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I. Sector Landscape and Outlook
Australia’s Construction Materials sector entails the mining and refining of metals, chemical products (fertilizers, industrial gases, etc.), which are processed and manufactured as raw materials for other companies to be developed into finished goods. The infrastructure sector comprises of roads, railways, electricity, telecommunications, ports, and airports, etc., and is among the most important sectors in the Australian economy.
Both the Australian Construction Materials & Infrastructure sectors are thriving on the back of an increased pipeline of projects, with the growing support from government in the form of investment. Mining-related construction is expected to pick pace as the demand for resource commodities continues to grow. A record rise in iron ore prices has given a significant push to the demand for construction materials in the mining sector. Similarly, increased investment in road and rail projects is driving growth in the infrastructure segment. Commercial construction may also pick pace as the country adopts to the new normal and demand begins to recover with increased government support and withdrawal of restrictions.
As charted below, S&P/ASX 200 Materials Index has outperformed S&P/ASX 200 Index by 66.56% in the last 5 years.
Figure 1. S&P/ASX 200 Materials (Industry Group) vs S&P/ASX 200 (*5 Year)
Data Source: Refinitiv, Thomson Reuters *19th November 2015 – 19th November 2020; Chart Created by Kalkine Group
Growth Drivers
Removal from High-Risk Industry List: The building and construction industry was removed from the “high-risk” industry list from 28 October 2020 onwards. Some of the restrictions applicable to small scale construction included restriction on worker numbers and movement between sites for workers and specialist contractors. Under the new regime, pre-contract works on occupied homes (such as site measurements) can occur. Restriction on worker numbers and movement between sites for specialist contractors are no longer applicable to large scale construction.
New and Accelerated Transport Infrastructure Projects: The Australian Government has agreed to an additional investment of $14 billion in new infrastructure projects over the next four years, according to Federal Budget 2021. The projects include road upgrades, highway upgrades, township improvements, etc. These projects will support a further 40,000 jobs during construction thereby driving the demand for construction materials.
Figure 2. Infrastructure Investment in Australia
Data Source: Budget 2020-21, Chart Created by Kalkine Group
Investment in Water Infrastructure: The Government is building water infrastructure and investing a further $50 million to build on-farm dams, tanks, and troughs under the Federal Budget 2021 to increase water security. An additional $2 billion will be invested in new water infrastructure projects through the National Water Infrastructure Development Fund.
Figure 3. Government Initiatives to Boost Water Infrastructure
Data Source: Ministers for Infrastructure, Transport, Regional Development and Communications, Chart Created by Kalkine Group
Supporting Residential Construction: The Government announced an extension to the First Home Loan Deposit Scheme under Federal Budget 2021, which will enable additional 10,000 first home buyers to purchase a new home in 2020-21. This initiative will stimulate activity in housing construction and is estimated to generate an additional $800 million in economic activity and will boost the demand for construction materials. In June 2020, the Government also announced the HomeBuilder program with a grant of $25,000 to build a new home or rebuild an existing home to eligible owner-occupiers.
Figure 4. Applications Under the HomeBuilder Program
Data Source: The Treasury, Australian Government, Chart Created by Kalkine Group
Growing Importance of Concrete in Construction: The increased budget allocation for public infrastructure spend by the government is expected to boost cement and concrete demand. Western Sydney airport at Badgery’s Creek and Melbourne Metro Rail Project were some landmark infrastructure projects. These investments are expected to benefit the heavy construction materials industry which employs about 30,000 Australians directly and 80,000 indirectly. It is worth mentioning that some 29 million m3 of pre-mixed concrete is produced from more than 1,500 concrete batching plants to build these landmark projects every year.
Figure 5. Growing Usage of Concrete in Construction
Data Source: Cement Concretes & Aggregates Australia, Chart Created by Kalkine Group
Increase in Demand for Iron Ore: Recovery in construction activity across the globe, especially China, led to an increase in demand for Australian iron ore along with a record increase in iron ore prices. Demand was also boosted due to lack of supply from Brazil owing to COVID-19 restrictions. Strong exports of iron ore in June 2020 drove the total value of exports by 8%. During the quarter ended 30th June 2020, iron ore mining increased by 1.4% owing to increased global demand. Other mining increased by 2.5% due to strong production volumes in gold and copper. The above factors indicate a positive outlook for the demand of construction materials in mining.
Growing Contribution in Employment: Employment in the construction industry is growing at a decent pace as depicted in the chart below. Moreover, the sector has the third largest employment growth rate after household services and business services.
