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Date : 06/04/2021

Monadelphous Group

ASX :

MND

Market Cap : $1.00 Billion

Dividend Per Share : $0.24

Dividend Yield : 3.44 %

Buy

52 Week Range : $7.77 - $15.55

Share Price : $10.74

Monadelphous is recovering very quickly and they have snapped up several new contracts in FY2021. Strong balance sheet and earnings forecasts underpin rising dividends. We recommend investors to 'Buy".

Company Analysis

Monadelphous Group Limited (ASX: MND) is a Perth headquartered company that is the business of providing construction, engineering, and maintenance services to clients from the energy sector, resources or commodity sector, and infrastructure sector. They operate mainly in Australia, New Zealand, Chile, Mongolia, China, and also derive small amounts of revenue from other countries such as Papua New Guinea, Philippines, etc. Monadelphous recognizes revenues from 2 streams – Engineering Construction and Maintenance & Industrial Services.

  • Engineering Construction: This division provides large-scale project management, design and construction services including supply and erection of structural steel, installation of heavy mechanical equipment and piping systems, marine and port works, and as well as demolition and plant commissioning. This sector includes the Electrical and Instrumentation Services division which provides electrical engineering, telecommunication services, instrumentation specification, installation and maintenance services and the Water Infrastructure division providing the design, construction and maintenance of water treatment plants and irrigation infrastructure.
  • Maintenance and Industrial Services: This division provides comprehensive mechanical and electrical services to manage and maintain plant and equipment for the company’s customers within the resources and energy markets through sustaining minor capital works, shutdowns as well as operations and facility management.

In addition to these two large segments that the firm operates in,  It also provides water and wastewater asset construction and maintenance, irrigation services, construction of transmission pipelines and facilities, operation and maintenance of power and water assets, heavy lift and specialist transport, access solutions, dewatering services, corrosion management services, specialist coatings, and rail track and rolling stock maintenance services, as well as turnkey design and construction, heavy lift and crane, and civil and electrical disciplines services.

Among all the markets and geographies that Monadelphous operates in, the Australian market contributes to 89% of their revenues.

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Company Updates

Diminished demand for their services due to the effects of covid19 resulted in lots of volatility during 2020 for the Monadelphous stock price. Various projects were suspended and/or deferred, while new projects coming in were very slow. Another hiccup that the firm had to manage during this period was the underperformance of its water infrastructure business. Contract disputes resulted in low profitability and finally ended up with an initiation of a strategic review and a discontinuation of its New Zealand operations.

However, the news of the emergence of a vaccine back in November proved to be the catalyst as high trading volumes took the stock to new highs as much as $15.55 a share. Since then, the stock has declined and come back down to earth. Large spikes of buying pressure during the surge and selling pressure during the fall can also be seen from the chart below. Monadelphous is not affected directly by the commodity prices of miners. They are however sensitive to production cycles and supply side economics of the commodity sector. The forecasts being made by global investors regarding lower Chinese demand for commodities may have also been a factor in the share price continuing to dip sharply in 2021 despite the fairly positive half year earnings result.

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Source: Tradingview.com

Half-Year Earnings – FY2021

Revenue of $947.8 million was generated for the period ended 31 December2020. The result was up 18.7% on the second half of the FY2020 as the industry steadily recovered from the initial impact of COVID-19 and was an increase of 11.2 per cent on the same period last year.

The Engineering Construction division reported revenue of $460.3 million, a 68% increase on the prior corresponding period, with work progressing strongly on a significant number of resource construction projects which had experienced COVID-19 related delays in the first half of the 2020 calendar year.

The Maintenance and Industrial Services division reported revenue of $491.5 million, down 15.9% on the prior corresponding period. Maintenance activity levels early in the period were lower than usual as the industry steadily regained momentum after the initial impact of the pandemic, as well as from the effects of reduced levels of demand within the oil and gas sector.

EBITDA was $57.0million, a 3.5% reduction on the prior corresponding period. Earnings in the first few months of the period were lower than normal as the industry regained momentum following the initial impact of the pandemic. During the period, the company reversed a one-off provision of $6.5 million made in FY2019 for research and development tax incentives claimed by the company in previous years which were determined to be ineligible.

Net profit after tax for the period was $31.6million – representing an EPS of 33.4 cents a share, with the Board of Directors declaring an interim dividend of 24cents per share fully franked.

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Source: Monadelphous

  • The recovery from the depths of the pandemic has thus begun for Monadelphous. Earlier last month, the firm announced a new contract that is worth close to $150 million for crane services being received by Fortescue Metals Group, the iron ore giant.
  • Monadelphous secured close to $360 million in new contracts and contract extensions during the recent half-year period. BHP’s Jimblebar iron ore mine in Western Australia’s Pilbara as well as the miner’s Olympic Dam copper mine in South Australia were the two biggest deals that it struck.

