Company Overview: Downer EDI Limited provides services to customers in markets, including transport services, technology and communications services, utility services, rail, mining, and engineering, construction and maintenance. The Company's segments include Transport Services, which includes its road, rail infrastructure, bridge, airport and port businesses, and provides a range of transport infrastructure services, such as maintenance and earth works; Technology and Communications Services, including services, such as civil construction, network construction, commissioning and testing; Utility Services, including water lifecycle solutions for municipal and industrial water users and sugar cane waste fired cogeneration plants; Rail, including rail asset solutions, such as passenger and freight build; Engineering, Construction and Maintenance, which includes services, such as engineering design and civil works for projects, and Mining, including blasting services and exploration drilling services.

DOW Details

Downer EDI Limited (ASX: DOW) is engaged as a services provider in Australia, New Zealand, Asia-Pacific, South America, and Southern Africa. The group seems to be benefitting from the positive macro environment in key markets across road & rail transport, infrastructure and mining/ resources. There has been improvement in cash losses indicated during the release of latest financial result and DOW’s work-in-hand project base has been enhancing. The group has also increased dividends at the back of a resilient financial performance. The next two years are expected to pave the path for low double digit rise in Earnings per share while recent pull back offers an opportunity at this time frame.

Media speculation related to a potential management buyout of mining services business: Known for operating in  three divisions, Transport & Infrastructure; Mining, Energy and Industrial, DOW has always been discussed with regards to its mining services business reportedly under consideration for a management buyout. The organization, CapRaise is looking for an expression of interest for an investment through a management buyout in a major tier one mining services provider and one of Australia’s largest open-cut mining service contractors, and the market anticipates the target to be Downer Mining. However, the company has confirmed that it has not received any such proposal. DOW’s Mining services’ segment has posted a revenue of about $1.4 billion and has employed 5000 employees in the business.


Financial Performance (Source: Company Reports and Thomson Reuters)

Very strong pipeline of work for the years ahead & Resilient financial 2018 performance: For FY 18, DOW has met the guidance for the seventh year in a row. For FY 18, DOW has delivered the consolidated underlying Net Profit After Tax and before Amortisation of acquired intangibles, or NPATA, of $295 million despite the sale of the freight rail business halfway through the year 2018 and a weaker result from the Mining business. The company’s competitive landscape remained tough, however all six of the service lines achieved revenue growth in 2018: Transport has posted 31% growth, Rail grew by 38%, Utilities grew by 18%, EC&M grew by 20%, Mining has expanded by 4.5% and Spotless has increased by 3%. Moreover, the company continued with the strong cash performance along with cash flow conversion of 91% of Earnings Before Interest, Tax, Depreciation and Amortisation despite the negative impacts of the new Royal Adelaide Hospital and some substantial one-off costs. This is also DOW’s seventh year of cash flow conversion of more than 88%. The company has also maintained the strong balance sheet with gearing at 22.7% and the company has undrawn funding capacity and cash of more than $1.5 billion. DOW’s Work-in-hand has risen to $42 billion, which reflects a very strong pipeline of work for the years ahead. In addition, DOW has increased the total dividend to 27 cents per share, up from 24 cents per share last year.


FY 18 Financial Performance (Source: Company Reports)

Integration of Spotless: Downer is undergoing well with the integration of Spotless. From an operational perspective, Spotless has now become to be one of DOW’s four divisions. Further, this acquisition is a significant and strategic investment for DOW. The combination of capabilities of Spotless has led to the market leading positions for DOW across many sectors, which will allow the company to provide a broader range of services to both existing and potential customers. The acquisition has strengthened the Group’s position as a stable, services-focused business with resilient earnings. It enhances the ability to benefit from the continued trend towards government outsourcing significantly. The company has secured over $100 million of work through joint bidding, that comprises for example the Victorian Police Headquarters in the Melbourne CBD and the Ballarat Energy Storage project. Spotless is now delivering to the company more than $150 million of work that was previously contracted to other companies, and included activities relating to cleaning trains, NBN linework and facilitating management at Downer offices.

Two new significant train projects are progressing well: DOW’s two new significant train projects,  Sydney Growth Trains and Melbourne’s High Capacity Metro Trains, are progressing well. The company is doing performance testing for Sydney Growth Trains project. Further, in Melbourne, the High Capacity Metro Trains are arriving from China and are being assembled at the company’s Newport facility.

