1. Sector Landscape
In March 2022 quarter, Australia’s manufacturing activities showcased a Gross Value Added (GVA) growth of 1.1% (QoQ) led by a 7.6% surge in machinery and equipment and a 1.6% increase in other manufacturing. This was attributed to non-metallic mineral product manufacturing and timber. Australia’s real estate industry holds a strong base of the architectural portfolio with massive structures and iconic sites. Construction services increased by 1.4% as businesses worked through the project backlogs.
Favourable Macro Factors Supporting the Sector
Improved Gross Domestic Production (GDP): In March 2022 quarter, the Australian economy advanced by 0.8% on a sequential basis and 3.3% throughout the year. The domestic implicit price deflator edged up by 1.4%, the strongest witnessed since the introduction of the Goods and Services Tax, representing high demand scenario.
Improved Terms of Trade: The terms of trade advanced by 5.9%, with exports surging by 9.6% and import prices edged up by 3.5%. Strong demand for Australia's agriculture and mining commodities contributed to export prices.
Favourable Labor Force Statistics: For April 2022, the unemployment rate stood stable at 3.9%, and employment increased to 13.401 million. The underemployment rate slipped to 6.1% and worked monthly hours edged by 23 million hours. Full-time employment increased by 92k, and part-time employment shrunk by 88k.
Increased Capital Expenditure and Improved Gross Operating Surplus
Decent Capital Expenditure Levels: In March 2022 quarter, the total new capital expenditure slipped by 0.3% sequentially but remained elevated with a 4.5% increase through the year. The PcP uptick was witnessed due to a 7.1% capex increase in buildings and structures, clocking an investment of $17.34 billion and a 1.8% capex surge in equipment, plant & machinery.
Improved Gross Operating Surplus: Gross operating surplus plus gross mixed income (GOSMI) expanded by 3.4%. The mining operating surplus surged 14.7%, reflecting robust growth in commodity markets. The export of mining commodities increased by 10.5% in current price terms.
Index Performance
The ASX 200 Materials (GIC) and ASX 200 Industrials (GICS) have generated a 10-year returns of ~87.18% and 99.68%, respectively, compared to ~73.01% return by the ASX 200 Index. Increased capacity expansion by miners, strong export growth, supportive government policies, and recovery in global supply chain are favourable factors driving sector gains.
The ASX 200 Materials (GIC) and ASX 200 Industrials (GICS) outperformed ASX 200 Index in the past ten years by whooping ~14.17% and ~26.67%, respectively.
Source: REFINITIV as of 09 June 2022
Key Risks and Challenges
The increased domestic final demand implicit price deflator reflects a surge in input costs. Private sector compensation of employees (COE) increased by 2.3% as wage pressures continued building up from skilled labour shortages. Construction activities witnessed a 1.3% decline in building construction in March 2022 quarter driven by project delays due to adverse weather conditions and material constraints. Severe weather events in Queensland, South Australia, and New South Wales affected the supply chain and dampened activities in specific industries.
Outlook
Increased Private New Capital Expenditure Estimates: In the March 2022 quarter, the total capital expenditure is set to clock $142.8 billion in FY22, 1.4% higher than the previous estimate, as per the Australian Bureau of Statistics (ABS).
Improved Value of Construction Activities: In the March 2022 quarter, the value of construction work done increased by 1.4% PcP and stood at $53.66 billion, primarily attributed to a 4.8% increase in engineering construction and a 1.0% increase in non-residential construction.
Favourable Statistics in Business Services: In March 2022 quarter, the total GVA of Services Industry rose by 0.5%, driven by surged demand for business services, particularly a 3.1% increase in professional scientific & technical services.
Infrastructure Investment Program: The Australian Government announced an investment of $120 billion over ten years from FY23 in transport infrastructure across Australia via rolling out an infrastructure pipeline.
Investment Backing for Manufacturing Activities: In FY23 Budget, the government continued to back manufacturing activities with an additional investment of over $1 billion. This has built onto the initial $1.5 billion investment commitment via the Modern Manufacturing Strategy.
