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

Secured Parramatta Light Rail project from the New South Wales Government: Downer EDI Limited (ASX: DOW) is into providing various services in Australia, New Zealand, the Asia-Pacific zone, South America, and Southern Africa. The company operates through three divisions, Transport & Infrastructure, Mining, Energy and Industrial. The company caters to market sectors that include Minerals & Metals, Oil & Gas, Power, Transport, Telecommunications, Water and Property. With support from its strength in capabilities and light rail related experience, DOW has lately secured Parramatta Light Rail project from the New South Wales Government. This is to construct the Stage 1 of the project, which is a 50:50 joint venture with CPB Contractors. The company is projected to get the revenue of $420 million from the design and construct Infrastructure Works contract. Stage 1 of the Parramatta Light Rail is scheduled to start in terms of construction in 2019 and the project will connect the Parramatta CBD to the Westmead Precinct, new Bankwest Stadium, the new Powerhouse Museum and cultural precinct on the Parramatta River, the Rosehill Gardens Racecourse and three Western Sydney University campuses at Westmead, Parramatta and Rydalmere. It will also cross through the Parramatta North Growth Centre, the Camellia Town Centre, and the private and social housing redevelopment at Telopea. It is worth noting that Parramatta Light Rail is planned to start passenger services in 2023. This new win sets the EPS growth scenario for FY20 and beyond. Further, DOW tracks well on its plan for achieving the FY19 guidance and thus supports future prospects with building of confidence among investors.

Media Speculation Relating to the company’s mining division: There was speculation in the media regarding the potential management buyout of the company’s mining services business, which DOW rejected subsequently. The company has confirmed that it has not received the buyout proposal. As per the media, CapRaise was said to be looking for an investment through a management buyout and DOW’s mining services business is reportedly under lens for a potential management buyout. As per the market analysts, the mining services business is of valuation of approximately $666 million to $732 million, which forms 10 to 11-times earnings before interest and tax. The division generates the revenue of approximately $1.4 billion. The company’s division approximately, represents 11 per cent of DOW's projected earnings in the 2019 financial year. This division has customers that include BHP Mitsubishi Alliance, Roy Hill Iron Ore, Glencore, Karara Mining, Millmerran Power Partners, Newmarket Gold, Newmont, Rio Tinto, Stanwell Corporation, OZ Minerals and Yancoal Australia. The division supports its customers in asset management, blasting services, explosives manufacture and supply, civil projects (mine site infrastructure), crushing, exploration drilling, mine closure and mine site rehabilitation, mobile plant maintenance, open cut mining, training and development for ATSI employees, tyre management (through the subsidiary Otraco International) and underground mining.

Growth across all the segments in FY 18: For FY 18, DOW was able to meet the guidance for the seventh year in a row. For FY 18, DOW has delivered significant increase in the consolidated underlying Net Profit After Tax and before Amortisation of acquired intangibles (NPATA) to about $296 million. This is despite the sale of the freight rail business halfway through the year 2018 and a weaker performance from the Mining business. The company’s competitive landscape is challenging, however all six of the service lines were able to achieve decent revenue growth in 2018. The Transport segment posted 31% growth, Rail division grew by 38%, Utilities division grew by 18%, EC&M segment grew by 20%, Mining division 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. The company has posted Statutory NPATA of $117.9 million, which fell down from $186.6 million and delivered the Statutory net profit after tax (NPAT) of $71.1 million. However, total revenue for the Group grew by 61.5% to over $12 billion. Further, this is also DOW’s seventh year of cash flow conversion of more than 88%. The company’s underlying earnings before interest, tax and amortization of acquired intangible assets (EBITA) increased by 68.2% to $479.6 million, from $285.2 million. The Statutory EBITA fell down to $271.5 million from $285.2 million and Statutory earnings before interest and tax (EBIT) fell down to $204.8 million from $277.8 million in FY 18. Spotless’ EBITA contribution for the one year was $167.7 million. The company has recognized Individually Significant Items (ISI) in EBIT in the FY 18 of $208.1 million ($178.6 million after tax). Therefore, during the FY 18, DOW has included Individually Significant Items of aggregate $178.6 million after tax. This comprised of $76.4 million Mining goodwill impairment, $40.6 million from the loss on divestment of freight rail, $17.5 million of unsuccessful Auburn rail claim, $20.0 million related with Divisional merger costs and $24.1 million related to Spotless management redundancies, transaction costs and residual Strategy Reset costs. Moreover, 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)

Status of Work-in-hand: Transports’ work-in-hand stood at $7.4 billion in FY 18. The division’s revenue grew 30.8% to $2.8 billion and EBITDA grew 14.4% to $142.9 million. Rail’s work-in-hand stood at $8.2 billion in FY 18. The division’s revenue grew 37.5% to $1169.2 million and EBITDA grew 29.4% to $39.2 million. Utilities Division work-in-hand stood at $3.4 billion in FY 18. The division’s revenue grew 17.5% to $1783 million and EBITDA grew 12.7% to $94.8 million. Engineering, Construction and Maintenance (EC&M) segment work-in-hand stood at $2.2 billion in FY 18. The division’s revenue grew 19.9% to $2.4 billion and EBITDA grew 34.2% to $70.6 million. Spotless division work-in-hand stood at $18 billion in FY 18. The division’s revenue grew 3.2% to $2.8 billion, however its EBITDA declined by 2.4% to $167.7 million. Mining division work-in-hand stood at $2.8 billion in FY 18. The division’s revenue grew 4.5% to $1.4 billion, however its EBITDA declined to $50.4 million from $83.4 million. The group expects to maintain the continuity in terms of work in hand for the upcoming year.


Result for Utilities and Engineering Segments (Source: Company Reports)

Outlook: As per the update for the first few months of the FY 19, the company is performing 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 growth of about 13% in the guidance for 2019, and reflects DOW’s strong position in the major markets. DOW is expected to continue to enjoy the benefit from significant government investment in public transport in both Australia and New Zealand, particularly related with 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. 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, DOW 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.


Revenue trend by geography (Source: Company Reports)

DOW projects that  the telecommunications 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 major investments in upgrading and extending Australia’s transmission grid to cope with the requirements of renewable and energy storage capacity; and this will benefit Downer, which is one of the leading players in support. 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 related construction, as the major LNG builds come to an end, but 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 utilization to take advantage of the market.

Stock Recommendation: DOW stock has fallen 16.20% in three months as on January 04, 2019. The company is trading at a price of $6.81, and has support at $6.3 and resistance at $7.1. The company’s divisions grew in FY18 and the company was able to meet the guidance for the seventh year in a row. Group’s gross margin has been at 44.6% for 2018, well above the industry median of 38%, while the group has to improve its operating margins. The quick ratio and current ratio have been up by low double digit on a year on year basis. One year cash receipts’ growth has been 61.6%. Given the entire scenario and latest developments, the stock is expected to witness a target price growth of single digit in the next 12-24 months. Forward 12 month dividend yield is expected to be maintained between 4% to 5%. Therefore, we give a “Buy” recommendation on the stock at the current price of $ 6.81 (up 4.4% on January 7, 2019), ahead of the FY19 half year result expected in February 2019.
 

DOW Daily Chart (Source: Thomson Reuters)

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