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

Turnaround Bottom-Line Performance in 1HFY19: Downer EDI Limited (ASX: DOW) is an ASX-listed company which is engaged in the business of providing integrated services in Australia and New Zealand. As on August 5, 2019, the market capitalisation of Downer EDI Limited stood at ~A$4.48 billion. The company earlier released its results for 1H FY19 in which it witnessed rise in its total revenue, EBITA (or earnings before interest, tax and amortisation of acquired intangibles assets), and NPAT. The company’s total revenue encountered an increase of 8.6% on a YoY basis and stood at $6.6 billion while its EBITA stood at $268.0 million, an increase from $83.0 million. The company added that the Transport’s revenue witnessed a rise by 0.8% or $16.2 million and stood at $2.1 billion despite revenue lost after the divestment of freight rail business in the prior period. Also, it was added that the utilities revenue rose 27.5% and stood at $1.2 billion, because of strong contributions from nbn^TM  contracts in Australia and new renewable energy projects. There was an increase of 34.1% in EC&M revenue to $945.1 million due to increased activities on the Ichthys project in the Northern Territory and the six months contribution from MHPS following acquisition. Also, Mining revenue witnessed a rise of 3.6% and the figure stood at $714.2 million, mainly because of increased activities at Blackwater and Carrapateena and contribution from new contracts.

Moving forward, there are expectations that the company’s capabilities to generate revenues and cash might help the company to achieve respectable growth in the future. The company has a decent outlook as the group focuses on improving engagement with customers, embed operational technology into core service offerings, innovation, investment towards targeted growth opportunities, and creating new positions in the appropriate markets. This might help to drive top-line growth and act as a tailwind for the company moving forward.


Key Financial Numbers (Source: Company Reports)

Top 10 Shareholders: The following table provides a broader overview of the top 10 shareholders in Downer EDI Limited:

Top 10 Shareholders (Source: Thomson Reuters)

YoY Improvement in Key Margins: Downer EDI Limited’s key financial margins have witnessed an increase in 1H FY19 on a YoY basis, which further strengthens the confidence in the company’s core business activities. The company’s net margin stood at 2.2% in 1H FY19 which implies an increase of 2.5% on a YoY basis that reflects that DOW’s capabilities to convert top-line into bottom-line has been improved. Also, the company’s operating margin stood at 3.8% in 1H FY 2019, reflecting an increase of 2.9% on a YoY basis. The company’s liquidity position can be considered at respectable levels and is evident from its 1H FY19 current ratio of 1.00x. Additionally, the company’s Debt/Equity ratio stood at 0.53x in 1H FY19 which implies a fall of 0.9% on a YoY basis and, thus, it can be said that the company’s debt has witnessed a reduction. The lower debt on the balance sheet provides some sort of confidence in the company’s balance sheet, which could help the overall company in achieving broader business growth.


Key Ratios (Source: Thomson Reuters)

Announcement of Update on Murra Warra Wind Farm: In the release dated August 1, 2019, there was important information related to the status of the project. As per the release, the current status of the project is that Downer’s balance of plant work has been wrapped up on schedule as well as on budget and 36 out of 61 wind turbine generators have been erected and 13 are generating electricity. Additionally, it was stated that DOW has entered into the agreements to secure title and possession to all the equipment which is required to wrap up the project and it has reached an agreement with Senvion GmbH for assistance with regards to the commissioning of wind turbine generators.
Downer EDI Limited has quantified the financial impact of Senvion’s insolvency. It was stated that the total losses with regards to DOW’s obligation to complete Murra Warra Wind Farm are anticipated to be $45 million before tax (or $31.5 million post tax). This includes cost-to-complete and contingency with regards to construction, performance, and liquidated damages. Downer EDI Limited would be recognising the impact of its losses relating to Murra Warra Wind Farm in the financial statements for the year ended June 30, 2019.

