I. Sector Landscape

Australia’s industrials and infrastructure sector is booming on the back of surged construction, transport, and manufacturing activities. Construction activities have magnified in 2021 with the rising development of non-residential and residential buildings. The improved value of work reinforced engineering activities commenced in roads, highways & subdivisions, bridges, and railways. The modern manufacturing strategy, a whole-of-government strategy, is well-positioned to scale up the Australian manufacturing activities.

Key Macro Factors Affecting the Sector

Update on Key Macroeconomic Indicators: In June 2021 quarter, GDP levels surged by 9.6% PcP, reflecting the subsequent easing of containment measures and recovery in the labour market. In addition, terms of trade rose by 24.1% PcP or 7.0% on a sequential basis, primarily driven by resilient export prices in mining commodities, contributing a 3.2% increase in nominal GDP.

Uptick in Production Across Industry: On a sequential basis, manufacturing production surged by 0.9% in June 2021 quarter, construction edged up by 1.0%, and transport, postal, and warehousing jumped significantly by 3.7% due to government intervention in developing a resilient supply chain.

Indicators Promoting Manufacturing Activities: Sales of goods and services in the manufacturing and wholesale trade industry surged by 8.1% and 13.8% PcP in June 2021 quarter, respectively. Aggregate inventories rose by 2.4% PcP to cater to increased consumption levels—aggregate gross operating profits inclined significantly by 7.1% on a sequential basis and 5.5% PcP.

Developments in Construction Activities:

Improved Construction Work Done: In June 2021 quarter, Australia registered a $22.66 billion value of work done in total engineering construction, up by 3.2% on a sequential basis. The total value of work commenced during the period surged by 0.6% sequentially and stood at $19.50 billion. In addition, the value of work done for roads and highways surged considerably by 22.95% QoQ, resurging to prior period levels.

Considerable Uptick in Building Activities: In June 2021 quarter, total dwelling unit commencements surged by 23.2% to 64,596 dwellings. House commencements surged by 13.7% to 40,820 dwellings in the new private sector. The outstanding results were highly attributed to robust demand fueled by surging consumer confidence, low-interest record rates, dampened levels of stock in the property market.

Figure 1: Dwelling Commencement Stood High Amidst Favourable Economic Factors

Source: Based on Australian Bureau of Statistics Data, Analysis by Kalkine Group

Key Developments in Infrastructure Space

FY22 Budget Achievements: The Australian government aims to materialise their 10-year infrastructure program in job creation and redevelopment of Australia's supply chain. The program incorporates a $110 billion investment, forming a subpart of the National Economic Recovery Plan. The key deliverables for FY22 are a $15.2 billion investment in new project funding and a $1 billion investment in the Local Roads and Community Infrastructure Program.

Resurgence in Public Sector Construction Activities: In June 2021 quarter, the total value of engineering construction stood high with sequential gains, primarily driven by a 6.7% surge in the value of work done for the public sector and secondarily driven by a 0.9% surge in the private sector. In a separate release, investments by state and local government reached $2,406 per capita in 2020-21. Seven out of eight states witnessed increased investments with South Australia and Victoria demonstrated significant increase.

Figure 2: Recent Resurgence in Construction Activities

Source: Based on Australian Bureau of Statistics Data, Analysis by Kalkine Group

Index Performance:

The ASX 200 Industrials Index (GIC) Index posted 10-year returns of ~+91.49% compared to ~+73.56% by the ASX 200 Index. Increasing public infrastructure spend, surged engineering and construction activities, favourable government support for manufacturing businesses, upward trending exploration activities and resurgence in industrialization have contributed to the sector growth.

Figure 3: The ASX 200 Industrials Index (GIC) outperformed the ASX 200 Index in the past ten years by ~17.93%: 

Source: REFINITIV as of 28 October 2021

Key Risks and Challenges

The pace of investment growth had decelerated in June 2021 quarter with 3.2% growth as compared to 5.5% in March 2021 quarter. As delivery levels paused and contracted for September 2021, Australia’s Purchasing Managers’ Index (PMI) took a marginal hit of 0.4 points and stood at 51.2 points, indicating a weaker expansion rate. Recent lockdowns and further uncertainties due to COVID-19 slowed economic activities may considerably affect Australia’s supply chain and, in turn, poses challenges for logistics businesses. Rising real estate prices may outpace government initiatives; hence affordability may remain a significant concern. Gradual retrenchment of government subsidies has significantly affected operating surplus in businesses involved in construction materials.

Figure 4: Key Risks and Challenges

Source: Analysis by Kalkine Group

Outlook

Figure 5: Key Driving Factors of Industrials and Infrastructure Sector

Source: Analysis by Kalkine Group

Higher Expectations for Private Capital Expenditure: The Australian Bureau of Statistics estimates the new private capital expenditure to register $127.70 billion in FY22, up by 12.5% from the previous estimate. Consequently, spending on mining activities is forecasted to clock $39.78 billion by FY22.

Improving Commodity Prices: Upward momentum witnessed in commodity prices have significantly supported the operating surplus plus gross mixed income (GOSMI), which surged 3.2%, despite low volumes.

