Australia’s improved capital expenditure statistics across both the private and public sectors bestowed support to engineering and construction activities. For the March 2021 quarter, work done for the private sector rose by 1.8% on a sequential basis, stood at ~$13.40 billion, and an astonishing +3.6% on a PcP basis, according to The Australian Bureau of Statistics. With the diversion of funds toward COVID-19 recovery, work done for the public sector declined by 1.8% on a sequential basis, stood at ~$8.34 billion, and -6.3% on a PcP basis. The value of total construction work done inclined by 2.4% and value of total building work done inclined by 2.5% on a sequential basis. On an aggregate front, total work done in engineering construction grew to $21.75 billion, up by 0.4% on a sequential basis.
Figure 1: Total Work Done in Engineering Construction:
Source: Australian Bureau of Statistics, Analysis by Kalkine Group
The Supply Chain Resilience Initiative (SCRI) contributed $107.2 million towards hostile disruptions caused during the onset of the COVID-19 pandemic across the economy, which shall enable a sustainable demand and supply equilibrium. As proposed in the FY22 budget, the government plans an investment of $7.5 billion on transport infrastructure projects across the economy. Total government infrastructure funding surged to ~$57.17 billion in FY20, relative to ~$45.24 billion in FY19.
In June 2020, the government 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. The Asset Recycling Initiative has contributed circa $3 billion in funding to monetize existing public assets via sale or lease to the private sector, with proceeds reinvested in new infrastructure projects. Moreover, the M12 Motorway falls under the high priority project list to suspend support to Western Sydney's growing population and connectivity requirements. The benefit-cost ratio of the project stands at 1.8x with a net present value of ~$1.17 billion at a 7% real discount rate.
Figure 2: Surge in Total Committed Government Infrastructure Funding:
Source: Infrastructure Partnerships Australia, Analysis by Kalkine Group
Construction and Building activities are expected to outreach the pre-COVID pace. As reported by the Australian Bureau of Statistics, the Residential Property Price Index (RPPI 8 caps) surged to 5.4% on a sequential basis. 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% QoQ. For the March 2021 quarter, the total value of residential work done increased by 4.2% on a PcP basis and stood at ~$18.96 billion. On the contrary, the total value of building work done declined by 1.8% and stood at ~$30.19 billion.
For the December 2020 quarter, total commenced dwelling units surged to 51,055 a 19.4% PcP surge, primarily driven by an increase in new private-sector houses, standing at 33,761 units (up 35.7% PcP), and partially offset by a decrease in other new residential buildings in the private sector, standing at 16,049 units (down 6.7% PcP).
Figure 3: Total Value of Building Work Done – Segregated into Residential and Non-Residential:
Source: Australian Bureau of Statistics, Analysis by Kalkine Group
The Australian government has heavily invested in road and rail infrastructure to enhance transport access, safety, and efficiency. For instance, $405 million investment in Northern Road in New South Wales and $274 million for North East Link in Victoria. Top 2020 developments include approval of 163 projects under the Building Better Regions Program, management of a $100 billion infrastructure pipeline that encompasses NorthLink, Midland Highway Upgrade, Monaro Highway Upgrade, and Monash Freeway Stage 2. Furthermore, the approval of 2,294 projects under the Stronger Communities Programme represents $21.3 million in expenditure.
The Australian government’s administered assets inclined by $10.7 billion in 2020, contributing to $1.0 billion equity payments to asset portfolio entities, including Australian Rail Track Corporation. Despite COVID-19 and Bushfire constraints in FY20, the Australian government supported the movement of freight and people via $5.342 billion infrastructure investment in road and $1.057 billion in rail infrastructure. In partnership with private sector investors, the Australian government braced the funding of Inland Rail between Melbourne and Brisbane with $425.7 million in equity and $28.3 million in grants.
Figure 4: Major Infrastructure Projects Underway with Extensive Government Aid:
Source: Department of Infrastructure, Transport, Regional Development and Communications (DITRDC), Analysis by Kalkine Group
Figure 5: Key Risks and Challenges:
Source: Analysis by Kalkine Group
Although the government has dispensed lucrative support via Supply Chain Resilience Initiative (SCRI), the supply chain disruptions stay intact. Ambiguity across delta-variant and the potential resurgence of COVID-19 may derange infrastructure operations. During various business cycles, Australia often faced a shortage in skills and labor due to labor immobility. Australia's engineering and construction industry may face mounting risks from concurrent changes in technology, and structural shifts post COVID-19. The federal government executes a key role in funding and catalyzing infrastructure investment but assumes no control over project management and driving projects to completion, which creates skills shortages, price bubbles, and other substantial risks.
