Government Infrastructure and Agri Exports to Underpin Resilient Growth in Chemicals and Industrials

I. Sector Landscape

The Industrials sector in Australia is backed by strong government spending on infrastructure and a spurt in engineering construction activity. The construction sector upheld the economic output with Gross Value Added (GVA) of ~ $133.8 billion in 2020, representing ~7.4% of overall GVA. The chemical industry serves as the third largest manufacturing sector in Australia, according to Chemistry Australia. It has a mammoth workforce strength of over 61,000.

Notwithstanding the supply chain bottlenecks caused by the pandemic, exports of the chemical industry grew by an astonishing 9.6% in November 2021 to reach $888 million compared to the preceding month, according to the Australian Bureau of Statistics (ABS). The exports were up 3.3% over the last year, indicating a solid progression towards recovery to the pre-pandemic era. The industry growth was underpinned by favorable agriculture offtake in Australia and increased international demand.

Further, the government’s $1.5 billion modern manufacturing initiatives announced in 2020 is likely to apprehend the technological advancements and generate employment opportunities.

Figure 1: Chemicals Showing Rebound in Exports:

Source: Based on Australian Bureau of Statistics Data, Analysis by Kalkine Group

Engineering construction work done in Australia fell 2.3% on a sequential basis in September 2021 quarter to reach $22.71 billion. However, it is still higher over 0.4% to last year levels.  Private sector work done fell at a faster clip to reach $13.43 billion over the preceding quarter. While public sector engineering work done broadly remains unchanged with a 0.1% drop to $9.28 billion. The backdrop of labour shortages and mobility restrictions imposed due to lockdowns has impacted engineering activity.

Nevertheless, work commenced in September 2021 quarter surged 26.9% on QoQ basis to $25.05 billion, indicating a solid recovery.

Figure 2: Decline in Engineering Activity Owing to the Pandemic:

Source: Based on Australian Bureau of Statistics Data, Analysis by Kalkine Group

Index Performance

The ASX 200 Industrials Index posted a 1-year returns of +18.87%. Increased budgetary allocation for infrastructure by the government, resurgence in capex spend on buildings and structures, and upward trending dwellings approval are supportive factors driving sector gains.

Figure 3: The ASX 200 Industrials Index outperformed the ASX 200 Index in the past one year by ~2.09%.

Source: REFINITIV as on 13 January 2022

Key Risks and Challenges

Higher than expected rainfall in November in Northern and Central West NSW brought losses to some producers. Hence, chemical inputs used in agriculture hence is highly seasonal. Prices of agricultural commodities are driven by international prices and supply. This may affect the realization and drive down the margin. The increasing spread of the new virus variant may hold down the economic expansion and infrastructure spending affecting the industrials. Rollback of various government soaps and withdrawal of accommodative policy stance across the globe may inflate the borrowing cost and hamper the expansion plans.

Figure 4: Key Risks and Challenges:

Source: Analysis by Kalkine Group

Outlook

According to ABARES, Australia’s crop export is forecasted to reach a record $35 billion in 2021-22, an increase of 37% YoY. Higher winter crop production and favorable outlook for summer crops are likely to lift-up demand for fertilizer and agricultural chemicals. In the 2021-22 Budget, the government proposed a 10-year $110 billion plan for investment in various infrastructure projects that helps to bring freight connectivity and reduce road congestion. As part of the plan, the government has committed $15.2 billion that includes investment in road and community infrastructure program, road safety programs covering eight states. Capex estimates have been upwardly revised to $138.6 billion in 2021-22, an increase of 8.7% over the prior year. In the recent release by ABS, capex spent by businesses dropped 2.2% in September 2021 quarter (on a QoQ basis) but remained elevated at 12.9% over the previous year. Investments in buildings and structures flocked 9.0% YoY is expected to lift the industrials sector.

II. Investment theme and stocks under discussion (SGF, CXL, LCK, NUF)

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’ multiple method and TTM valuation.

1. ASX: SGF (SG Fleet Group Limited)

(Recommendation: Buy, Potential Upside: Low Double-Digit, Mcap: A$848.12 million)

SGF is engaged in the fleet management solutions space. It offers vehicle leasing, vehicle fleet management, consumer vehicle finance, short-term hire, and salary packaging services in Australia, New Zealand, and the UK.

