The Australian Industrial Sector Set to Bounce on Improved Macro Factors

I. Sector Landscape

Australia’s industrial sector is prospering from surged construction, transport, and manufacturing activities. Construction activities amplified in 2021 with the rising development of non-residential and new-residential buildings. The improved value of work reinforced engineering activities in roads, highways & subdivisions, bridges, and railways. The modern manufacturing strategy, a whole-of-government strategy, is well-positioned to scale Australian manufacturing activities.

Key Driving Factors from Macro Perspective

Surged GDP Manifesting Improved Productivity: The Australian GDP surged by 3.4%, according to the Australian Bureau of Statistics (ABS), in the December 2021 quarter. Private demand contributed 3.0 ppts to GDP, with a 6.3% surge in household final consumption expenditure. The household savings to income ratio slipped from 19.8% to 13.6%, driven by increased spending.

Improvements in Labor Market: The compensation of employees (COE) rose by 2.0% this quarter, reflecting both employment and hours worked. Private COE edged by 2.2%, manifesting a rebound from last quarter’s 0.4% dip as trading and movement restrictions terminated in several states. Public COE advanced by 1.5%, reflecting the public sector COVID-19 response via vaccinations, hospitalizations, and testing.

Production in Manufacturing and Transport, Postal & Warehousing Segments: For December 2021 quarter, the manufacturing industry clocked a 1.8% QoQ and 4.5% PcP increase in production. The transport, postal & warehousing industry remained in positive territory with a 3.0% QoQ and 7.4% PcP increase.

Key Statistics on Manufacturing and Infrastructure Activities

Progressive Indicators for Manufacturing Activities: The Australian Industry Group Australian Performance of Manufacturing Index (Australian PMI®) surged by 2.5 points to 55.7 points in March 2022 on a seasonally adjusted basis, demonstrating a robust pace of expansion in March 2022, suggesting the recovery is underway. This was the highest PMI result since July 2021.

FY23 Budget Contribution: The infrastructure Australia published Delivery Outcomes on 21 March 2022 to address the long-term challenges facing Australia’s infrastructure sector. Furthermore, the Infrastructure Australia has engaged with proponents on 81% of proposals exceeding $250 million.

Key Risks and Challenges

Construction activities took a recent hit, as illustrated by a 1.7% QoQ decline in private sector engineering construction work done in December 2021 quarter. The current supply chain disruptions are expected to stand intact in the short term. Strikes have continued in Australian ports, bolstering supply delays and surging prices. Primary metal and metal production has shrunk due to increased input costs and decarbonization policies in China, promoting supply pressures.

Outlook

Improved Business Turnover Indicator: In February 2022, the business turnover indicator in Manufacturing increased by 4.1% MoM, and the transport, postal & warehouse experienced a 9.3% MoM increase due to increased airline activities.

Increased Capital Expenditure: ABS expects the new capital expenditure on equipment, plant & machinery to clock $61.3 billion in FY22, 2.3% over the previous estimate. For FY23, the estimate stands at $45.7 billion.

Manufacturing Integration Stream: The manufacturing integration stream has come up with six grant opportunities aligned with the National Manufacturing Priorities.

Infrastructure Investment: The government announced an investment of $7.1 billion in Australia’s infrastructure transformation to assist the country in pushing into new frontiers of growth and production.

National Water Grid Fund: The government has augmented the reliability and supply of water for farming communities and regions by establishing a National Water Grid Fund to deliver critical water infrastructure projects.

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

After understanding the sector, let us now look at three companies listed on the ASX. The price potential of the companies under discussion has been analysed based on the ‘EV/Sales’ multiple method.

1. ASX: SVW (Seven Group Holdings Ltd)

(Recommendation: Buy, Potential Upside: Low Double-Digit, Mcap: A$7.01 billion)

SVW is a diversified conglomerate with interests and investments in heavy equipment sales and service, hire of equipment, building products & construction materials.

Valuation

Our illustrative valuation model suggests that stock has a potential upside of 17.38% on 28 April 2022. However, we believe that the stock might trade at some premium compared to its peer average EV/Sales (NTM Trading multiple) given commodity price risk and stiff competition. For valuation, peers such as Reece Ltd (ASX: REH), Emeco Holdings Ltd (ASX: EHL), Acrow Formwork and Construction Services Ltd (ASX: ACF), and others are considered. Given the decent financials, Boral capital return, improved bottom-line, and upside indicated by valuation, we give a “Buy” recommendation on the stock at the closing market price of $19.620, up by ~1.605% on 28 April 2022. In addition, the stock has delivered an annualised dividend yield of 2.38%.

SVW Daily Technical Chart (Data Source: REFINITIV)

2. ASX: RWC (Reliance Worldwide Corporation Limited)

(Recommendation: Speculative Buy, Potential Upside: Low Double-Digit, Mcap: A$3.07 billion)

RWC is engaged in the design, manufacturing, and supply of water flow control and monitoring products and solutions for the plumbing & heating industry.

Valuation

Our illustrative valuation model suggests that stock has a potential upside of 20.82% on 28 April 2022. Moreover, we believe that the stock might trade at some premium compared to its peer average EV/Sales (NTM Trading multiple) given the decent industry trends. For valuation, peers such as GWA Group Ltd (ASX: GWA), CIMIC Group Ltd (ASX: CIM), Monadelphous Group Ltd (ASX: MND), and others are considered. Given the decent financial performance, upward industry trends, upside indicated by valuation, and key risks associated with the business, we give a “Speculative Buy” recommendation on the stock at the closing market price of $4.010, up by ~3.084% on 28 April 2022. In addition, the stock has delivered an annualised dividend yield of 3.41%.

RWC Daily Technical Chart (Data Source: REFINITIV)

3. ASX: AZJ (Aurizon Holdings Limited)

(Recommendation: Hold, Potential Upside: Low Double-Digit, Mcap: A$7.16 billion)

AZJ is one of Australia’s leading rail freight operators that provide integrated freight and logistics solutions across an extensive national rail and road network.

Valuation

Our illustrative valuation model suggests that stock has a potential upside of 9.51% on 28 April 2022. Moreover, the stock might trade at a slight premium compared to its peer average EV/Sales (NTM Trading multiple) given improved infrastructure support from government and mounting growth in bulk segment. For valuation, peers such as Qube Holdings Ltd (ASX: QUB), Kelsian Group Ltd (ASX: KLS), Camplify Holdings Ltd (ASX: CHL), and others have been considered. Given the growth expectations in coal and bulk segment, favourable bottom-line guidance, current trading levels, and upside indicated by valuation, we give a “Hold” recommendation on the stock at the closing market price of $4.000, up by ~2.827% on 28 April 2022. In addition, the stock has delivered an annualised dividend yield of 6.40%.

AZJ Daily Technical Chart (Data Source: REFINITIV)

Markets are trading in a highly volatile zone currently due to certain macro-economic issues and geopolitical tensions prevailing. Therefore, it is prudent to follow a cautious approach while investing. 

Note: All the recommendations and the calculations are based on the closing price of 28 April 2022. 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 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.