I. Sector Landscape and Outlook 

The Industrial sector covers several sub-sectors and broadly houses logistics, transportation, infrastructure, and engineering and construction. Due to the essential nature, the sector is considered as a cornerstone of economic development. The resurgence of e-commerce sales drove the sector during the peak of the pandemic. Australia, being a leader in worldwide exports of iron ore, showed strong trade performance contributing to the industrial sector growth. The government’s ambitious $110 billion budget is expected to boost the transportation and infrastructure sector in Australia. The Roads of Strategic Importance has received financial support from the government worth $4.6 billion to support regional businesses’ connectivity to local and international markets.

Favourable GVA boosted the construction and transportation industry: The economy has shown recovery with a rise in Gross Value Added (GVA) in 17 out of 19 industries in the December 2020 quarter. The Industrial sector rebounded with an increase in output of construction, wholesale and retail trade, and transportation. Strong grain harvest benefited the Agriculture industry which drove demand for transportation of agricultural produce. As indicated in Figure 1, the GVA of the construction industry increased by 0.3% in December 2020 quarter, followed by Wholesale trade with +3.6%, Retail trade industry by +3.7%, and Transport, Postal, and Warehousing industry grew by 6.1% in the December 2020 quarter (on Q-o-Q basis).

Figure 1. Growth in Output Covering Core Sectors in Industrials:

Government investment to drive growth and jobs: The government’s 10-year transport infrastructure investment pipeline of $110 billion is anticipated to drive 100,000 new jobs on worksites in Australia. In addition, the government has decided to finance $14 billion in fresh and fast-tracked infrastructure projects over the next 4 years, which will add 40,000 new jobs.

Fast-track projects to create jobs: The government has opened an additional $3 billion shovel-ready projects to drive further job creation and economic recovery. This includes $2 billion for small-scale road safety projects and an additional $1 billion for the Local Roads and Community Infrastructure Program, in addition to the $500 million already announced earlier. These initiatives are expected to drive ~10,000 jobs over the next 2 years.

Figure 2. Investment Pipeline in Infrastructure Sphere:

Data Source: Commonwealth of Australia 2020-21 Budget, Table Created by Kalkine Group

Lifting construction ban drove the sector: Due to Covid-19, the Industrial sector was under pressure to realize optimal productivity in the construction and transportation sector. Businesses in these sectors are labour-intensive and require skilled resource to achieve the targeted results. The construction work done fell by 0.9% to $51,170.6 million in the quarter ended December 2020, led by a 2.8% fall in engineering work to $21,796.6 million, and is 0.3% lower than last year. However, building work done increased 0.6% to $29,373.9 million but is 2.2% lower than last year. The rise in buildings was driven by residential building work done, which increased by 2.7% in the December quarter, but non-residential building work declined by 2.4% and is 4.5% lower than last year.

Figure 3. 5-Year Trend Showing Construction Work Done in Australia:

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

Export exceeds import driving international trade: The country reported a 2% increase in export to $32,113 million in February 2021 driven by an increase of 38% in non-ferrous metals to $298 million, followed by the rise of 39% in meat to $291 million, petroleum increased by 28% to $184 million, coal increased by 5% to $163 million, cereals increased by 14% to $159 million, and textile fibres increased by 112% to $158 million, while metalliferous ores declined by 6% to $833 million, gas fell by 7% to $200 million.

Imports of goods in February 2021 increased by 2% to $23,437 million driven by increase in road vehicles by 24% to $705 million, transport equipment up by 57% to $164 million, articles of apparel up by 16% to $131 million, and fertilisers up by 88% to $117 million, while telecommunications and sound equipment down by 27% to $414 million and medicinal and pharmaceutical products down by 11% to $120 million.

Figure 4. Trend in export and import over 12 months:

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

Surface transport above pre-Covid levels: Road and rail freight were resilient to travel as other sectors. As per the Bureau of Infrastructure, Transport and Regional Economics (BITRE) evaluations that of national vehicle kilometres travelled (VKT) driven by GPS-probe data, heavy vehicle VKT did not fell phenomenally during the COVID-19 phase and is currently evaluated to be above pre-COVID-19 levels. Transurban toll road data between December 2019 and July 2020 indicates that truck activity on Sydney toll roads did not fell phenomenally, despite a substantial drop and gradual recovery for car activity. This indicates that road freight is resilient to the pandemic, and the important role it plays to keep the supply-demand balanced.

Similarly, the Australian Rail Track Corporation reported a rise of ~13% in the national rail network driven by the rise in consumer demand. Extra rail freight services operating across the Sydney network to meet the demand for essential supplies and exports, using infrastructure freed up by cutting commuter services in peak time. According to The Department of Infrastructure, Transport, Regional Development and Communications, rail, and roadways dominate the transportation sector in Australia with tonne-kilometre by rail to reach 514.1 billion and road at 337.4 billion by 2040.

Figure 5. Actual and projected domestic freight (billion tonne kilometre (tkm))

Data Source: Department of Infrastructure, Transport, Regional Development and Communications, Chart Created by Kalkine Group

E-Commerce to Drive the Change: E-commerce sales are picking momentum very quickly around the world. As per Freight Australia, e-commerce sales in the world are expected to reach 40% by 2026 (from 10% in 2018). Online grocery shopping and delivery is possibly the norm in the future, which open the door for round-the-clock business, on-demand delivery, better quality, environmental, social, and ethical impacts of products, transparent supply chains, new approaches to urban planning, design, and mobility, innovations in first and last-mile deliveries, distribution and collection, and improved visibility.

