We have successfully recommended Monadelphous Group (ASX:MND) shares in past editions of The Dynamic Investor. After a strong gain in the shares recently, we revisited the stock in our weekly reports. Does the recent re-rating have further momentum, or is it time for a breather?
About Monadelphous Group
Monadelphous Group provides construction, maintenance and industrial services to the resources, energy and infrastructure sectors and operates primarily in Australia. The Company operates through two key divisions: Engineering & Construction (‘E&C’) and Maintenance and Industrial Services (‘Maintenance’).
Key Fundamental Drivers
Contract Wins Continue
Aside from earnings results, MND shares tend to have a correlation with contract awards. Maintaining strong revenue growth in the E&C division is highly dependent on near-term contract wins in the iron ore and energy sectors. The outlook is supported by several favourable macro factors. These include: Higher production volumes expected to support sustaining capital and maintenance activity (in particular iron ore miners); ii) Strong ongoing demand for maintenance services in energy; and iii) A growing pipeline of renewable projects.
Further E&C contracts have been announced in FY25 to date, with the Company having secured $1.65b of work in FY25 to date. This figure is ahead of the same time last year ($1.1b in FY24). The recent contract wins provide upside to E&C revenue forecasts for FY25. Further, the recent contract wins are expected to more than offset the revenue headwind in FY25/26 from the termination of the Albemarle Kemerton project.
Market Concerns About Lower Iron Prices May Re-Surface
At the FY24 results release, the Company highlighted a robust pipeline across various commodity groups including iron ore. Iron ore makes up >25% of MND’s group revenue and ~40% for E&C. With ~$51b of iron ore opportunities to be handed out over the next decade, there is a buoyant pipeline of smaller construction work packages.
In our recent report, we highlighted how the decline in the iron ore price had heightened market concerns about a potential slowdown/deferral in iron ore construction activities. While the iron ore price has since largely remained stable, it is worth noting that market concerns about lower iron ore prices may re-surface. This is due to additional supply is expected to come online this calendar year and an increase in visible iron ore stockpiles at Chinese ports.
Notwithstanding the risk of declining iron ore prices, MND’s near-term iron ore opportunities relate to replacement and sustaining CAPEX. While the latter is not perfectly immune to iron ore price movements, the risk of significant deferral is meaningfully lower in comparison to larger iron ore construction opportunities.
Margins Expected to Expand
At the AGM update in November, the Company guided to expected continued margin improvement for FY25. This guidance was well received by the market given that MND typically does not provide margin commentary at AGM.
EBITDA margin expansion is expected to continue in FY25 on the back of: i) The lift in proportion of higher-margin E&C as percentage of revenue (on the back of recent contract wins), ii) Improved access to skilled labour pool in WA as a result of completion of large metropolitan infrastructure projects; and iii) A more disciplined approach to tenders and MND’s proven track record of project management.
While labour availability continues to remain a headwind, MND has noted that this has eased. Labour demand in Australia (in particular WA) is slowly improving with vacancies ~25% lower than peak levels in 2023.
Fundamental View
The re-rating in MND shares has lifted the 1-year forward P/E multiple to ~20x. This multiple is in line with the 2-year average of ~20x. MND shares have historically presented better value when its discount to its historical multiple has been large. The other key risk at this juncture is re-emerging market concerns about a weaker iron ore price (which impacted sentiment in September-October last year).
Charting View
We last looked at the Monadelphous chart on 3 December in The Dynamic Investor when it was trading at $13.02 and noted that it was breaking the downtrend and that it should start heading higher again. The shares have rallied well since that breakout. There have been consolidations along the way and this move appears sustainable. We may see a dip back under $15 in the short-term and that could provide investors with a buying opportunity.
Michael Gable is managing director of Fairmont Equities.
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