After a tough few years driven by increasingly frugal resource customers, Ord Minnett suggests things may be looking up for the contractors sector. Mining capital expenditure looks set to increase by more than 10% in FY18 and the Australian east coast should benefit from a boom in infrastructure spending.
We estimate FY17 Australian mining capital expenditure levels were equivalent to one-third of FY12’s peak, falling from 35% to 13% of sales. We believe these markets have troughed, however, and expect growth of more than 10% in FY18 although competition will likely restrict margin growth. There is also a large expansion in east coast infrastructure under way, which should assist earnings growth.
Meanwhile, there are nuances in understanding which companies are likely to benefit and what is already priced in after some significant share price performances in the year to date.
In terms of stocks with exposure to the sector, our order of preference is as follows:
- RCR Tomlinson – We initiate coverage of RCR with a Buy recommendation and a target price of $5.08, as we see a tremendous opportunity in solar energy. RCR has won close to $1 billion of solar work, with FY17 revenues of $1.3 billion, and has a strengthened balance sheet with an attractive valuation relative to the opportunity;
- CIMIC Holdings – We maintain our Hold recommendation on CIMIC and have raised our target price to $44.11 from $43.55 for the former Leighton. Our view is based on substantial growth in east-coast infrastructure spending, but not enough potential upside to justify a higher rating;
- Monadelphous Group – We resume coverage of Monadelphous with a Hold recommendation and a $14.30 target price. The stock is trading at a premium to peers, but we expect oil and gas construction, which accounts for 27% of sales, to cause headwinds for the company in FY19. That said, the business has a strong net cash balance sheet with M&A aspirations, and is well-positioned to benefit from recovering mining capital expenditure.; and
- Downer EDI – We resume coverage of Downer with a Lighten recommendation and a target price of $6.20. We believe the majority of Downer’s businesses are well-positioned to experience growth over the next couple of years, particularly in transport. However, we see earnings risks from the newly acquired Spotless Group.