The services sector plays a pivotal role in economic development. About 82% of the country’s Gross Value Added was derived from the services sector in 2019, according to the Australian Trade and Commission. The nation witnessed a lesser dependency on resources and agriculture through the broadening of exports in services. Technology serves as a pillar driving the transition to a service-based economy. Australia is widely known for pioneering technology in agriculture, education, financial services, health, and other sectors. The nation ranked among the top ten in services trade with fewer regulatory restrictions. According to OECD Services Trade Restrictiveness Index for 2020, Australia scored below the OECD average and low when compared to other countries indicating a stable regulatory environment over the past years. Legal services, rail freight transport, accounting services, and engineering services were in the limelight with low scores.

With top-notch research institutions, service exports benefited from robust demand from international students. The nation also topped in attractive tourist destinations with an increasing number of international visitors. Exports of the services sector stood at $152.5 billion, representing 32.1% of total exports in 2019-20, of which education, tourism, and travel-related services alone accounted for 26.7% of the total exports.

Figure 1. Services Sector Constitutes 32.1% of Total Exports in 2019-20:

Data Source: The Department of Foreign Affairs and Trade, Chart Created by Kalkine Group

The pandemic-led restrictions severely affected the services sector. Due to the closure of international borders and the freeze on travel budgets, the tourism sector posted a monthly loss of $10 billion during the initial period of the pandemic, according to the Department of Foreign Affairs and Trade. The social distancing norms and headcount reduction severely affected the film and TV broadcasting industry. On a positive note, the pandemic helped the services sector to achieve a seamless transition to digital platforms like the advent of telemedicine, work from home culture, and shift to paperless transactions in the payment industry, etc. Technology-driven sectors such as professional services, education, and information and technology accounted for 14% of Gross Domestic Product in 2019-20 to reach $273.82 billion, according to the data by The Australian Bureau of Statistics. In the chart below, out of 15 sub-sectors catered to services, six posted positive movements in the economic output.

Figure 2. The Pandemic Impacted The Services Sector:

Data Source: The Australian Bureau of Statistics, Chart Created by Kalkine Group

Services exports are yet to show recovery as the international travel ban continue to hurt travel-related services and tourism exports. Intrastate travel showed a silver lining with an upswing in domestic overnight travel. The new year holiday in most states posted a record increase in visitors and travel spend in January 2021. Transportation showed resilience during the pandemic with an increase in road freight movement. Expansion at rail freight network helped to meet increased consumer demand. The decline in travel services exports was partially mitigated by repairs and maintenance and exports of business services such as legal, leasing, management consulting, among others.

Figure 3. Trend Showing Exports of Services:

Data Source: The Australian Bureau of Statistics, Chart Created by Kalkine Group

The Morrison government has reached a conclusion in supporting the Australian services sector with an action plan that helps to find new export opportunities and boost the share of exports by the services sector. These action plans are aimed to break the regulatory complexities, make progress on barriers overseas, and provide support to services firms as they become internationally competitive. Based on 72 recommendations, 81 actions are being identified, covering five broad categories. Of these five categories, recommendations were largely received for the digitization of the services sector. The government has initiated 18 action plans out of 24 recommendations. It had agreed to support the private sector in invests in 5G trials and testbeds, innovation in regulatory technology, innovation in payment architecture, collaboration with research institutions with MTPConnect, among others. It is worth mentioning that the Australian government wants Australia to become a leading digital economy by 2030.

Figure 4. The Government Action Plan in Services Sector:

Data Source: The Department of Foreign Affairs and Trade, Chart Created by Kalkine Group 

Key Risks: The services sector is highly influenced by disposable incomes, unemployment rate, interest rates, and bond yield. Delay in vaccine rollout may slow down the recovery of tourism with a ban on international movement to continue. Change in visa approvals regime to affect education sector and affect related travel requirements. Volatility in local currency to affect services exports earnings. Trade restrictions by China and global geopolitical risks may hamper trade movements and affect the freight transportation sector. A low-interest rate policy may affect investment income and influence superannuation gains impacting the financial services sector. Delay in various infrastructure plans by the government may affect the construction sector.

Figure 5: Key Risks Affecting Services Sector:

Source: Analysis by Kalkine Group

Outlook: Business conditions improved in Australia, largely supported by a surge in new businesses. The Business Activity Index tracked by IHS Markit rose from 53.4 in February 2021 to 55.5 in March 2021. The index has been upward trending for the straight seven months. Strong demand conditions and gains in employment lifted the index. Businesses continue to show confidence over the next twelve months. The government action plan is likely boost service sector exports and support firms to become internationally competitive. It had initiated plans to reduce retape, making it easier for businesses to invest and create jobs through the deregulation task force in the services sector. Further, the government intends to simplify the export market development grants program to promote SMEs. The government had a $43.6 billion infrastructure pipeline to spur tourism in arts, recreation and business services, aviation, and accommodation services. Considering the developments in the services sector in Australia, we have figured out 4 stocks on ASX that are set to see the momentum.

