Category: Financial Markets
At the group level, however, returns are below the cost of capital, as the firm has made poor acquisitions in adjacent segments and new geographies and suffered execution issues in the construction division. This has overwhelmed the positive impact of an unprecedented building cycle in Australia and New Zealand which peaked in 2018. Following the substantial losses sustained in its construction segment, Fletcher has taken corrective action–divesting its global Formica business and backing away from commercial construction projects which led to significant losses. But we’d like to have seen a more comprehensive restructure, involving a marked reduction in the group’s level of diversification. We’d advocate for Fletcher to re-focus the group’s attention on its businesses which are well positioned competitively. The potential for management to create value for shareholders is maximised when it’s free from the distraction that comes with the ownership of a plethora of disparate businesses.
The company operates across seven divisions: building products, distribution, steel, concrete, construction, residential and development, and Australia. We forecast improving EBIT margins across most divisions, with the most pronounced improvement in building products and Australia, but aren’t confident ROICs can sustainably remain above cost of capital. Nonetheless, strong brands, dominant market share in key categories, and control of distribution should help to sustain pricing and margins in the building products division, which generates around 6% of group revenue and 20% of adjusted EBIT. We see steady growth in revenue and slight margin expansion, resulting in mid-single-digit EBIT growth over the long term.
Financial Strength
With the balance sheet awash with liquidity, Fletcher also announced a NZD 300 million share buyback. With the cyclical revival of residential construction activity in New Zealand and Australia, we think the return of cash to shareholders is well-timed. With the buyback to commence in June 2021, we anticipate the lion’s portion of share repurchases will occur in fiscal 2022. Upon conclusion of the share buyback, we forecast leverage–defined as net debt/EBITDA including IFRS 16 lease liabilities–of 1.4 times at fiscal 2022 year-end, near the midpoint of Fletcher’s through-the-cycle leverage target of 1-2 times and up from 1 times at fiscal 2021 year-end. As such, significant debt covenant headroom exists relative to Fletcher’s leverage covenant, which is calibrated at 3.25 times net debt/EBITDA. While further capital expenditure will be allocated to Fletcher’s new plasterboard facility–with total project spending of an estimated NZD 400 million—other nonessential capital outlays have been pared back in order to minimise cash outflows in fiscal 2021. Management anticipates NZD 230 million in capital expenditure in fiscal 2021. We forecast full-year dividends of NZD 0.27 per share, reflecting a 70% payout of net income–near the top end of Fletcher’s targeted 50%-75% payout ratio.
General Advice Warning
Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.
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Downer EDI Ltd
But the fair value impact of the earnings declines is countered by boosted cash levels from the asset sales. It should be noted the company still provides no earnings guidance for fiscal 2021 given uncertainty around coronavirus.
Our unchanged fair value equates to a fiscal 2025 EV/ EBITDA of 6.2, P/E of 14.5, and dividend yield of 4.1% on a reinstated 60% payout. We now assume a 5-year EBITDA CAGR of 5.9% to AUD 945 million by fiscal 2025, and a midcycle EBITDA margin of 7.4%. The margin forecast is above the 5-year historical average nearer 6.5% and first half fiscal 2021’s 6.0%. This anticipates a recovery from Spotless Group which recorded a 6.4% margin in first-half fiscal 2021, down from levels nearer 8.0% prior to fiscal 2020.
At around AUD 5.60, Downer shares have more than doubled from sub-AUD 2.60 March 2020 lows, and are now only somewhat undervalued. Downer is exiting mining in pursuit of more capital-light and government-backed revenue business models in urban services including in operating, maintaining, servicing, and supply. If mining cools as per our thesis, Downer could be viewed in a more favourable light by a market currently enamoured with mining.
Downer finished December 2021 with net debt of AUD 1.1 billion excluding operating leases–improved on June 2020’s AUD 1.5 billion–gearing ND/(ND+E) at a comfortable 28%, down from 36% six months prior. We now estimate net debt at around AUD 550 million, following the latest round of asset sales, ND/(ND+E) at just 15%. This would have net debt/EBITDA at a conservative sub 1.0. But Downer says its optimal capital structure is net debt at 2-2.5 times EBITDA, meaning capital returns and acquisitions could feature.
In the June half to date, Downer has undertaken combined asset sales of AUD 605 million, of which proceeds of AUD 476 million have so far been received. This includes sale of Open Cut Mining West for over AUD 200 million, sale of Downer Blasting Services for AUD 62 million, sale of plant and equipment to Byrnecut at Carrrapateena mine for AUD 70 million, sale of 70% of laundries for AUD 155 million, and sale of the Otraco tyre management business to Bridgestone Corporation for AUD 79 million.
