With the resurgence of private capital expenditure, in consequence of favorable infrastructure and financial support, Australia is set to outreach pre-COVID levels. The total new capital expenditure has increased by an astounding 6.3% in March 2021 quarter and stood at $31.5 billion, wherein investments in buildings & structure, equipment & machinery have been the key driving factors, growing by 3.8% and 9.1%, respectively, in March 2021 quarter (on QoQ basis). The Australian Government’s introduction of full expensing and temporary loss carry-back policies in the FY21 budget have established a tax-favorable business environment for businesses which is further expected to harness a GDP boost of $2.5 billion in 2020-21. As shown below, non-mining capex showed a steep recovery, while mining consistently performing.

Figure 1.: The Fall and Rise of Total New Capital Expenditure:

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

Capital expenditure in equipment, plant, and machinery stood at $15.3 billion, up by 9.1% in March 2021 on a QoQ basis and it is estimated to reach $57.2 billion for FY21. The Morrison Government had set out a Modern Manufacturing Strategy, with estimated funding of $1.5 billion to reverse COVID-19 aftermath and establish a globally competitive manufacturing industry. Moreover, the Northern Territory government is expected to partner with AMGC in an investment of $8.75 million, spread over 5-years tenure, aiming to fast-track manufacturing projects, generate jobs, and facilitate the appropriate matching of co-investments.

The mining sector showed traction, with capex spend improved by 4.1% in March 2021 quarter to reach $8.8 billion (on QoQ). In March 2021 quarter, the OCE’s Resources and Energy Export Values Index improved by 11.8% on a pcp basis and subsequently OCE’s Resources and Energy Commodity Price Index improved by 18.5% followed by souring iron ore prices to nine-year highs. Iron ore prices uplifted in December 2020 from $US115/tonne to $US140/tonne, predominantly attributed to substantial increased China’s steel production, in turn, driven by COVID-19 related stimulus measures.

The construction sector posted a strong recovery with a 17.0% increase in capex spend in March 2021 quarter (on QoQ) aided by booming home prices. As per the Australian Bureau of Statistics, the Residential Property Price Index (RPPI 8 caps) surged by 3.0% on a QoQ basis and by 3.6% on a YoY basis in December 2020. Moreover, total construction completed in March 2021 quarter increased by 2.4% and stood at $51.98 billion, primarily driven by a surge in building construction by 2.5% on a quarterly basis. As proposed in the budget, the government plans an investment of $7.5 billion on transport infrastructure projects across the economy. In June 2020, the Government has collaborated with local governments, states, and territories to stimulate capital expenditure of $1.5 billion to fund $1 billion shovel-ready projects and $500 million for targeted road safety works.

Figure 2. Pick-up in Construction Activity:

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

Capex spent by the financial services sector showed a 17.6% growth in March 2021 quarter (on QoQ). Amidst the COVID-19 turmoil, banks successfully managed to increase their CET1 ratios by 100bps (as a whole), generating $16.9 billion in CET 1 capital. Cheap funding, enabled by Term Funding Facility (TFF) has curtailed the bank’s funding costs and equipped the bank’s liquidity. Under refinancing tasks, Banks have withdrawn a sizable $81 billion, with a facility to draw an additional $109 billion by June 2021, which may facilitate increased demand for loans, and, in turn, capital expenditure.

Key Risks: Although total expenditure manifested recovery from December 2020 quarter, it was trending downwards from March 2019 (pre-COVID era) until September 2020 quarter. With the present pandemic conditions in place, commodity markets have exhibited high volatility levels. Thus, considering the mining industry being a significant endogenous factor, capital expenditure is susceptible to swings in commodity markets. In line with a survey of the Australian Bureau of Statistics, 30% of businesses are currently undergoing supply chain disruptions with 37% significantly affected (major delays in material procurement and consequential impact on revenues). 

Figure 3. Key Risks Associated with Capital Expenditure:

Source: Analysis by Kalkine Group

Outlook: The Government’s Modern Manufacturing Strategy is expected to extend an infusion of $454.2 million and $587.4 million in FY22 and FY23, respectively. Further to this, the Australian Government’s 10-year infrastructure program is expected to infuse $110 billion investment, inclusive of $15.2 billion funding in new projects for FY22. As per the Australian Industry Group, Australian Purchasing Managers Index (PMI) climbed 1.8 points and stood at 61.7 points in April 2021, being the highest monthly reading since March 2018. Australia’s resource and energy exports for FY21 are estimated to hit a record at $296 billion, according to the Department of Industry, Science, Energy and Resources. Considering the improvement in capex covering mining, construction, and financial services, we have figured out 4 stocks on ASX that are set to see the momentum.