Secured a three-year contract from BHP Billiton Iron Ore Pty Ltd: DOW secured a three-year contract by BHP Billiton Iron Ore Pty Ltd, under which the company will have to provide general maintenance services at its Western Australia Iron Ore (WAIO) operations in Port Hedland, Western Australia. Downer’s scope of works comprises the maintenance of the Port Hedland export operations across the Finucane Island and Nelson Point facilities. This will also include the provision of mechanical, electrical, heating, ventilating and air conditioning (HVAC), minor civils, rope access services and integration with the BHP maintenance team in planning and executing the services. This new contract has been provided to DOW on the back of Asset Services capabilities. The company also in this way got the opportunity to work closely with BHP.

Secured Five year contract from Millmerran Power Partners: Downer has secured a contract by Millmerran Power Partners to continue to provide the mining services at the Commodore open cut coal mine in South East Queensland. The project is situated adjacent to the Millmerran Power Station, which is approximately 200 kilometres west of Brisbane. This is a contract extension, which is meant for an additional five-year term and the total value associated with this is about $286 million. Therefore, Downer will continue to do operations at Commodore until the end of August 2024. DOW has been providing a total mining service at Commodore since 2001, under which it delivers coal to the Millmerran Power Station. As per the contract, the work will entail operating and managing the mine and associated activities, including mine planning and design, drill and blast, overburden removal, coal mining and rehabilitation. DOW also holds statutory responsibility for the mine site. Moreover, the company got this contract after it secured a $120 million mining services contract at the CSA mine in New South Wales, which is a five-year maintenance and support services contract at the Chevron-operated Gorgon and Wheatstone facilities in Western Australia, and a $660 million underground mining services contract at the Carrapateena copper gold mine in South Australia.


Transport and Rail Performance (Source: Company Reports)

Healthy Outlook: For the first few months of the FY 19, the company has demonstrated performance in line with the expectations set for the new financial year and is targeting consolidated NPATA of $335 million before minority interests for the FY 19. This means a growth of 13% in the guidance for 2019, which reflects Downer’s stronger position in the major markets. Downer will continue to enjoy the benefit from significant government investment in public transport in both Australia and New Zealand, particularly light and heavy rail, and the company also expects further outsourcing of government bus networks. The company expects the demand for the network management and related maintenance services to remain strong, which will benefit DOW. The company is not a major civil constructor, however the growth in road construction in Australia will benefit the company’s road surfacing and bitumen products’ businesses. Non-residential commercial building is expected to remain strong in New Zealand, and the company expects significant demand for Hawkins’ services.

Moreover, Downer will continue to benefit from significant government investment in public transport in both Australia and New Zealand, particularly light and heavy rail, and the company also anticipates further outsourcing of government bus networks. DOW projects that the telecommunication market will stay relatively buoyant over the next few years while growth in utilities will be on the back of wind and solar projects in Australia. Water, gas and power distribution is expected to continue to grow and the company expects to witness major investments in upgrading and extending Australia’s transmission grid to cope with the requirements of renewable and energy storage capacity, in which Downer is the market leader. Additionally, population growth and government outsourcing is expected to accelerate growth in social infrastructure opportunities across most Australian states in health, education, and other government services such as defense. However, while there is a decline in oil and gas construction, as the major LNG builds come to an end, the company is growing their asset services business in this sector. Due to 25 process trains soon to be in operation around Australia there will be significant opportunities in shutdowns, turnarounds and general maintenance. There will also be increased investment in greenfield and brownfield iron ore projects. In addition, the company’s Mining business is becoming more efficient and expected to improve asset utilisation to take advantage of the market scenario.

Stock Recommendation: Lately, Robert Regan has been appointed the Group General Counsel and Company Secretary and he will be commencing the role on 1 January 2019. Prospects around Parramatta Light Rail outcome and Royal Adelaide Hospital (RAH) resolution seem to be important. Meanwhile, DOW stock has fallen 9.45% in three months as on November 16, 2018. The company is trading at a price of $6.78, and has support around $6.70 and resistance at $7.35. DOW is a leader in the roads market in both Australia and New Zealand. Particularly, the company has market leadership in asphalt and emulsion technology that includes the recycled inputs, and this will also help the company to grow as it provides smart solutions for the customers. Moreover, the company has very strong pipeline of work for the years ahead. The group in the next 24 months is expected to witness rise in dividend yield and overall resilient performance with EPS growth can drive stock price in single digit (in terms of % growth). Therefore, we give a “Buy” recommendation on the stock at the current price of $ 6.78.
 

DOW Daily Chart (Source: Thomson Reuters)

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