Australia’s Industrials and Materials Sector has Gone Great Guns with Policy Support and Promising Indicators

I. Sector Landscape and Outlook

Australia’s Industrials and Materials sector broadly encompass industries in resources and energy and building and construction industries. Australia’s global trade access predominantly revolves around a grid of 15 free trade agreements. Over the past 20 years, total foreign investment share has increased by 8% annually, with the US, UK, EU, Japan, and Canada being the most prominent investors. As a result, the value of Australia’s exports clocked ~$475 billion in FY20, up by 1% despite challenging times. Australia’s resources & energy exports accounted for 6.4% of global exports, placing Australia at the third-largest resources & energy exporter podium.

Figure 1. Broad Indicators of Industrials and Materials Sector:

Source: Analysis by Kalkine

With the onset of COVID-19 in 2020, the manufacturing and construction sector took a considerable hit, and in turn, the capital expenditure activities declined. In support of recoveries and to scale-up competition among Australian manufacturers, the Morrison Government rolled out Modern Manufacturing Strategy intending to infuse $1.5 billion in new funding in the next four years. The strategy includes $107.2 million in the Supply Chain Resilience initiative to identify and address supply chain vulnerabilities and a $52.8 million expansion of the Manufacturing Modernization Fund to address competitiveness among priority sectors. During March 2021 quarter, total new private capital expenditure clocked at ~$31.5 billion, up by 6.3% on a QoQ basis, predominantly attributed to the mining industry. Capital expenditure in equipment, plant and, machinery stood at $15.3 billion, up by 9.1% in March 2021 on a QoQ basis, and it is estimated to reach $57.2 billion for FY21.

Figure 2. A Recent Uptick in Private New Capital Expenditure

Source: Australian Bureau of Statistics, Analysis by Kalkine Group

Businesses have shown improved sentiments. In a survey conducted by the Australian Bureau of Statistics, 20% of all businesses have ceased accessing government support measures. And 43% of businesses are expecting their existing cash on hand to be adequate to cover operations for more than three months.

In a separate report by the Australian Bureau of Statistics, seasonally adjusted sales of transportation companies have shown a strong rebound reaching $33.84 billion in March 2021, up by 8.6% on a sequential basis. While construction companies witnessed a 4.0% growth to reach $85.39 billion. Mining companies have posted an astonishing result with sales reaching +1.9% and gross operating profit by +14.7% on a QoQ basis.

Australian resource and energy industry has approached recovery from prominent one-off issues caused by COVID-19 pandemic and China trade reflected by $73.3 billion resources and energy exports in December 2020 quarter. For instance, the industry growth parameters, such as increased commodity prices, rising global demand, and fully-fledged operations, have aggravated export earnings forecast to ~$296 billion for FY21, as per the data by The Department of Industry, Science, Energy, and Resources. Consequently, OCE’s Resource and Energy Export Volume Index improved by 2.8% in March 2021 quarter on a QoQ basis. Mining companies have invested ~$35 billion in FY20, and spending for all commodities edged up to ~$947 million in December 2020 quarter. Exploring for the Future program has been extended to support exploration operations across the country. In June 2020, the government invested an additional ~$125 million for a span of 4 years, with eight new projects announced.

Figure 3. Sighting Recovery at Pre-COVID Levels

Source: Office of the Chief Economist, Analysis by Kalkine Group

Recoveries are witnessed in the building and construction industry post-COVID-19 impact, with total construction work done improved to ~$51.96 billion, up by 2.4% on a QoQ basis, primarily driven by an upswing in residential, building, and engineering construction by 5.1%, 2.5%, and 2.2%, respectively. In support of the industry, the Morrison Government’s fund infusion of ~$7.5 billion in transport infrastructure is expected to revive the supply chain and drive building and construction industry operations. Critical investments under the fund include ~$750 million stages 1 Coomera Connector in Queensland, ~$560 million Singleton Bypass in New South Wales, and upgradation of ~$528 million Shepparton and Warrnambool Rail Line in Victoria. In addition, the government’s 10-year infrastructure program is expected to aid ~$15.2 billion in new projects into the industry in FY22. As shown below, the building and construction sector delivered a substantial impact on the Australian economy with a GVA of $142.3 billion in FY20.

Figure 4. Sustainable Growth in the Construction GVA Over the Past 20 Years:

Source: Australian Bureau of Statistics, Analysis by Kalkine Group

Index Performance:

The ASX 200 Materials (GIC) Index has generated a 1-year return of ~29.99% as compared to ~22.19% by the ASX 200 Index. Increasing exports of resources sector, favourable support from the government to boost infrastructure and recovering business sentiments drove the sector gains.

Figure 5: The ASX 200 Materials (GIC) Index outperformed ASX 200 Index in the past one year by ~7.80%:

Source: REFINITIV as on the close of 3 June 2021

Key Risks and Challenges:

Gross operating profits of companies in Australia broadly declined by 0.3% in the March 2021 quarter (on a QoQ basis) as shown in the survey by the Australian Bureau of Statistics, because of the pandemic. Being a prominent trade partner, China is affected by restrictive monetary policy measures that pose risks to the Chinese housing sector and Australian industrials and materials sector. There is a significant risk of disruptive heavy rainfall in coal extraction sites of Queensland and NSW. The commodity market has recently witnessed extreme volatile events, which may drain the bargaining power of the sector.