Figure 6. Employment Growth by Industry
Data Source: ABS, RBA
Key Risks
Figure 7. Key Risks/Challenges for the Construction Materials & Infrastructure Sector
Source: Kalkine
Decline in Investment: The sector is largely influenced by capital expenditure spending by businesses. Investments by private sector is influenced by several macro factors like construction demand, housing prices, inflation, interest rates, etc. Total capital expenditure deteriorated in June 2020 quarter by 5.9% on sequential basis and dropped by 11.5% YoY basis. Investments in building and structures fell by 4.4% on QoQ basis and 9.4% on YoY basis.
Figure 8. Industry Share of Business Investment
Data Source: ABS, RBA
Decline in Value of Housing Construction: The housing market is characterized by seasonal factors and is directly linked to household income and unemployment rate. Total value of new construction dropped by 0.7% on QoQ basis and declined by 2.2% on YoY basis. Residential building construction showed sharp contraction with 5.5% on QoQ basis in June 2020 and 12.1% on YoY basis.
Decline in Property Prices: Residential property prices fell 1.8% in June 2020 quarter. Except Canberra, prices dropped in all cities. Buyers showed less enthusiasm on account of the pandemic. The lockdown in Melbourne and decline in population growth rate detracted home buying. If the current conditions continue to impact the prices, the demand for construction materials in Australia may remain subdued.
Reduced Household Spending: Construction materials sector is influenced by household spending. Disposable personal income dropped by 7.8% in the June 2020 quarter. As households resorted to more savings, consumption declined by about 6.7%.
Outlook: The construction materials and infrastructure sector is being driven by the government’s financial stimulus for increased transport infrastructure spending and housing construction released in Federal Budget 2021. Since the onset of COVID-19, the government has announced $14 billion investment to boost demand in the infrastructure sector and create jobs over the next four years. The sector is also a beneficiary of the ever-rising demand for Australia’s resource commodities like iron ore.
While the sector has suffered a setback due to decline in household spending and reduction in activity, the above factors are expected to weather the impact of COVID-19 and boost the demand in the sector. Moreover, investment in infrastructure projects remains a key priority for the government due to its significant role in employment, and hence, the overall economic growth of the country.
II. Investment theme and stocks under discussion (CIM, DOW, WGN, and ABC)
After understanding the sector, let us now look at four companies listed on the ASX. The price potential of the companies under discussion has been analysed based on ‘EV/EBITDA’ method.
1. ASX: CIM (CIMIC Group Limited)
(Recommendation: Buy, Potential Upside: Low Double Digit, Mcap: A$ 7.23 Billion)
CIMIC Group Limited is engaged in providing construction, mining and operation and maintenance services for infrastructure.
Valuation
Our illustrative valuation model suggests that the stock has a potential upside of ~31.3% on 19 November 2020 closing price. For the said valuation, we have taken the overall industry median. At the same price, the stock of CIM was offering a dividend yield of ~3.05%.
2. ASX: DOW (Downer EDI Limited)
(Recommendation: Buy, Potential Upside: Low Double Digit, Mcap: A$ 3.66 Billion)
Downer EDI Limited is a leading provider of integrated services in Australia and New Zealand.
Valuation
Our illustrative valuation model suggests that the stock has a potential upside of ~23.4% on 19 November 2020 closing price. For the said valuation, we have taken peers such as Monadelphous Group Ltd (ASX: MND), CIMIC Group Ltd (ASX: CIM), and Fletcher Building Ltd (ASX: FBU). At the same price, the stock of DOW was offering a dividend yield of ~5.35%.
3. ASX: WGN (Wagners Holding Company Limited)
(Recommendation: Buy, Potential Upside: Low Double Digit, Mcap: A$ 300.45 Million)
The company is engaged in the provision of construction materials and services and new generation building materials.
Valuation
Our illustrative valuation model suggests that the stock has a potential upside of ~27.8% on 19 November 2020 closing price. For the said purposes, we have taken peers such as Adbri Ltd (ASX: ABC), Reliance Worldwide Corporation Ltd (ASX: RWC), James Hardie Industries PLC (ASX: JHX), etc.
4. ASX: ABC (Adbri Limited)
(Recommendation: Hold, Potential Upside: High Single Digit, Mcap: A$ 2.00 Billion)
Adbri Limited is engaged in the manufacturing of cement, lime, concrete, and aggregates and concrete masonry products.
Valuation
Our illustrative valuation model suggests that the stock has a potential upside of ~13.2% on 19 November 2020 closing price. For the said purposes, we have taken peers such as James Hardie Industries PLC (ASX: JHX), Boral Ltd (ASX: BLD), ALS Ltd (ASX: ALQ), etc. At the same price, the stock of ABC was offering a dividend yield of ~3.16%.
Note: All the recommendations and the calculations are based on the closing price of 19 November 2020. The financial information has been retrieved from the respective company’s website and Refinitiv (Thomson Reuters).
Disclaimer
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