $22 per share final cash offer. We believe the market’s reaction has been exaggerated and that CIM price action may fall back to its earlier valuation below $19 per share.

Furthermore, Cimic is amidst a scandal and has been accused of underpaying hundreds of workers, subcontractors and banks in its troubled Middle East operations by more than $500 million. This major issue could lead to criminal prosecution and drag the Company’s shares price action back to its long-term bearish momentum. We recommend “Avoiding” CIM for now.

 

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