2. Investment theme and stocks under discussion (REH, EHL, BXB)
After understanding the sector, let us now look at three companies listed on the ASX. The price potential of the companies under discussion has been analysed based on the ‘EV/Sales’ multiple method.
1. ASX: REH (Recce Limited)
(Recommendation: Buy, Potential Upside: Low Double-Digit, Mcap: A$9.30 billion)
REH is a supplier of bathroom, plumbing, heating, air-conditioning, ventilation, waterworks and refrigeration products in the retail, trade, commercial, and infrastructure markets.
Valuation
The illustrative valuation model suggests that the stock has a potential upside of 17.64% on 09 June 2022. Moreover, the stock might trade at a slight premium compared to its peers, given the broad US network. For valuation, peers such as Emeco Holdings Ltd (ASX: EHL), Acrow Formwork and Construction Services Ltd (ASX: ACF), Seven Group Holdings Ltd (ASX: SVW), and others have been considered. Given the favourable financial conditions despite currency fluctuations, considerable refinancing activities, current trading conditions, and upside indicated by valuation, we give a “Buy” recommendation on the stock at the closing market price of $14.080, down by ~2.290% on 09 June 2022. In addition, the stock has delivered an annualised dividend yield of 1.38%.
REH Daily Technical Chart, Data Source: REFINITIV
2. ASX: EHL (Emeco Holdings Limited)
(Recommendation: Speculative Buy, Potential Upside: Low Double-Digit, Mcap: A$421.69 million)
EHL provides support services for underground mining in Australia. It operates in three business segments – Rental, Workshops, and Pit N Portal.
Valuation
The illustrative valuation model suggests that the stock has a potential upside of 18.65% on 09 June 2022. However, the stock might trade at a slight discount compared to its peers, given the shortage of customer operators. For valuation, peers such as Coventry Group Ltd (ASX: CYG), Acrow Formwork and Construction Services Ltd (ASX: ACF), Seven Group Holdings Ltd (ASX: SVW), and others have been considered. Given the decent fundamental updates, elevated margins, steady growth in Pit N Portal, current trading conditions, and upside indicated by valuation, we give a “Speculative Buy” recommendation on the stock at the closing market price of $0.810, up by ~1.250% on 09 June 2022. In addition, the stock has delivered an annualised dividend yield of 3.08%.
EHL Daily Technical Chart, Data Source: REFINITIV
3. ASX: BXB (Brambles Limited)
(Recommendation: Hold, Potential Upside: High Single-Digit, Mcap: A$15.60 billion)
BXB is engaged in the global logistics business. Through its circular business model, the company is involved in the sharing and reusing the world's largest pool of reusable pallets and containers.
Valuation
The illustrative valuation model suggests that the stock has a potential upside of 8.34% on 09 June 2022. Moreover, given improved guidance, the stock might trade at a slight premium compared to its peers considering rise in guidance for FY22. For valuation, peers such as Namoi Cotton Ltd (ASX: NAM), SG Fleet Group Ltd (ASX: SGF), Mader Group Ltd (ASX: MAD), and others have been considered. Given the decent financial metrics, favourable outlook, increased top-line, current trading conditions, and upside indicated by valuation, we give a “Hold” recommendation on the stock at the closing market price of $10.820, down by ~0.459% on 09 June 2022. In addition, the stock has delivered an annualised dividend yield of 2.70%.
BXB Daily Technical Chart, Data Source: REFINITIV
Comparative Price Chart:
Source: REFINITIV
Markets are trading in a highly volatile zone currently due to certain macro-economic issues and geopolitical tensions prevailing. Therefore, it is prudent to follow a cautious approach while investing.
Note: All the recommendations and the calculations are based on the closing price of 09 June 2022. The financial information has been retrieved from the respective company’s website and REFINITIV.
Investment decisions should be made depending on the investors' appetite for upside potential, risks, holding duration, and any previous holdings. Investors can consider exiting the stock if the Target Price mentioned as per the valuation has been achieved and is subject to the factors discussed above.
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