Outlook
As per a post-COVID report from Infrastructure Australia, the commute is on recovery with semi-permanent changes to mode choice and WFH with freight getting expensive with an increase in last-mile deliveries. COVID-19 pandemic eroded $5 billion in construction and building projects with recovery expectations to pre-COVID levels by FY23. The government's smart initiative of $80 million investment into a new Traffic Management System may improve traffic controls and reduce journey time. The Department of Infrastructure, Transport, Regional Development and Communications (DITRDC) administered an Infrastructure Investment Program which forms a considerable contribution to the government's $110 billion rolling infrastructure plan spreading across a span of 10 years from FY21. Total government infrastructure funding surged to ~$57.2 billion in FY20, relative to ~$45.2 billion in FY19, and forecasts a staggering rise to ~$58.9 billion in FY21 and ~$55.7 billion in FY22. Considering the improvement in the Australia’s engineering and construction activities, we have figured out 4 stocks on ASX that are set to see the momentum.
(1) Lendlease Group (Recommendation: Buy, Potential Upside: Low Double-Digit)
(M-cap: A$ 7.62 billion, Annual Dividend Yield: 1.64%)
Strong Pipeline Riding on Fast-Pace Recovery from Pandemic: Lendlease Group (ASX: LLC) is involved in infrastructure development of commercial buildings & apartments, construction services and investment management. In FY20, LLC reported a loss after tax of $310 million relative to a profit after tax of $467 million in FY19. Amidst COVID-19 turmoil, LLC faced delays in urbanization projects, mandatory site shutdowns and valuation declines in an investment portfolio. As a result, operating EBITDA from core activities declined by 62% and stood at $563 million. However, cash conversion stood resilient at 175% despite the challenging scenario, magnifying the closing cash balance from $1.29 billion in FY19 to $1.562 billion in FY20.
In H1FY21, segment EBITDA declined by 21% and stood at $469 million; however, it considerably improved from the H2FY20 figure of $126 million. EBITDA margins improved to 3% from 2.3% in H1FY20. Partial relief from lower net debt leads to a 12% decline in finance costs. LLC holds a development pipeline of $110 billion with a $12.2 billion work in progress. H1FY21 production stood at $1.8 billion, including Two Melbourne Quarter (~51,000 sqm), 440 residential for sale settlements, apartments for sale in Chicago and 1,043 communities’ settlements in Australia.
Outlook: LLC aims to convert $20 billion of development pipeline by the end of FY23. Revenue backlog in construction remains to be $14.5 billion, $11.8 billion represented from external clients. The urbanization pipeline is estimated to build $50 billion institution-grade assets, translating to over 2x of the current $38 billion of funds under management.
Valuation Methodology: Price/Book Value Multiple Based Relative Valuation (Illustrative)
A-VIX vs LLC (Source: REFINITIV)
Stock Recommendation: Over the last month, the stock of LLC went down by ~12.559%. The stock made a 52-weeks’ low and high of $10.370 and $14.890, 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 (in percentage terms). However, we believe that the company may trade at a slight discount compared to its peer's average, considering project delays, potential labour immobility and valuation declines. For this purpose, we have taken peers such as GPT Group (ASX: GRT), Mirvac Group (ASX: MGR), Goodman Group (ASX: GMG), to name a few. Considering the robust development pipeline and scope of urbanization pipeline to boost funds under management, the current trading levels, and valuation, we give a ‘Buy’ rating on the stock at the closing price of $11.070 as of 5 July 2021.
(2) CSR Limited (Recommendation: Buy, Potential Upside: Low Double-Digit)
(M-cap: A$ 2.74 billion, Annual Dividend Yield: 6.44%)
Eroded Top-Line Balanced by Higher Operational Efficiency: CSR Limited (ASX: CSR) is involved in building products to construct homes and commercial buildings in Australia and New Zealand. In FY21, revenue declined to $2,122.4 million (-4% YoY) due to the first half's slowdown in residential construction activities. However, material cost-saving strategies, for instance, reduced SG&A expenses by $31 million, growth in building products and increased property earnings led to a 10% increase in EBIT, which stood at $237.9 million.