Figure 6. Key Risks Associated with Industrials and Minerals Sector:

Source: Analysis by Kalkine Group

Outlook:

After a fall of 3.5% in FY20, IMF forecasts world GDP to grow by 5.5% in FY21 and by 4.2% in FY22. The Australian Bureau of Statistics (ABS) has revised the total capital expenditure estimates to ~$124 million for FY21, up by 2.2% and ~$113 million for FY22, up by 7.9% from the previous estimate. The iron ore export earnings are estimated to stand at ~$136 billion in FY21. Looking ahead for FY21, export earnings from the resources and energy industry are forecasted to record ~$296 billion, with a modest 3% fall in FY22. Under the FY22 budget prospects, the Australian government committed ~$1 billion for local roads and community infrastructure programs.

II. Investment theme and stocks under discussion (SVW, AZJ, DOW, PLS)

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: SVW (Seven Group Holdings Limited)

(Recommendation: Buy, Potential Upside: Low Double-Digit, Mcap: A$7.37 Billion)

SVW is a diversified group with major operations in heavy equipment sales & service, equipment hires, media and broadcasting.

Valuation

Our illustrative valuation model suggests that stock has a potential upside of ­­­­­­19.08% on 3 June 2021. We believe that the stock might trade at a slight premium as compared to its peer median EV/Sales (NTM Trading multiple) given appropriate liquidity position, growth prospects in Waitsai development and East Coast supply and additional flexibility via low-cost stand-by facilities. For the said purposes, we have taken peers such as Reece Ltd (ASX: REH), Acrow Formwork and Construction Services Ltd (ASX: ACF), Emeco Holdings Ltd (ASX: EHL), to name a few. Considering the low-cost measures to promote operational efficiency, decent performance in H1FY21, improving growth prospects for FY21, valuation, and trading levels, we give a “Buy” recommendation on the stock at the current market price of $20.290, down by 0.050% on 3 June 2021. The stock has delivered an annualized dividend yield of 2.16%.

2. ASX: AZJ (Aurizon Holdings Limited)

(Recommendation: Buy, Potential Upside: Low Double-Digit, Mcap: A$6.75 Billion)

AZJ is engaged in rail-transportation services in Australia. The company operates in three segments, namely Coal, Bulk and Network.

Valuation

Our illustrative valuation model suggests that stock has a potential upside of 18.44% on 3 June 2021. We believe that the stock might trade at a slight discount as compared to its peer median EV/Sales (NTM Trading multiple) given high degree of counterparty risks, susceptibility to geopolitical alterations, unfavourable weather conditions and associated legal risks. For the said purposes, we have taken peers such as Lindsay Australia Ltd (ASX: LAU), Dalrymple Bay Infrastructure Ltd (ASX: DBI), Qube Holdings Ltd (ASX: QUB), to name a few. Considering the restructuring initiatives, decent performance in H1 FY21, rising Australian export coal demand, valuation, and trading levels, we give a “Buy” recommendation on the stock at the current market price of $3.700, up by ~0.817% on 3 June 2021. The stock has delivered an annualized dividend yield of 7.59%.

3. ASX: DOW (Downer EDI Ltd)

(Recommendation: Hold, Potential Upside: Low Double-Digit, Mcap: A$3.89 Billion)

DOW is involved in transportation services, utilities, facilities, and engineering, construction & maintenance.

Valuation

Our illustrative valuation model suggests that stock has a potential upside of 11.31% on 3 June 2021. We believe that the stock might trade at a premium as compared to its peer median EV/Sales (NTM Trading multiple) given adequate liquidity position, growth prospects in urban services businesses, expected recovery in hospitality sector and government investments to strengthen supply chain. For the said purposes, we have taken peers such as BSA Ltd (ASX: BSA), AMA Group Ltd (ASX: AMA), Millennium Services Group Ltd (ASX: MIL), to name a few. Considering the future growth prospects, decent revenue growth amidst COVID-19 impact in H1FY21, recoveries sought in related industries, valuation, and trading levels, we give a “Hold” recommendation on the stock at the current market price of $5.600, up by ~0.719% on 3 June 2021. The stock has delivered an annualized dividend yield of 4.10%.

4. ASX: PLS (Pilbara Minerals Limited)

(Recommendation: Hold, Potential Upside: Low Double-Digit, Mcap: A$3.75 Billion)

PLS is involved exploration, mining, and development of mineral resources.

Valuation

Our illustrative valuation model suggests that stock has a potential upside of ­­­­­­15.12% on 3 June 2021. We believe that the stock might trade at a slight discount as compared to its peer average EV/Sales (NTM Trading multiple) given reported net losses, high exploration risks, fluctuating operating costs and legal & regulatory risks attached. For the said purposes, we have taken peers such as Strandline Resources Ltd (ASX: STA), Bellevue Gold Ltd (ASX: BGL), Galaxy Resources Ltd (ASX: GXY), to name a few. Considering the future growth prospects, increased market demand for lithium with improved prices, strategic project acquisitions, economies of scale achieved, valuation, and trading levels, we give a “Hold” recommendation on the stock at the current market price of $1.300, up by ~0.386% on 3 June 2021.           

Note: All the recommendations and the calculations are based on the closing price of 3 June 2021. The financial information has been retrieved from the respective company’s website and REFINITIV. 

Investment decision should be made depending on the investors’ appetite on upside potential, risks, holding duration, and any previous holdings. Investors can consider exiting from the stock if the Target Price mentioned as per the Valuation has been achieved and subject to the factors discussed above.

Disclaimer

Kalkine New Zealand Limited is authorised to provide class advice only. The information on this site does not take into account any of your investment objectives, financial situation or needs. Before you make a decision about whether to acquire a financial product, you should obtain the Product Disclosure Statement from the product issuer. You should consider the appropriateness of advice taking into account your own objectives, financial situation and needs and seek independent financial advice before making any financial decisions.