(1) Macmahon Holdings Limited (Recommendation: Buy, Potential Upside: Low Double-Digit)

(M-cap: A$ 420.22 Million, Annual Dividend Yield: 3.33%)

Revenue Growth Drives Record Fundamentals: Macmahon Holdings Limited (ASX: MAH) is a pioneering mining contractor engaged in facilitating Australian and Southeast Asian markets with mining services. During FY20, the company reported $1,380.4 million in revenues, up 25% on a YoY basis. During the same period, EBITDA stood at $238.7 million, up by 32% and NPAT stood at $69.2 million, up by 22% relative to FY19. The earnings and revenues were primarily driven by positive returns on executed projects, acquisition of GBF, and expanded client base.

In H1FY21, reported revenue stood at ~$652.5 million, down by 5% on pcp basis as a result of alterations in accounting treatment on specific client-provided consumable items at Batu Hijau. Nevertheless, EBITDA progressed to ~$121.2 million and up by 6% on pcp basis. MAH has held a strong liquidity position with improved net assets, from ~$497.8 million as of 30 June 2020 to ~$516.6 million as of 31 December 2020, while further extended and increased existing debt facility to ~$170 million from ~$75 million.

Outlook: With most recent developments in client base, for instance, being selected as mining contractor for Gwalia underground gold project, appointed as underground mining contractor at Gwalia, and selected as mining contractor for Dawson South mine, MAH remains positive. MAH seeks lucrative long-term growth prospects as a result of a current pipeline valued at ~$7.0 billion, along which ~$3 billion represents the new clients and ~$1.2 billion represents underground operations.

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

A-VIX vs MAH (Source: REFINITIV)

Stock Recommendation: Over the last month, the stock of MAH went up by ~2.63%. The stock made a 52-weeks’ low and high of $0.180 and $0.287, respectively. The stock 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 slight premium as compared to its peer median EV/Sales (NTM trading multiple) considering better liquidity position, ~$7 billion pipeline, and better competitive margins. We have taken peers like Capral Ltd (ASX: CAA), Perenti Global Ltd (ASX: PRN), Mount Gibson Iron Ltd (ASX: MGX), to name a few. Considering the decent performance in H1FY21, high margin operations, better liquidity position, and valuation, we give a ‘Buy’ rating on the stock at the current market price of $0.195 as of 31 May 2021.

(2) ALE Property Group (Recommendation: Buy, Potential Upside: Low Double-Digit)

(M-cap: A$ 893.81 Million, Annual Dividend Yield: 4.76%)

Favourable Macro Factors steering Top line growth: ALE Property Group (ASX: LEP) is involved in the business of owning freehold pub properties in Australia. During FY20, revenue from properties increased to ~$61.4 million, up 2.0% on pcp basis. The top-line improvements were primarily attributed to an average CPI rent increase of 1.7% on 43 properties and a full-year benefit of 10% increase on 36 properties. Further, distributable profits increased from ~$30.4 million in FY20, up 7.5% on a YoY basis, substantially resulting from reduced one-off rent review expenses. Further, the average yield has declined by 10 bps, on a YoY basis, in FY20 to 5.08%.

In H1FY21, the CPI increase of ~0.64% coupled with favourable impact of rent determination, reduced interest expense culminated in improved rent income by 2.16% on pcp basis. Moreover, NPAT has substantially increased to $68.1 million, up by 232% on pcp basis, predominantly affected by appreciated property values. On the contrary, the weighted average adopted yield has tightened by a drop of ~14 bps to 4.94% on pcp basis.

Outlook: ALE has announced distribution guidance of 21.50 cents per security, reflecting an improvement of 3% on a YoY basis, for FY21. To strengthen the liquidity position, LEP has entered into binding agreements with two Australian Banks for a bilateral loan facility of ~$100 million. Further, ALE has put together prudent risk management instruments with 100% of forecasted net debt being hedged for the coming 4.9 years. 

Valuation Methodology: Price/Book Value Multiple Based Relative Valuation (Illustrative) 

A-VIX vs LEP (Source: REFINITIV)

Stock Recommendation: Over the last month, the stock of LEP went down by ~0.45%. The stock made a 52-weeks’ low and high of $4.250 and $5.510, respectively. The stock underperformed the market volatility index. We have valued the stock using the Price/Book Value 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 slight discount as compared to its peer median Price/Book Value (NTM Trading multiple), considering high-interest rate uncertainties, no government relief from the pandemic, and rising operating costs. We have taken peers like Ingenia Communities Group (ASX: INA), Servcorp Ltd (ASX: SRV), Centuria Capital Group (ASX: CNI), to name a few. Considering the decent performance in H1FY21, stabilized yield, rising rent, and valuation, we give a ‘Buy’ rating on the stock at the current market price of $4.450, down by ~0.225% as of 31 May 2021. 