In FY21, Net cash position surged to $134 million in FY20 relative to $95 million in FY19, followed by $272 million in operating cash flows and $101 million property proceeds (net of capex), partially offset by capex, statutory fulfilments and dividend payments. However, building products segment revenue declined by 4% and stood at $1.5 billion in consequence of masonry & insulation down 4%, interior systems down 3% and construction systems down 3%.
Outlook: Detached market is expected to represent 54% of building products’ revenue backed by HomeBuilder commencements. Medium-density markets are expected to be more robust relative to high rise markets following a sequential decline in high rise approvals. Alterations and Additions segment shall deliver strong retail performance complemented by renovation projects. Horsley Park site holds $146 million in sale proceeds contracted for three years.
Valuation Methodology: EV/Sales Multiple Based Relative Valuation (Illustrative)
A-VIX vs CSR (Source: REFINITIV)
Stock Recommendation: Over the last month, the stock of CSR went down by ~5.351%. The stock made a 52-weeks’ low and high of $3.360 and $6.480, respectively. The stock overperformed 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 (in percentage terms). Moreover, we believe that the company may trade at a slight premium compared to its peer's average, considering higher operational efficiency and favourable cash position. For this purpose, we have taken peers such as Adbri Ltd (ASX: ABC), Brickworks Ltd (ASX: BKW), Boral Ltd (ASX: BLD), to name a few. Considering the favourable impact of HomeBuilder commencements, rise of medium density markets, and future cash flow from the Horsley Park site, we give a ‘Buy’ rating on the stock at the closing price of $5.660, up by ~0.176% as on 5 July 2021.
(3) GDI Property Group (Recommendation: Hold, Potential Upside: Low Double-Digit)
(M-cap: A$ 617.86 million, Annual Dividend Yield: 6.88%)
Improved Leasing Structure to Strike Outperformance: GDI Property Group Limited (ASX: GDI) manages properties and funds management. In FY20, total revenue from ordinary activities declined from ~$77.81 million in FY19 to ~$70.29 million. Subsequently, net profit from continued operations declined to ~$66.74 million from ~$85.07 million in FY19. During the period, GDI purchased a $98 million portfolio (fully leased) of metropolitan Perth properties occupied by service centres on major arterial roads and high-profile car dealerships.
In H1FY21, total FFO declined to $14.252 million relative to $23.811 million in H1FY20 due to COVID-19 related write-offs, departure of UGL from Westralia Square and high net interest expenses. Relative to H1FY20, total revenue declined to $26.037 million from $36.212, and PAT declined to $10.476 million from $59.546 million. Funds management FFO inclined to $3.7 million relative to $2.0 million in H1FY20, followed by distributions from office trust and property trust.
Outlook: Improved leasing structure of Westralia Square with level 11 leased for ten years to cash converters and level 12 wanders under agreement for 6.5 years lease, commencing in early 2022. A major tenant of 50 Cavill Ave extended for five years and expected to double occupancy. Developments on the funds' management front include two new leases of peripheral sites, a draft of a 3-year lease at Stanley Place, and an 8-year lease at 1 Adelaide Terrace.
Valuation Methodology: Price/Book Value Multiple Based Relative Valuation (Illustrative)
A-VIX vs GDI (Source: REFINITIV)
Stock Recommendation: Over the last month, the stock of GDI went down by ~0.881%. The stock made a 52-weeks’ low and high of $1.000 and $1.300, respectively. The stock overperformed 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 (in percentage terms). Moreover, we believe that the company may trade at a slight premium compared to its peer's average, considering improved occupancy and relatively sustainable flow flows from operations. For this purpose, we have taken peers such as GPT Group (ASX: GPT), Carindale Property Trust (ASX: CDP), ALE Property Group (ASX: LEP), to name a few. Considering the improved leasing structure with investment-grade counterparts and improved occupancy expectations, and growth strategy, we give a ‘Hold’ rating on the stock at the closing price of $1.125, down by ~1.316% as of 5 July 2021.