Index Performance:

The ASX 200 Industrials (GIC) Index generated a 10-year return of ~53.94% as compared to ~38.22% by the ASX 200 Index. The economic growth, rise in trade in the domestic and international markets, and government initiatives for future growth, among other factors, resulted in a robust index returns.

Figure 6: S&P/ASX 200 Industrials (GIC) outperformed S&P/ASX 200 Index by ~15.72% in 10 years:

Source: Refinitiv (Thomson Reuters) as on the close of 1 April 2021

Key Risks and Challenges:

The Industrial sector largely relies upon the trade movement for growth in transportation. The ongoing trade wars with China and geopolitical tensions may cripple exports and import movements. The construction sector is dependent on the government’s thrust in infrastructure programs. The pandemic delayed the project execution which had risked the survival of many companies in the sector. Consumer spending and affordability drive the residential building construction which may be affected by the expiry of various government programs such as Jobskeeper Plan, The HomeBuilder Scheme, etc. The inflation risks and interest rate directly impact the sector which is highly dependent on capital requirements for the execution of projects. Fundraising complications and low bond yield may invariably affect the investments into projects.

Figure 7. Key Risks in the Industrial Sector:

Sources: Analysis by Kalkine Group

Outlook:

Investments in national infrastructure are considered a top priority by the government as laid down in the roadmap. There are 44 new infrastructure proposals with a $59 billion pipeline of nationally significant investment opportunities. The themes revolve around, developing gateways to support international competitiveness, investment in new sources of energy, water security, regional infrastructure that drives economic development, service quality, digital connectivity, and digital health services. Australia’s freight task is expected to grow by over 35% between 2018 and 2040, an increase of 270 billion tonnes (cumulating the total volume of ~1,000 billion tonnes), as per Freight Australia.

II. Investment theme and stocks under discussion (MND, ALX, QUB, AZJ)

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’ method.

1. ASX: MND (Monadelphous Group Limited)

(Recommendation: Buy, Potential Upside: Low Double-Digit, Mcap: A$985.51 Million)

MND operates as an engineering company, providing construction, maintenance, and industrial services to the Australian resources, energy, and infrastructure sectors. 

Valuation

Our illustrative valuation model suggests that stock has a potential upside of 23.54% on 1 April 2021. We believe that the stock might trade at a slight discount as compared to its peer median EV/Sales (NTM Trading multiple) considering its sizeable exposure to large projects for engineering and construction which are sensitive to economic swings and supply-chain delays may distort the cash flows. For the said purposes, we have taken peers such as Lycopodium Ltd. (ASX: LYL), Service Stream Ltd. (ASX: SSM), NRW Holdings Ltd. (ASX: NWH). The stock delivered annualized dividend yield of 3.48%.

2. ASX: ALX (Atlas Arteria)

(Recommendation: Buy, Potential Upside: Low Double-Digit, Mcap: A$5.70 Billion)

ALX is an operator of private toll roads and infrastructure developer with projects in highways, roads, bridges, and tunnels.

Valuation

Our illustrative valuation model suggests that stock has a potential upside of 19.61% on 1 April 2021. We believe that the stock might trade at a discount as compared to its peer average EV/Sales (NTM Trading multiple) considering the impairment effects and restructuring at its Germany operations which will have a lingering effect on profitability. In addition, the stock has been trading at premium valuation multiples compared to its peers historically, which may subside given the challenges. For the said purposes, we have taken peers such as Sydney Airport Holdings Pty Ltd. (ASX: SYD), Qube Holdings Ltd. (ASX: QUB), Transurban Group (ASX: TCL). The stock delivered annualized dividend yield of 4.04%. 

3. ASX: QUB (Qube Holdings Limited)

 (Recommendation: Hold, Potential Upside: Low Double-Digit, Mcap: A$5.68 Billion)

QUB is a logistics solutions provider with Operating Division, Infrastructure & Property and Patrick as its business segments.

Valuation

Our illustrative valuation model suggests that stock has a potential upside of 17.77% on 1 April 2021. We believe that the stock might trade at a slight premium as compared to its peer median EV/Sales (NTM Trading multiple) considering the resilient busines model and share issuances under its Dividend Reinvestment Plan. For the said purposes, we have taken peers such as Transurban Group (ASX: TCL), Dalrymple Bay Infrastructure Ltd. (ASX: DBI), Sydney Airport Holdings Pty Ltd. (ASX: SYD). The stock delivered annualized dividend yield of 1.61%.  

4. ASX: AZJ (Aurizon Holdings Limited)

(Recommendation: Hold, Potential Upside: Low Double-Digit, Mcap: A$7.17 Billion)

AZJ is as a rail-based transport operator providing coal, bulk, and general freight haulage services in Australia.

Valuation

Our illustrative valuation model suggests that stock has a potential upside of 18.10% on 1 April 2021. We believe that the stock might trade at a discount as compared to its peer median EV/Sales (NTM Trading multiple) as the management downwardly revised projects for FY21 coal volumes citing tough market conditions in China and its network operations may show under-recovery of revenues. For the said purposes, we have taken peers such as Lindsay Australia Ltd. (ASX: LAU), Atlas Arteria Group (ASX: ALX), Transurban Group (ASX: TCL). The stock delivered annualized dividend yield of 7.27%.  

Note: All the recommendations and the calculations are based on the closing price of 1 April 2021. The financial information has been retrieved from the respective company’s website and Refinitiv (Thomson Reuters).

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