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Stock of the Day - Downer EDI (HOLD)

In this report we cover Downer EDI (DOW). Strong management team, low gearing, good cash conversion capability with strong balance sheet, and unwavering earnings as opposed to competitors are considered to be DOW’s strengths. While dealing with external headwinds, the Company’s share price dip of 26% since June 14, is still better than many peers who have witnessed a 35% reduction in respective share prices.


Financial Overview (Source – Company Reports)

Nonetheless, we note the completion of various construction contracts which may affect earnings in the coming months. There is also a decline in mining revenues which tend to affect DOW’s performance.

The Infrastructure Australia division of DOW is estimated to have a good chunk of revenue emanating from nonrecurring related activities. The important point here is the possible slip in value owing to the ending of greenfield construction contracts in FY15. Further, the tender opportunities are also not very high. However, the full year contribution from the acquisition of Tenix appears to bring a sigh of relief. The softness in commodity prices (primarily, iron ore and coal) seems to affect DOW’s Mining division owing to margin pressures, scope and volume reductions, and termination of contracts by BMA etc. The market senses that the FY16 revenue growth for the aforementioned divisions may fall to a great extent. However, DOW has received two letters from Adani Mining indicating the intention to award construction and mining services contracts for the proposed Carmichael coal mine in Galilee Basin in Central Queensland. The contracts are valued around $2.0bn over 7 years with the capital for the major fleet of the mining services contract to be provided by Adani. This reflects around $300m of revenue per annum. Further, the construction is expected to start in 4Q15 with first mining scheduled for 2Q16 and first coal in 2017. This is, nonetheless, subject to securing project funding. It is also to be noted that the project is linked to a strategic interest as it emphasizes on thermal coal exports to supply the growing Indian power sector. Thus, movements including the execution of binding contracts between DOW and Adani will set the way forward.


Infrastructure Division_Financial Performance (Source – Company Reports)

For the Infrastructure New Zealand division, the outlook is considered unwavering owing to long-term contracts although revenues may slightly dip in consideration of some telecommunications contract re-pricing. The division’s telecommunications and road infrastructure revenues are more or less contracted to 2019. Specifically, telecommunications revenues are driven by the Ultra-Fast Broadband and Next Generation Access contracts which extend to 2019. The road infrastructure revenues are driven by long term contracts. Only one small road maintenance contract has been acknowledged for retender between FY15-FY19.

Overall, DOW still has a base load of engineering work entailing around Wheatstone and Gorgon along with road maintenance work supported by growth in New Zealand. The moves to watch over would be potential buyback of shares and 1H results in February 2015. A 5-10% buy back is expected to be 3-6% accretive to DOW’s FY15E EPS. Moreover, early this month, DOW announced the signing of a contract with a major mining company to maintain haul truck fleets at two coal mines in the Bowen Basin in Queensland. This contract, which is for two years with an additional one year option with commencement on 1 February, 2015, is valued at around $60 million.

At the same time, we also do not want to undermine the risks related to economic conditions, project execution, access to qualified labor, and negative sentiments prevailing around the mining division and the FMG Christmas Creek contract. We also note that sales of $7.37 billion were reported during the year ended June of 2014, indicating a decrease of 12.0% over 2013. In 2014, DOW’s market cap declined to $223.2 million. DOW’s EBITDA was $625.29 million, or 8.5% of sales and the EBITDA to sales ratio was found to be at par with that of 2013 when the EBITDA ratio was 8.1% of sales. During 4Q14, the reported earnings per share were of $0.27, i.e., an increase of 7% versus 4Q13.


Group Revenue (Source – Company Reports)

Under the given scenarios, whether 1H15 financial performance can drive the share price and help meet FY15 guidance with DOW’s efforts to reduce costs across the business to manage external factors, is to be watched closely. The Company stated that it is targeting NPAT of around $205 million for FY15.



Downer EDI Daily Chart (Source - Thomson Reuters)

Given the above, we put a HOLD recommendation for this stock at the current price of $4.23.