(4) Transurban Group (Recommendation: Hold, Potential Upside: Low Double-Digit)
(M-cap: A$ 39.12 billion, Annual Dividend Yield: 2.51%)
Short-term Financial Hits to Recover with Improving Daily Traffic: Transurban Group (ASX: TCL) is engaged in building, operating, and providing retail services for toll roads. In FY20, toll revenue declined to $2,492 million (down 3.4% YoY) due to an 8.6% decline in average daily traffic (ADT) amidst containment measures. EBITDA declined to $1,841 million from $1,996 million in FY19, primarily driven by decreased toll revenue and increased costs in strategic growth projects. EBITDA margins assumed a modest decline from 75.4% in FY19 to 72.3% in FY20, consequent to restrictions in movement mandates.
In H1FY21, toll revenue declined by 16.6% PcP and stood at $1,165 million, and subsequently, EBITDA declined by 23.2% PcP and stood at $840 million. ADT across all markets declined by 17.8%, while traffic volumes recovered in the period from 1.8 million in July to 2.1 million in December 2020. During the period, M8 and NorthConnex projects were completed, and M5 East commenced tolling. As a result, free cash conversion stays robust at 114% in H1FY21.
Recent Announcement: On 12 May 2021, TCL announced that WestConnex Group had priced $1.8 billion in senior secured notes. TCL owns 25.5% interest in WestConnex Group. TCL estimates to receive $280 million on a pro-rata basis.
Outlook: The company seems to be well-capitalized to participate in the opportunities in core markets. Further, the easing of restrictions and traffic recovery to pre-COVID levels augurs well for TCL, as it positions itself for growth. Progressive project pipeline holds 11 advanced projects, with three completed in FY20.
Valuation Methodology: Price/Book Value Multiple Based Relative Valuation (Illustrative)
A-VIX vs TCL (Source: REFINITIV)
Stock Recommendation: Over the last month, the stock of TCL went up by ~1.682%. The stock made a 52-weeks’ low and high of $12.360 and $15.635, respectively. The stock overperformed 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 (in percentage terms). However, we believe that the company may trade at a slight discount compared to its peer's average, considering slow recovery in average daily traffic and short-term disruption in fundamentals. For this purpose, we have taken peers such as Qube Holdings Ltd (ASX: QUB), Atlas Arteria Group (ASX: ALX), Sydney Airport Holdings Pty Ltd (ASX: SYD), to name a few. Considering the toll ready projects, easing restrictions and prudent capitalization, we give a ‘Hold’ rating on the stock at the closing price of $14.510, up by ~1.539% as of 5 July 2021.
Comparative Price Chart (Source: REFINITIV)
Note 1: The reference data in this report has been partly sourced from REFINITIV.
Note 2: Investment decisions should be made depending on investors’ appetite on upside potential, risks, holding duration, and any previous holdings. Investors can consider exiting from the stock of the Target Price mentioned as per the Valuation has been achieved and subject to factors discussed above.
Disclaimer - This report has been issued by Kalkine Pty Limited (ABN 34 154 808 312) (Australian financial services licence number 425376) (“Kalkine”) and prepared by Kalkine and its related bodies corporate authorised to provide general financial product advice. Kalkine.com.au and associated pages are published by Kalkine.
Any advice provided in this report is general advice only and does not take into account your objectives, financial situation or needs. You should therefore consider whether the advice is appropriate to your objectives, financial situation and needs before acting upon it.
There may be a Product Disclosure Statement, Information Statement or other offer document for the securities or other financial products referred to in Kalkine reports. You should obtain a copy of the relevant Product Disclosure Statement, Information Statement or offer document and consider the statement or document before making any decision about whether to acquire the security or product.
You should also seek advice from a financial adviser, stockbroker or other professional (including taxation and legal advice) as necessary before acting on any advice in this report or on the Kalkine website. Not all investments are appropriate for all people.
The information in this report and on the Kalkine website has been prepared from a wide variety of sources, which Kalkine, to the best of its knowledge and belief, considers accurate. Kalkine has made every effort to ensure the reliability of information contained in its reports, newsletters and websites. All information represents our views at the date of publication and may change without notice.
Kalkine does not guarantee the performance of, or returns on, any investment. To the extent permitted by law, Kalkine excludes all liability for any loss or damage arising from the use of this report, the Kalkine website and any information published on the Kalkine website (including any indirect or consequential loss, any data loss or data corruption). If the law prohibits this exclusion, Kalkine hereby limits its liability, to the extent permitted by law, to the resupply of services.
Please also read our Terms & Conditions and Financial Services Guide for further information.
On the date of publishing this report (referred to on the Kalkine website), employees and/or associates of Kalkine do not hold interests in any of the securities or other financial products covered on the Kalkine website.