Monadelphous Group’s (ASX:MND) recent financial results have been marred by labour availability pressures over the past 24-30 months. Skilled labour shortages continue, costs are escalating and ongoing supply chain risks remain. On the other hand, the Company has continued its impressive track record of securing new contracts and work extensions.
With this in mind, we assess whether the risk/reward profile more appealing at current levels.
About Monadelphous Group
Monadelphous Group provides construction, maintenance and industrial services to the resources, energy and infrastructure sectors. It operates primarily in Australia, with smaller overseas operations in NZ, China, PNG, Mongolia and the US. The Company operates through two key divisions: Engineering & Construction (‘E&C’) and Maintenance and Industrial Services (‘Maintenance’).
Key Fundamental Drivers
Project Awards Gaining Momentum
The Company has won $780m of new E&C contracts over the first four three months of 1H24. Based on this rate, MND is already significantly outperforming the amount of contract wins in FY20 and FY21. In context, the amount of major contract wins secured in FY22 was $1.1b.
More recently, the Company secured the Stage 1 contract with Lynas Rare Earths for the structural, mechanical and piping works at its Mt Weld mine. This contract is one of the three near-term construction opportunities that MND had its eye on.
In terms of potential future contract wins, these include a project with Arafura Rare Earths, as well as a series of $50-100m upgrades for the iron ore miners.
New Work is Incremental to Revenue and Margin
Importantly, the contracts won are significant in terms of the incremental contribution to revenue for the E&C division over FY24 and FY25. In addition, there is potential further margin expansion.
Although only contributing 25% of group revenue, the E&C division has the potential to meaningfully increase group profit. It is estimated that EBITDA margins on maintenance contracts are 5-6%, but new E&C contracts can deliver well over 10%. This compares to an EBITDA margin of ~6% for the E&C division overall. While this usually involves fixed priced contracts, and therefore higher risk, MND has a very good track record of successfully delivering projects.
Maintenance Division Remains a Significant Value Driver
Aside from new contract wins in the E&C space, MND is securing additional maintenance work. At the FY23 results release in August, the Company alluded to continued growth in revenue for the Maintenance division. However, the magnitude of revenue growth is unclear. This is due to continuing skilled labour shortages, an escalating cost environment and potential ongoing supply chain risks. In addition, MND did not provide revenue growth guidance, thereby highlighting the uncertain revenue growth outlook.
Following an 11% increase in revenue growth for the Maintenance division in FY23, revenue growth in FY24 is expected to be around mid-single digit (in percentage terms).
Net Cash Position Provides Scope for Acquisitions
The balance sheet was in a net cash position of $177m as at 30 June 2023. This is slightly lower than the net cash position of $190m as at 31 December 2022. The strong balance sheet position, coupled with typically high levels of cash conversion (112% in FY23) have supported dividend payments. This has allowed the Company to maintain a dividend payout ratio of 70-90%.
In addition to maintaining dividend payment, MND may consider further small acquisitions to facilitate ongoing service expansion and market diversification. As an example, the Company announced in early October 2023 a small acquisition that allows MND to broaden its multi-disciplinary construction offering to include civil capability.
We highlight two factors supporting a cautious view on MND at current levels:
i. The shares are currently trading on a 1-year forward P/E multiple of ~21x, which is broadly in line with its 5-year average and above its 2-year average of ~17x. MND shares have historically presented better value when its discount has been larger. Accordingly, we consider lower levels to be a more attractive entry opportunity. In particular, a lower P/E multiple relative to it medium-term EPS growth profile of ~+14% would make the risk/reward profile more appealing.
ii. The potential for further contract wins is likely to be well received by the market However, this factor is negated by heightened concerns about the availability of labour (in light of skilled labour shortages) to service future contracts.
Having said that, a key catalyst for the shares is likely to be the release of FY24 guidance at the Company’s AGM on 21 November, noting that the Company’s revenue guidance is typically conservative.
When we reviewed MND in The Dynamic Investor on 20 October 2023, we commented that “MND is consolidating against the prior uptrend and once this consolidation is over, we should see further upside in the share price. A break above $14.30 would be the sign that it is going to trend higher again”. With this breakout having now occurred and MND now rallying, there is a risk that it continues to head higher from here. However, if it rejects this $15 level and falls quickly in the next few days, then that would be a negative sign. From a charting point of view, that could lead to a dip back near $14. In the event that happens, it would provide a better entry point for investors.
Michael Gable is managing director of Fairmont Equities.
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