We reviewed CIMIC Group (ASX:CIM) in early July in The Dynamic Investor and rated it as a buying opportunity. The share price is now 20 per cent higher and the company is trading ex-dividend. In light of this, it is worth revisiting the fundamental drivers and the share price chart to determine if there is more upside for the share price. (If you want to get in early with our best recommendations, then click here to sign up to an 8-week FREE trial of The Dynamic Investor)
Overview of CIMIC Group (ASX:CIM)
CIMIC Group is an infrastructure, mining, services and public private partnerships group. The Company has businesses in Construction (CPB Contractors and Leighton Asia), Mining and Mineral Processing (Thiess and Sedgman), operation and maintenance services (UGL), Public Private Partnerships (PPPs) and engineering. Overall, the macro environment remains very strong in CIM’s core markets across transport infrastructure and resources.
Key Growth Drivers for CIMIC
1. Key Divisions Performing Strongly
The major contributor to group revenue is the Construction division. Earnings growth in 1H18 (+11%) benefited from a ramp-up in major Australian transport infrastructure project development activity. Here we had earnings growth outstripping revenue growth as a result of a greater shift towards high-margin Construction work.
The next major contributor to group revenue is the Mining division. It had earnings growth in 1H18 (+27%) driven by growth in mine production activity and new contract awards as mining cycle momentum improves.
2. Margins Remain Elevated
EBIT margin across the core businesses for 1H18 remains close to FY17 levels. They do not appear to be showing any signs of weakening. Of the core businesses, the biggest expansion in EBIT margin appears to have come from the Services division. This is where CIM has had success in leveraging new higher-margin market segments.
Whilst there are some potential headwinds for EBIT margin in the Construction division in relation to controlling costs (i.e. labour shortages and a more concerted effort by the NSW Government to undertake a more collaborative approach with construction suppliers, including reduced bidding costs and better sharing of risk), the Company is confident that the measures that it has taken to mitigate this risk would minimise the impact on EBIT margin. In particular, the Company has entered into more JVs in recent years to reduce both the size and risk of individual projects. It has become more focused on pro-active in-contract management of costs and scope changes.
3. Work in Hand for Core Businesses Strengthening
The Company’s overall Work in Hand (WIH) balance increased from $34.6b in March 2018 to $34.8b as at 30 June 2018. Whilst the reduction in overall WIH is typically not ideal, it is worth noting that this is as a result of CIM’s reduced exposure to its Middle East operations. Hence, the key focus for the market in regards to WIH trends is the level for the Company’s core businesses (i.e. Construction, Mining & Mineral Processing, and Services) which comprise ~91% of overall WIH and are continuing to grow off the back of a strong pipeline and new work and contract extensions. To this end, it is worth noting that since early August 2018, CIM has won significant new contracts and contract extensions across each of its core businesses.
4. Surplus Capital Supports Merger & Acquisition Activity and Capital Management
CIM has recently had a strong balance sheet and typically generates strong free cashflow and has high cash conversion rates. The net cash position as at 30 June 2018 was $1.3b, up from $912m as at 31 March 2018.
Combined with $2.5b of undrawn debt facilities, the Company is better positioned to “pursue strategic growth initiatives, capital allocation opportunities and to sustain shareholder returns”. In the absence of any acquisitions (including further infrastructure PPP equity investments), capital management options include: i) Activating a share buyback of up to 10% of its shares and/or ii) Paying higher dividends.
There has been continued strength in the share price since our review of the Company in July, as a result of the market’s positive reaction to the 1H18 results and a consistent stream of ASX announcements regarding new contract wins/extensions. Despite this, we do not consider the 1-year forward P/E multiple of ~20.5x to be demanding in light of the key growth drivers identified above.
After jumping higher in late July, CIM then managed to hold its ground, congesting under the 2017 high. Despite recently going ex-dividend, CIM is now pushing up towards the old high. With the July-August consolidation now over, we expect there to be little selling pressure here during the next few weeks or so.
Michael Gable is managing director of Fairmont Equities.
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