Industry Analysis

The engineering construction and maintenance industry are low growth industries with several competitors operating with similar strategies. Iron Ore and the Oil and Gas industry have been the major industries that have supported MND and its competitors for the last few years. Iron Ore demand is expected to be high as global economies will support infrastructure spending in order to revitalise their economies. The USA has just unveiled a new stimulus check for infrastructure projects and if South East Asia and India follow suit, the demand for economically sensitive metals such as Iron Ore and Copper will increase – and hence require production of these commodities to go up. This is the direct link between the mining industry and engineering construction industry. With Australia being a very mining friendly country and also home to several of the top mining companies in the world, the engineering construction and maintenance industry has performed above average. We expect the industry to keep going along with the overall development of the mining industry in Australia – both of which are dependent on each other.

The boom in renewable energy is forecasted to bring additional demand, however, given the prospects and the structural decline of the oil and gas industry in the long run, we expect the gains to offset the loss.

Water treatment and wastewater treatment demand has increased recently due to the stronger environmental measures that mining companies have been taking. This also another space where growth is expected to expand in the medium to long-term. This space also brings into play agriculture companies and the like in addition to energy and metals that generally constitute the list.

Investment Thesis

Monadelphous generated 32% of its revenues from Iron Ore customers in FY2020. Oil and Gas made up 28% of its revenues. Given the decrease in demand for oil and gas and the halted production during the pandemic, Monadelphous revenues at the end of the first half period of FY2021 showed that 54% came from Iron Ore customers, and only 18% from oil and gas customers. Overall, the 11.2% growth over pcp shows that Iron Ore demand and production soared so high during the period that it has completely mitigated the impact of the decline in oil and gas industry customers.

Monadelphous has two divisions, one is an engineering division where it builds something once-off, the second is a maintenance division. Revenues from the Engineering Construction segment as a result increased. The increased demand for iron ore and other minerals increased the need for Monadelphous services. $175 million of new contracts were secured in the half year period in this segment. The maintenance and industrial services segment being extremely reliant on the oil and gas industry for customers resulted in a decline in revenues. However, $185 million in new contracts and extensions were entered into by Monadelphous. Again, iron ore sector demand mitigated the decline from the oil and gas segment. Monadelphous continued to broaden services in rail, marine, civil, CSG and corrosion management. Monadelphous will benefit from the increased exploration activity among the mining companies in Australia as the demand for commodities is only projected to go up.

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The low profitability of Monadelphous has been a question in recent years. The EBITDA margins slumped further in FY2020 as projects were suspended and/or deferred. The recovery that we have witnessed gives us confidence to go along with the 10% growth in revenues that the management is expecting in FY2021. The earnings will be boosted immediately as all the costs have already been allocated to the suspended and deferred projects. With exploration activity and mining production in Australia expected to expand in FY2022 as a result of increased demand for commodities from all over the world, we are assuming that Monadelphous revenues will grow by around 12% in FY2023 and follow a mean-reversion path henceforth – with the mining industry standard 4%-6% growth.

Profitability will be an area that will continue to entail the same challenges given the high-cost business model in this entire sector. We estimate EBITDA margins as a result to hover in the high 6s range.

Coming to the balance sheet, it is extremely strong. On examination, we can see that the accounts receivables have increased from $290 million at FY2020 to $426 million in H1 FY2021 due to the new contracts and also the suspended and deferred projects. The accounts payable has increased as well due to the pandemic’s effects. It has gone from $74 million to $288 million. Monadelphous has $169 million in cash at the end of the period and with just $97 million in total debt, the firm is in a very healthy net debt position. In the short-term, the current ratio and quick ratio – measures of liquidity show that the firm is very healthy with a 1.84x and 1.83x ratio, respectively. In the long-term, the total assets outweigh the total liabilities by 1.92x – further demonstrating the financial health of Monadelphous.

The dividends of the firm are extremely healthy. While the Earnings per share has declined due to the same reasons as its revenues and earnings we mentioned earlier, the firm has not paid out more dividends than it can afford to. This showcases an efficient management and puts the latest full year dividend at a 90% payout ratio. Chart, bar chart

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Based on the current market capitalisation, we arrive at an enterprise value of $960.7 million. Using the total enterprise value and the forecasted revenues and earnings, we arrive at the below valuation multiples that Monadelphous is currently trading at. Based on expected growth in the remainder of the year and the recent correction in share price, MND trades at 17.75x forward P/E and 8.21x forward EV/EBITDA multiple – both fairly conservative multiples given today’s price.

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Recommendation

Monadelphous is recovering well from the pandemic. They have signed a fair number of new deals already and their earnings are expected to rebound rather quickly. With a very strong balance sheet, it is a fairly stable business that is expected to see growth as exploration and the demand for commodities grows. We issue a “Buy” recommendation for long-term investors.

 

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