Valuation

Our illustrative valuation model suggests that the stock has a potential upside of 17.32% on 13 January 2022. However, the stock might trade at a slight discount compared to its peers’ average EV/Sales (NTM trading multiple) given potential COVID-19 uncertainties in global supply chain space and potential operational halts. For valuation, peers like Mader Group Ltd. (ASX: MAD), Cleanaway Waste Management Ltd (ASX: CWY), HRL Holdings Ltd (ASX: HRL), and others are considered. Given the improved net margins, bulged topline, disruption in new vehicle supply, improved financial position, and upside indicated by valuation, we give a “Buy” recommendation on the stock at the current market price of $2.460, as of 13 January 2022, at 01:08 PM (GMT+10), Sydney, Eastern Australia. In addition, the stock has delivered an annualized dividend yield of 5.07%.

2. ASX: CXL (Calix Limited)

(Recommendation: Speculative Buy, Potential Upside: Low Double-Digit, Mcap: A$1.02 billion)

CXL offers industrial solutions and runs five segments: Water, Co2 mitigation, Biotech, Advanced Batteries, and Sustainable Processing.

Valuation

Our illustrative valuation model suggests that the stock has a potential upside of 19.17% on 13 January 2022. Moreover, the stock might trade at a slight premium compared to its peers’ average EV/Sales (NTM trading multiple) given high potential in the water segment and improving sales revenue. For valuation, peers like Secos Group Ltd (ASX: SES), Clover Corporation Ltd (ASX: CLV), Scidev Ltd (ASX: SDV), and others are considered. Given the improved topline, the favorable outlook for the water segment, support from grants & rebates, current trading levels, upside indicated by valuation, and, key risks associated with the business, we give a “Speculative Buy” recommendation on the stock at the current market price of $6.410, as on 13 January 2022, at 12:25 PM (GMT+10), Sydney, Eastern Australia.

3. ASX: LCK (Leigh Creek Energy Limited)

(Recommendation: Speculative Buy, Mcap: A$129.93 million)

LCK is a mining and exploration company with projects in gold, copper, zinc, lead, silver, and other metals.  

Technical Analysis:

LCK's prices witnessed a downside correction from the higher levels in the past couple of sessions; however, sustaining above an upward sloping trend line, indicating the possibility of an upside movement hereon. On the daily chart, the leading indicator RSI (14-period) is hovering around the mid-point and currently trading at ~46.04 levels. The trend-following indicator 50-period SMA is placed below the CMP and acts as a crucial support level for the stock. Now an immediate resistance level for the stock is at AUD 0.180, while support is at AUD 0.130 level.

Valuation

The stock of LCK gave a positive return of ~15.385% in the past six months. The stock is currently trading lower than the 52-weeks average price level band of $0.100 - $0.310. On a TTM basis, the stock of LCK is trading at a price-to-book value multiple of 2.5x, lower than the industry average (Energy) of 3.3x, signalling undervaluation. Considering the current trading levels, valuation on a TTM basis, low estimations for operating costs at LCUP, improving fertilizer demand, low domestic competition, optimistic outlook, and associated key risks with the business, we give a “Speculative Buy” recommendation on the stock at the closing market price of $0.150, as of 13 January 2022.

LCK Daily Technical Chart, Data Source: REFINITIV

Note:  The purple color line in the chart depicts RSI (14-period), while the yellow color line represents the trend line.

4. ASX: NUF (Nufarm Limited)

(Recommendation: Hold, Potential Upside: Single High-Digit, Mcap: A$1.82 billion)

NUF provides crop protection chemicals such as herbicides, insecticides and fungicides.

Valuation

Our illustrative valuation model suggests that the stock has a potential upside of 9.48% on 13 January 2022. Moreover, the stock might trade at a slight premium compared to its peers’ average EV/Sales (NTM trading multiple) given gains in the crop market and improved seasonal conditions. For valuation, peers like Orica Ltd (ASX: ORI), Scidev Ltd (ASX: SDV), Incitec Pivot Ltd (ASX: IPL), and others are considered. Given the increased market share, favorable cash position, low financial leverage, significant operational efficiencies, topline upside, and valuation, we give a "Hold" recommendation on the stock at the closing market price of $4.850, up by ~1.041% on 13 January 2022. In addition, the stock has delivered an annualized dividend yield of 0.83%.

Note: All the recommendations and the calculations are based on the closing price of 13 January 2022. The financial information has been retrieved from the respective company’s website and REFINITIV.  

Investment decisions should be made depending on the investors' appetite for 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 is subject to the factors discussed above.

Disclaimer

Kalkine New Zealand Limited is authorised to provide general advice only. The information on this website 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.