Company Reports

Australian engineering construction and maintenance & industrial services provider no-moat Monadelphous reported strong demand for maintenance services in resources and energy, and increasing expenditure related to decarbonization. The company secured more than AUD 1.8 billion of new and extended contracts over the 2024 fiscal first half, nearly double the previous corresponding period. This accords with our expectation for strengthening group revenue in the near to midterm.

The massive scale and complexity of the mining and energy construction projects undertaken in the past decade generated a robust tendering pipeline, with numerous medium- to large-scale contracts available based on price, capability, reputation, and reliability. This facilitated Monadelphous developing into a major provider of engineering construction and maintenance services in the domestic iron ore, energy, and coal markets. Each year, the company has taken on larger engineering construction projects, mainly competing for AUD 5 million-AUD 100 million contracts typically lasting one to two years, but now tendering for midsize to large projects valued at more than AUD 100 million. Engineering construction contracts undertaken are traditionally 66% schedule-of-rates-based and 34% fixed-price schedule, which allows the company to balance risk and margins. Monadelphous predominantly tenders for industrial maintenance contracts in the AUD 10 million-50 million per year range, with contract duration of two to three years. The maintenance contract work is undertaken on a rates-reimbursable basis, with a high level of renewal because of the implicit switching costs for customers.

Our AUD 14.25 fair value estimate for no-moat Monadelphous stands. The Australian engineering construction and maintenance and industrial services provider has so far announced just over AUD 850 million in new and extended contracts for fiscal 2024. This is considerably ahead of the five-year average of AUD 470 million for the first five fiscal months, lending support to our sanguine revenue growth projections.

The massive scale and complexity of the mining and energy construction projects undertaken in the past decade generated a robust tendering pipeline, with numerous medium- to large-scale contracts available based on price, capability, reputation, and reliability. This facilitated Monadelphous developing into a major provider of engineering construction and maintenance services in the domestic iron ore, energy, and coal markets. Each year, the company has taken on larger engineering construction projects, mainly competing for AUD 5 million-AUD 100 million contracts typically lasting one to two years, but now tendering for midsize to large projects valued at more than AUD 100 million. Engineering construction contracts undertaken are traditionally 66% schedule-of-rates-based and 34% fixed-price schedule, which allows the company to balance risk and margins. Monadelphous predominantly tenders for industrial maintenance contracts in the AUD 10 million-50 million per year range, with contract duration of two to three years. The maintenance contract work is undertaken on a rates-reimbursable basis, with a high level of renewal because of the implicit switching costs for customers.

We maintain our AUD 14.25 per share fair value estimate for no-moat Monadelphous. Fiscal 2023 sales of AUD 1.829 billion, down 5% on last year and at the upper end of management guidance, beat our forecast by 1.5% due to stronger-than-expected engineering construction. Adjusted net profit after tax of AUD 52 million, or AUD 0.51 per share, disappointed by 4% on a weaker-than-expected EBIT margin of 4%. It was broadly flat on fiscal 2022, but missing by 4.3% on our forecast. Shares appreciated modestly with earnings and trade in 3-star territory at a 6% discount to our fair value estimate.

We maintain our fair value estimate of AUD 13.35 for no-moat-rated Monadelphous following the release of fiscal 2021 results. Full-year adjusted EBITDA margins of approximately 5.0% were roughly 90 basis points below our expectations. State and international border restrictions are reducing the availability of skilled labour in Australia, and this is affecting costs and productivity. While these conditions are a headwind, we forecast a reduction in border restrictions during fiscal 2022 beginning to alleviate shortages. Owing to the unfavourable labour market settings, we reduce our fiscal 2022 adjusted EBITDA margin by 90 basis points to approximately 6.1% and assume margin recovery from fiscal 2023 to around 8% at midcycle. Our midcycle EBITDA margin assumes an end to border closures and the relatively free movement of labour within Australia. Monadelphous routinely achieved EBITDA margins near 10% and above last decade, but our midcycle margin forecast remains below those heydays with no repeat of the commodities boom expected.

The massive scale and complexity of the mining and energy construction projects undertaken in the past decade generated a robust tendering pipeline, with numerous medium- to large-scale contracts available based on price, capability, reputation, and reliability. This facilitated Monadelphous developing into a major provider of engineering construction and maintenance services in the domestic iron ore, energy, and coal markets. Each year the company has taken on larger engineering construction projects, mainly competing for AUD 5 million to AUD 100 million contracts typically lasting one to two years, but now tendering for midsize to large projects valued at more than AUD 100 million. Engineering construction contracts undertaken are traditionally 66% schedule-of-rates-based and 34% fixed-price schedule, which allows the company to balance risk and margins. Monadelphous predominantly tenders for industrial maintenance contracts in the AUD 10 million-AUD 50 million per year range, with contract duration of two to three years. The maintenance contract work is undertaken on a rates-reimbursable basis, with a high level of renewal because of the implicit switching costs for customers.

The massive scale and complexity of the mining and energy construction projects undertaken in the past decade generated a robust tendering pipeline, with numerous medium- to large-scale contracts available based on price, capability, reputation, and reliability. This facilitated Monadelphous developing into a major provider of engineering construction and maintenance services in the domestic iron ore, energy, and coal markets. Each year the company has taken on larger engineering construction projects, mainly competing for AUD 5 million to AUD 100 million contracts typically lasting one to two years, but now tendering for midsize to large projects valued at more than AUD 100 million. Engineering construction contracts undertaken are traditionally 66% schedule-of-rates-based and 34% fixed-price schedule, which allows the company to balance risk and margins. Monadelphous predominantly tenders for industrial maintenance contracts in the AUD 10 million-AUD 50 million per year range, with contract duration of two to three years. The maintenance contract work is undertaken on a rates-reimbursable basis, with a high level of renewal because of the implicit switching costs for customers.

Despite uneven global economic conditions, the Australian mining and energy sectors experienced an unprecedented investment boom in the past decade. The domestic engineering, construction, and maintenance industry is highly dependent on continuing solid domestic economic conditions and increasing capital investment in mining and energy projects. Monadelphous successfully rode the investment wave, but a less certain future demands diversification.

Despite uneven global economic conditions, the Australian mining and energy sectors experienced an unprecedented investment boom in the past decade. The domestic engineering, construction, and maintenance industry is highly dependent on continuing solid domestic economic conditions and increasing capital investment in mining and energy projects. Monadelphous successfully rode the investment wave, but a less certain future demands diversification.

Monadelphous has announced that it is involved in a contract dispute with a customer, Wiggins Island Coal Export Terminal. The dispute involves changes in the scope and nature of construction work undertaken by Monadelphous for an approach jetty, ship berth and shiploader in Gladstone, Queensland. As a result of the dispute, WICET has filed a claim against Monadelphous for AUD 130 million and Monadelphous has filed a counterclaim in excess of AUD 200 million. The outcome of remains uncertain at this stage as does the time line, although management stated that the dispute will not have an impact on fiscal year 2015 earnings. We maintain our near-term assumptions; however, we will continue to monitor the claims and make adjustments if necessary. We retain our fair value estimate of AUD 9.00 per share. In light of the pending claims, we note that industry conditions remain difficult, resulting in highly competitive tendering, and challenging growth prospects. At the current share price, we believe that Monadelphous is overvalued. We make no change to our narrow moat and very high uncertainty ratings. Monadelphous' long-established relationships with major mining and energy companies have been leveraged into recurring maintenance and industrial services contract work that exhibit high switching costs.