Manufacturing Modernization Fund: Round 2 of the Manufacturing Modernization Fund objectifies to support transformation in medium and small manufacturing businesses. The co-funded grant is likely to mull job creation and transform manufacturing activities. The grant will hold $50 million and be available for FY21 to FY23.

Surging Infrastructure Activities: In line with the data from Infrastructure Market Capacity Report published on 13 October 2021, major public infrastructure activities are expected to double and clock a value of $52 billion in 2023

First Home Loan Deposit Scheme (FHLDS): FHLDS is considered a long-term program as per the National Housing Finance and Investment Corporation (NHFIC). NHFIC reported that FHLDS and New Home Guarantee (NHG) supported 1 out of 10 of the total first home buyers during FY21.

II. Investment theme and stocks under discussion (AZJ, MGH, SGF, QUB)

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 the ‘EV/Sales’ multiple method.

1. ASX: AZJ (Aurizon Holdings Limited)

(Recommendation: Buy, Potential Upside: Low Double-Digit, Mcap: A$6.35 billion)

AZJ is one of Australia's leading rail freight operators that provide integrated freight and logistics solutions across an extensive national road and rail network.

Valuation

The illustrative valuation model suggests that stock has a potential upside of 17.29% on 28 October 2021. Moreover, the stock might trade at some premium compared to its peers’ median EV/Sales (NTM trading multiple), given improved infrastructure support from the government and mounting growth in the bulk segment. For valuation, peers like Lindsay Australia Ltd (ASX: LAU), Sealink Travel Group Ltd (ASX: SLK), Camplify Holdings Ltd (ASX: CHL) are considered. Considering the growth expectations in the coal and bulk segment, favourable bottom-line guidance, and valuation, we give a “Buy" recommendation on the stock at the closing price of $3.430, as of 28 October 2021, down by ~0.580%. In addition, the stock has delivered an annualised dividend yield of 8.34%.

2. ASX: MGH (MAAS Group Holdings Limited)

(Recommendation: Buy, Potential Upside: Low Double-Digit, Mcap: A$1.32 billion)

MGH is an Australia-based construction materials, equipment, and services provider with diversified exposures across the civil, infrastructure, mining and property markets.

Valuation

The illustrative valuation model suggests that stock has a potential upside of 20.30% on 28 October 2021. The stock might trade at a slight premium compared to its peers’ average EV/Sales (NTM trading multiple), given the commencement of inland rail contracts and other key projects. For valuation, peers like CIMIC Group Ltd (ASX: CIM), Monadelphous Group Ltd (ASX: MND), Lycopodium Ltd (ASX: LYL) are considered. Considering the improved growth potential in both segments, strategic acquisitions, and valuation, we give a "Buy" recommendation on the stock at the current market price of $4.650, as of 28 October 2021, at 02:56 PM (GMT+10), Sydney, Eastern Australia.

3. ASX: SGF (SG Fleet Group Limited)

(Recommendation: Buy, Potential Upside: Low Double-Digit, Mcap: A$909.67 million)

SGF provides vehicle fleet management, vehicle leasing, short-term hire services, financing of consumer vehicles and salary packaging services.

Valuation

The illustrative valuation model suggests that stock has a potential upside of 19.73% on 28 October 2021. Given prominent pipeline and order support, the stock might trade at a slight premium compared to its peers’ average EV/Sales (NTM trading multiple). For valuation, peers like Brambles Ltd (ASX: BXB), Downer EDI Ltd (ASX: DOW), AMA Group Ltd (ASX: AMA) are considered. Considering the rapid integration into MaaS capabilities, favourable order flow, and valuation, we give a “Buy" recommendation on the stock at the closing price of $2.550, as of 28 October 2021, ~down by 4.136%. In addition, the stock has delivered an annualised dividend yield of 4.72%.

 

4. ASX: QUB (Qube Holdings Limited)

(Recommendation: Hold, Potential Upside: High Single-Digit, Mcap: A$6.16 billion)

QUB provides comprehensive logistics solutions across multiple aspects of the import-export supply chain. Further, QUB is engaged in the management, development, and operation of strategic properties.

Valuation

The illustrative valuation model suggests that stock has a potential upside of 7.20% on 28 October 2021. Moreover, the stock might trade at some premium compared to its peers' average EV/Sales (NTM Trading multiple) given resilient financials at reasonable liquidity. For valuation, peers like Aurizon Holdings Ltd (ASX: AZJ), Sealink Travel Group Ltd (ASX: SLK), Dalrymple Bay Infrastructure Ltd (ASX: DBI) are considered. Considering the improved top-line inflow, prudent liquidity support, and valuation, we give a “Hold” recommendation on the stock at the closing price of $3.210, as on 28 October 2021. In addition, the stock has delivered an annualised dividend yield of 1.86%.

Note: All the recommendations and the calculations are based on the closing price of 28 October 2021. The financial information has been retrieved from the respective company’s website and REFINITIV.  

Investment decision should be made depending on the investors' appetite on upside potential, risks, holding duration, and any previous holdings. Investors can consider exiting from the stock if the Target Price mentioned as per the valuation has been achieved and subject to the factors discussed above.

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