1. CIMIC Group Limited (Recommendation: Buy, Potential Upside: Low Double-Digit)

(M-cap: A$ 5.52 Billion, Annual Dividend Yield: ~3.34%)

 

Strong Order Pipeline to Drive the Performance: CIMIC Group Limited (ASX: CIM) is an engineering and construction services company providing mining, mineral processing, concessions, infrastructure construction, operations, maintenance, and other services. The pandemic impacted new contract wins and project delays led to revenue fall by about 47% in FY20 over pcp. Both Construction and Services businesses were shown lower revenues in FY20. However, the company was able to sustain its position in the operations and maintenance services business with steady margins. CIM reversed ~$1.15 billion revenues owing to the resolution of Gorgon Jetty arbitration. It also sold off a 50% stake in Thiess (retained remaining 50%) which had generated revenue of $3.6 billion in FY20. EBITDA turned into losses for CIM owing to weak revenues in FY20. The company posted several one-offs such as impairment at property and oil and gas vessel businesses, project settlements and provisions, etc. Its net profit was lifted by gains from the divestiture of Thiess to the extent of $1.44 billion. CIM posted net cash of $190 million including undrawn credit lines after adjusting for financial guarantees. The average cost of debt declined to 1.9% from the year-ago levels of 3.3%. CIM claims that it had work in hand to the extent of $30.1 billion as of December 2020 with a strong pipeline in the construction segment. CIM had repurchased 12.4 million shares for a consideration of $281.3 million in FY20.

Outlook: CIM secured a 3-year syndicated bond facility of $1.4 billion in March 2021. This supports liquidity and capex requirements. CIM received several projects post-closure of FY20, such as 10-year operations and maintenance rail infrastructure project by its subsidiary UGL from Transport for New South Wales with a revenue potential of over $1.5 billion. CIM is optimistic with new projects recovering that helps to support the construction and services business, going forward. The government to show commitment in providing stimulus to the sector with opportunities through the PPP pipeline. 

Valuation Methodology: EV/Sales Multiple Based Relative Valuation (Illustrative)

EV/Sales Multiple Based Relative Valuation (Source: Refinitiv, Thomson Reuters)

Note: All forecasted figures and peers have been taken from Thomson Reuters, NTM-Next Twelve Months

A-VIX vs CIM (Source: Refinitiv, Thomson Reuters)

Stock Recommendation: The stock posted 3-month and 6-month negative returns of ~28.31% and ~17.48%, respectively. It is currently trading below the average of the 52-week high price of $28.720 and the 52-week low price of $17.320, implying an accumulation opportunity. The stock outperformed the market volatility index in the recent trading sessions driven by series of new contract wins. We have valued the stock using the EV/Sales multiple based illustrative relative valuation method and arrived at a target price of low double-digit upside (in percentage terms). We believe that the stock might trade at a premium as compared to its peer median EV/Sales (NTM Trading multiple) citing the recent fund raising of $1.3 bonds, rating upgrade by S&P, and new contract from Transport for New South Wales that unlocks revenue potential of $1.5 billion. For this purpose, we have taken peers such as Monadelphous Group Ltd. (ASX: MND), Lycopodium Ltd. (ASX: LYL), Johns Lyng Group Ltd. (ASX: JLG), to name a few. Considering robust order backlogs of $30.1 billion, adequate liquidity, funding flexibility, valuation, and current trading levels, we give a “Buy” recommendation on the stock at the current market price of $17.960, up by 1.240% on 12th April 2021. 

2. Service Stream Limited (Recommendation: Buy, Potential Upside: Low Double-Digit)

(M-cap: A$ 438.44 Million, Annual Dividend Yield: ~7.07%)

Utilities Drove the FY20 Results: Service Stream Limited (ASX: SSM) provides installation, construction, and maintenance of telecommunication facilities. Besides, it also provides infrastructure management services to utilities. The company’s utility segment is resilient to COVID-19 attacks with 45.3% growth in top-line in FY20. Telecommunications, being the essential services, declined by 7.7% over pcp due to the sale of nbn D&C operations. Its long-term nature of operations and maintenance contracts provided relief during the pandemic. The newly acquired Comdain Infrastructure business added utility revenues of $288.1 million in FY20. It had a strong pipeline of gas and water utility projects to support growth going forward. EBITDA margin improved to 11.5% in FY20 (vs. 11.0% in FY19) as both telecommunications and utility segment posted an increase in EBITDA.