Remaining noncore assets on the block including Mining Open Cut East and hospitality with the sale process underway. Downer currently has AUD 36.2 billion of work-in-hand, equivalent to a healthy three years of revenue at current rates. The most recently announced is a AUD 900 million eight-year contract to operate and maintain Sydney Northern Beaches buses through Downer’s 49% participation in the Keolis Downer joint venture.
Profile
Downer operates engineering, construction, and maintenance; transport; technology and communications; utilities; mining; and rail units. But the future of Downer is focused on urban services, and mining and high-risk construction businesses are being sold down. The engineering, construction, and maintenance business has exposure to mining and energy projects through consulting services. The mining division provides contracted mining services, including mine planning, open-cut mining, underground mining, blasting, drilling, crushing, and haulage. The rail division services and maintains passenger rolling stock, including locomotives and wagons.
Source:Morningstar
Disclaimer
General Advice Warning
Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.
Under its watch, the number of LNG trains has grown from one to five, taking gross output to 16.4 million metric tons per year. This pedigree is unmatched in the Australian oil and gas space, and there’s more potential development in the pipeline if prices will allow. Missteps, including commissioning delays and cost blowouts during the China-driven resources boom, are now past. Woodside has demonstrated commendable conservatism in capital allocation over several years.
Key Investment Considerations
- More than 80% of our Woodside fair value estimate derives from one product, LNG. LNG prices are referenced on a three-month running lag to the Japanese Customer Cleared oil price, so oil prices are key to any analysis.
- Including Pluto Train 2 and Other Prospects, around 30% of our fair value estimate derives from projects yet to produce any gas, reflecting our expectation for substantial growth.
- We are comfortable with a high proportion of value in development projects, given Woodside’s proven LNG delivery platform and first-mover advantage on the North West Australian coast.
- As Australia’s premier oil player, Woodside Petroleum’s operations encompass liquid natural gas, natural gas, condensate and crude oil. However, LNG interests in the North West Shelf Joint Venture, or NWS/JV, and Pluto offshore Western Australia are the mainstay, and the low-cost advantage of these assets form the foundation for Woodside. Future LNG development, particularly relating to the Pluto project, encompasses a large percentage of this company’s intrinsic value.
- Woodside is well suited to the development challenge. With extensive experience, it remains a stand-out energy investment at the right price. Gas is the fastest growing primary energy market behind coal, and the seaborne-traded LNG portion of that gas market grows faster still. China is building several import terminals, and so demand is likely to pick up, helping to move LNG pricing toward oil parity on an energy-equivalent basis.
- Woodside is a beneficiary of continued global economic growth and increased demand for energy. Behind coal, gas has been the fastest-growing primary energy segment globally. The traded gas segment is faster-growing still, and Woodside is favourably located on Asia’s doorstep.
- Woodside’s cash flow base is comparatively diversified, with LNG production making it less susceptible to the vagaries of pure oil producers. Gas is a primary component of Asian base-load power generation, instilling an element of demand stability, and is generally sold under long-term contracts.
- Gas has around half the carbon intensity of coal, and it stands to gain market share in the generation segment and elsewhere if carbon taxes are instituted, as some predict.
- The global economy is cooling off and demand for energy will follow suit, particularly if Chinese growth rates taper.
- Technological advances in the nonconventional U.S. shale gas industry have the potential to swing the demand supply balance increasingly in favour of the customer.
- LNG developments are hugely expensive, and the balance sheet is at risk until such projects are successfully commissioned.
(Source: Morningstar)
Disclaimer
General Advice Warning
Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.
In its home market, Fletcher has strong brands and a leading distribution channel, and it dominates market share in key categories. The building materials segment in general, however, is subject to easy product substitution, low switching costs, and limited pricing power, making a competitive advantage difficult to sustain. Together with a poor track record of acquisitions, Fletcher has been unable to earn a sustainable return above its cost of capital.
Key Aspects
- A number of Fletcher’s businesses have good competitive positioning, including the PlaceMakers distribution business and its plasterboard operations. But earnings visibility and returns on capital are low, given a complex structure.
- The recovery in New Zealand and Australian housing construction is nearing. However, the associated cyclical benefit to Fletcher’s earnings is priced in.
- Fletcher has divested its Formica business and is backing away from commercial construction. But Fletcher could benefit from a more broad-based restructure to refocus on its core businesses.
Company Profile
Fletcher Building is the largest building materials company in New Zealand, after it emerged from the Fletcher Challenge group in 2001. Its diverse range of business interests span building product manufacture and distribution in New Zealand and Australia, as well as commercial and residential property development. Operations have been refocused on New Zealand and Australia, following divestment of the global laminates business in fiscal 2019.
General Advice Warning
Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.