Selection of Downer To Provide Electricity Distribution Services: Downer EDI Limited made an announcement that it had been selected by AusNet Services in order to provide the operational as well as maintenance services on electricity distribution network in Victoria. The 5-year contract is worth circa $600 million and includes the options to extend for a further 6 years. Additionally, it was added that the contract is anticipated to start in the month of September 2019 after the completion of the workforce transition process. The key personnel of Downer EDI Limited stated that the contract reflects DOW’s ability to deliver and service the customers’ assets in order to help them provide the cost-effective, safe and reliable energy for communities.

Overview of Road Services Business: In Downer Group site tour presentation, it was stated that the Road Services business provides strong, vertically integrated supply chain to the customers and its value proposition mainly revolves around efficient and predictable journeys, environmental sustainability and safety. The customers include state and local governments, waste businesses, miners, airports as well as toll and other road owners. The tailwinds for the roads services business includes infrastructure investment, population growth, environmental sustainability focus, and smart city technology.


Vertically Integrated Multi-brand Strategy (Source: Company Reports)

Decent Dividends Might Attract Market Players Attention: The Company’s Board announced an interim dividend amounting to 14.0 cents per share, which is 50% franked while 13.0 cents per share (franked to 50%) was declared in the prior corresponding period. Considering the increase in the interim dividend, it can be said that the company has been focusing on the shareholders’ benefits. At CMP of $7.40, the company’s annual dividend yield stood at 3.72%, which can be considered at respectable levels. Additionally, the company’s cash receipts have witnessed a CAGR growth of 11.07% in the time frame of FY14- FY18 and, thus, it looks like that the company has decent capabilities to generate cash, which act as a key growth catalyst moving forward. The respectable levels of cash might place the company in a better position to achieve unhindered long-term growth.

What To Expect From DOW Moving Forward: As mentioned in the half-yearly report, DOW has increased the target guidance for FY19 to $352 million of consolidated net profit after tax and before amortisation of acquired intangible assets (or NPATA) before the minority interests. The company added that its performance bonding facilities amounted to $2,269.7 million as at December 31, 2018 and undrawn amount stood at $752.8 million. Resultantly, it looks like there is sufficient capacity in order to support its ongoing operations of the company.As at December 31, 2018, the company had liquidity amounting to $1.4 billion, comprising of $505.3 million of cash balances and $855.0 million of undrawn committed debt facilities.

Talking about the company’s balance sheet, the company’s current trade and other receivables witnessed a fall by $135.7 million and stood at $1,986.2 million which reflects an impact on the adoption of AASB 15 and strong cash collections.


Key Valuation Metrics (Source: Thomson Reuters)

Valuation Methodologies:

Method 1: EV/Sales Multiple Approach
 
EV/Sales Multiple Approach (Source: Thomson Reuters), *NTM: Next Twelve Months

Method 2: EV/EBITDA Multiple Approach

 EV/EBITDA Multiple Approach (Source: Thomson Reuters), *NTM: Next Twelve Months

(Note: All forecasted figures and peers have been taken from Thomson Reuters).

Stock Recommendation: The company’s stock has delivered the return of 12.72% on a YTD basis, while in the time frame of past one month, the stock’s return stood at 6.06% which can be considered at respectable levels. Additionally, from the analysis standpoint, the company is looking quite decent as its top-line has witnessed a CAGR growth of 13.02% in the time frame of FY14- FY18 which reflects that the company is possessing decent capabilities to generate revenues. There are expectations that the company’s revenue-generation capabilities, together with its capabilities to build cash levels, might support the long-term prospects for growth.

The company’s strategy revolves around zero harm, driving improvement in the existing businesses as well as operations, deploying towards targeted growth opportunities, and creating the new positions in the appropriate markets. Based on the foregoing, we have valued the stock using the two Relative valuation methods, EV/Sales and EV/EBITDA and have arrived at the target price in the range of $7.84-$8.16 (single-digit to low double-digit upside (in %)). Hence, considering the above-stated facts, we give a “Buy” recommendation on the stock at the current market price of A$7.400 per share (down 1.726% on 5 August 2019).
 

DOW Daily Technical Chart (Source: Thomson Reuters)

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