Its H1 FY21 results showed telecommunication revenue was affected to the extent of 29.5% because of a reduction in activation volumes (particularly in the wireless division). However, SSM able to renew three major contracts in the telecommunication segment for a maximum of eight years. Comdain Infrastructure continues to support its utility segment, partially offsetting the COVID-19 impacts on metering services. Overall EBITDA declined by 31.6% on YoY as both segments registered a decline in EBITDA from operations. SSM refinanced debt facilities for a 3-year term to November 2023 and borrowings increased to $275 million. Net cash turned positive to $10.5 million as of December 2020.

Outlook: SSM is expecting COVID-19 to continue to have a lingering effect on H2 FY21 profitability. Delays in client procurement programs and shortages of client-supplied materials may affect the FY21 results. The recently announced telecom upgrade program of $4.5 billion to underpin growth in H2 FY21.

Valuation Methodology: EV/Sales Multiple Based Relative Valuation (Illustrative)

EV/Sales Multiple Based Relative Valuation (Source: Refinitiv, Thomson Reuters)

Note: All forecasted figures and peers have been taken from Thomson Reuters, NTM-Next Twelve Months

A-VIX vs SSM (Source: Refinitiv, Thomson Reuters)

Stock Recommendation: The stock posted negative 3-month and 6-month returns of ~36.53% and ~50.93%, respectively. It is currently trading below the average of the 52-week high price of $1.025 and the 52-week low price of $2.470. The stock slightly underperformed the market volatility index. We have valued the stock using the EV/Sales multiple based illustrative relative valuation method and arrived at a target price of low double-digit upside (in percentage terms). We believe that the stock might trade at a discount compared to its peer average EV/Sales (NTM Trading multiple) as the management expects the ongoing pandemic to continue to impact the H2 FY21 profitability. The company’s Telecommunication and Utility segment is heavily influenced by macroeconomic swings and regulatory policies. For this purpose, we have taken peers such as MAAS Group Holdings Ltd. (ASX: MGH), Southern Cross Electrical Engineering Ltd. (ASX: SXE), NRW Holdings Ltd. (ASX: NWH), to name a few. Considering the synergies from recent acquisitions, cash position, valuation, and current trading levels, we give a “Buy” recommendation on the stock at the current market price of $1.060, down by 0.935% on 12th April 2021. 

3. Southern Cross Media Group Limited (Recommendation: Buy, Potential Upside: Low Double Digit)

(M-cap: A$ 538.99 Million, Annual Dividend Yield: 13.88%)

Digital Audio to Show Strong Momentum: Southern Cross Media Group Limited (ASX: SXL) is a broadcasting and publishing company. It operates regional radio and television stations in Australia, as well as publishes community newspapers in the United States. Stage 4 restrictions in Melbourne severely affected revenues, with Melbourne accounted for 12%-13% of the group’s revenues in FY20. Auto dealers and restaurants showed a weak advertising trend in Q4 FY20. Investment in digital audio assets is increasing with rising revenue momentum (podcast and instream ad revenues). The acquisition of Redwave Media helped to expand the national network to 99 stations. EBITDA plunged by 35.1% in FY20 even with lower operating expenses. SXL suspended dividends for FY21 and may resume paying it in FY22.

Strong performance by digital audio segment with revenues was up by 59% in H1 FY21 over pcp. Ad revenues showed an improved trend. The company launched LiSTNR and digital-first audio operating model in Australia during the period. Number of Australians accessing digital audio to reach 80% by 2024. SXL is expecting to increase the reach of 7.5 million audiences through LiSTNR. The company had committed investment of $5 million in H2 FY21 towards the initial launch of the platform. SXL is expecting a 2-3 year investment horizon to achieve growth. Through cost initiatives, SXL reduced group expenses by 23.6%. Nevertheless, EBITDA declined by 44.3% in H1 FY21 over pcp. Net debt reduced to $66 million following the repayment of $100 million debt. The leverage ratio dropped to 0.59x as of December 2020 (vs. 1.24x in June 2020).

Outlook: SXL is expecting Q3 FY21 revenue growth of -6% to -8%. The company expects a full-year capex of $15 million and cost guidance of 30% of revenue. Financing costs for 2H FY21 to be lower than H1 by $2 million due to reduction in debt and improvement in swap rates.