(3) IOOF Holdings Limited (Recommendation: Hold, Potential Upside: Low Double-Digit)

(M-cap: A$ 2.54 Billion, Annual Dividend Yield: 5.82%)

Market Volatilities Overseeing Fundamentals: IOOF Holdings Limited (ASX: IFL) operates in financial services, providing financial advice, portfolio & estate administration, and investment management products. During FY20, net operating revenue declined by 8.8%, primarily affected by diminution of net funds which in turn resulted in high market volatility and funds movement from higher-priced legacy & transition platforms to contemporary platforms with competitive fees. Moreover, PAT declined by 26.8% due to increased operating expenses in governance, additional risk management, and FTE compliance.

In H1FY21, gross margin improved by 40.7%, and PAT improved by 16.6% on pcp basis. This was primarily driven by the inclusion of ex-ANZ business in the period, partially offset by profitability decline across other segments. From a liquidity standpoint, IFL held ~$899.4 million as of on 31 December 2020 relative to ~$374.7 million on 30 June 2020. The improvement in cash position arose from equity raising activities and a share purchase plan to fund MLC acquisition.

Outlook: IFL has introduced Advice 2.0 aimed to attain long-term sustainability in the Advisor division for the better client experience. Moreover, the acquisition of ANZ’s OnePath Pansion and Investments (P&I) business and MLC acquisition will replicate in meaningful cost synergies. Almost 75% of all P&I businesses have been transferred to IFL.

Valuation Methodology: Price/Book Value Multiple Based Relative Valuation (Illustrative) 

A-VIX vs IFL (Source: REFINITIV)

Stock Recommendation: Over the last month, the stock of IFL went up ~8.22%. The stock made a 52-weeks’ low and high of $2.860 and $5.176, respectively. The stock outperformed the market volatility index. We have valued the stock using the Price/Book Value 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 slight premium as compared to its peer median Price/Book Value (NTM Trading multiple) considering its fast-paced expansion via inorganic growth and significant improvement in liquidity position. We have taken peers like Navigator Global Investments Ltd (ASX: NGI), Suncorp Group Ltd (ASX: SUN), Pacific Current Group Ltd (ASX: PAC), to name a few. Considering the improved cash position, rebound relative to FY20 KPIs, and valuation, we give a ‘Hold’ rating on the stock at the current market price of $3.950, up by ~0.765% as of 31 May 2021.

(4) Mirvac Group (Recommendation: Hold, Potential Upside: High Single-Digit)

(M-cap: A$ 11.06 Billion, Annual Dividend Yield: 2.79%)

NOI Growing at Faster Pace with Diversification Strategies in Pipeline: Mirvac Group (ASX: MGR) is a diversified property group with business segments encompassing Office & Industries, Retail and Residential & Corporate assets. For FY20, operating profits declined to ~$602 million, down by 5%, and EBIT declined to ~$796 million, down by 6% on pcp basis. The fundamentals were singlehandedly affected by market volatilities brought forward by the COVID-19 pandemic situation.

In H1FY21, MGR experienced significant improvements due to better market stability. Operating profits stood at ~$276 million, up by 10%, and EBIT increased to $364 million, up by 8% relative to H2FY20. The recent rebound is attributed to NOI growth in office & industrial and Retail segments, subsequently offset by a decrease in lot settlement in the residential segment and reduced corporate overheads in corporate & corporate & another segment. Adjusted funds for operation (AFFO) improved by 6% as compared to H2FY20.

Outlook: MGR seeks to stabilize earnings per share to range between 13.1 and 13.5 cents per share and consequently dividend per share to range between 9.6 and 9.8 cents per share. Further, MGR has got involved in a product diversification approach to meet customer preferences and hedge against market volatilities. MGR continues active capital management via restocking across different corridors and reducing completed unsold apartment stock. 

Valuation Methodology: Price/Book Value Multiple Based Relative Valuation (Illustrative) 

Stock Recommendation: Over the last month, the stock of MGR went up ~3.72%. The stock made a 52-weeks’ low and high of $2.010 and $2.890, respectively. The stock outperformed the market volatility index. We have valued the stock using the Price/Book Value 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 slight premium as compared to its peer median Price/Book Value (NTM Trading multiple) considering a dramatic rebound during COVID-19 stabilization and NOI growth in office & industrial and Retail segments. We have taken peers like LendLease Group (ASX: LLC), Stockland Corporation Ltd (ASX: SGP), Cedar Woods Properties Ltd (ASX: CWP), to name a few. Considering the improved performance in H1FY21 amidst COVID-19 stability, higher NOI growth, product diversification approach, and valuation, we give a ‘Hold’ rating on the stock at the current market price of $2.790, down 0.712% as on 31 May 2021. 

Comparative Price Chart (Source: REFINITIV)

Note 1: The reference data in this report has been partly sourced from REFINITIV.  

Note 2: 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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