Valuation Methodology: EV/Sales Multiple Based Relative Valuation (Illustrative) 

EV/Sales Multiple Based Relative Valuation (Source: Refinitiv, Thomson Reuters)

Note: All forecasted figures and peers have been taken from Thomson Reuters, NTM-Next Twelve Months

A-VIX vs SXL (Source: Refinitiv, Thomson Reuters)

Stock Recommendation: The stock posted 3-month and 6-month returns of ~-12.17% and ~+20.30%, respectively. It is currently trading slightly below the average of the 52-week high price of $2.920 and the 52-week low price of $1.050. The stock performed well over the market volatility index. We have valued the stock using the EV/Sales multiple based illustrative relative valuation method and arrived at a target price of low double-digit upside (in percentage terms).  We believe that the stock might trade at a discount as compared to its peer median EV/Sales (NTM Trading multiple) as the management is expecting Q3 FY21 revenue to de-grew. The company’s audio and video segment to continue to be impacted by disruptions caused by the pandemic. For this purpose, we have taken peers such as HT&E Ltd. (ASX: HT1), Enero Group Ltd. (ASX: EGG), Nine Entertainment Co Holdings Ltd. (ASX: NEC), to name a few. Considering the robust growth in the digital audio business, adequate capitalization with lower debt levels, we give a “Buy” recommendation on the stock at the current market price of $1.980, down by 2.942% on 12th April 2021.

4. IPH Limited (Recommendation: Hold, Potential Upside: Low Double Digit)

(M-cap: A$ 1.56 Billion, Annual Dividend Yield: 4.03%)

Resilient Business Model Supported By Acquisitions: IPH Limited (ASX: IPH) provides copyrights protection, commercialisation, enforcement, and management of intellectual property in Australia, New Zealand, Papua New Guinea, the Pacific Islands, and Asia. IPH maintains the number one position in the patent protection business in Australia, New Zealand, and Singapore. It had integrated Watermark business into its subsidiary, Griffith Hack, and divested Glasshouse Advisory practice during FY20.  Australia and New Zealand IP and Asia IP business showed strong traction in FY20 over pcp. EBITDA margin expansion is visibly seen in Asia IP and corporate business verticals. The scale benefits and geographic diversification aided IPH to post resilient performance in FY20. Its Xenith business achieved synergies of $3.5 million in FY20.

H1 FY21 revenues showed marginal growth as the Melbourne lockdown affected Griffith Hack business. Filings from the US clients have declined by 1.3% YoY. Patent filings declined by 5.7% in Australia (excluding patent innovation). IPH completed the acquisition of Baldwins through its subsidiary, AJ Park. EBITDA margin improved from year-ago levels of 31.7% to 32.3% in H1 FY21. It had repaid $32.7 million debt in H1 FY21 with a leverage ratio reached 0.6x. Cash flows were supportive for dividend distribution. IPH achieved a strong cash conversion of 105%.

Outlook: IPH is on track to deliver $2 million synergies from Griffith Hack and Watermark integration. Its Baldwins acquisition is slated to contribute EBITDA of $2-2.5 million (for eight months period).

Valuation Methodology: P/E Multiple Based Relative Valuation (Illustrative)

P/E Multiple Based Relative Valuation (Source: Refinitiv, Thomson Reuters)

Note: All forecasted figures and peers have been taken from Thomson Reuters, NTM-Next Twelve Months

A-VIX vs IPH (Source: Refinitiv, Thomson Reuters)

Stock Recommendation: The stock posted 3-month and 6-month returns of ~+19.19% and ~-0.485%, respectively. It is currently trading slightly below the average of the 52-week high price of $8.750 and the 52-week low price of $5.770. The stock performed well over the market volatility index, citing the resilient business model. We have valued the stock using the Price/Earnings multiple based illustrative relative valuation method and arrived at a target price of low double-digit upside (in percentage terms).  We believe that the stock might trade at a premium as compared to its peer average Price/Earnings (NTM Trading multiple), considering the sizeable synergies from the recently acquired business to boost profitability in the near term. For this purpose, we have taken peers such as ALS Ltd. (ASX: ALQ), Countplus Ltd. (ASX: CUP), Kelly Partners Group Holdings Ltd. (ASX: KPG), to name a few. Considering the leadership position in the patent business, adequate geographic diversification, adequate liquidity, and moderate debt levels, we give a “Hold” recommendation on the stock at the current market price of $7.190 as on 12th April 2021.

Comparative Price Chart (Source: Refinitiv, Thomson Reuters)

Note: 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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