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Stock: Downer EDI

Stock code: DOW

Share Price: $3.83 (as at close 29/07/11)

P/E Ratio:  9.69 (Sector P/E 12.50)

Market Cap: $1,643,000,000

Broker Calls

RBS – BUY

Zodiac Securities – BUY

Alto Capital – BUY

Paterson Securities – BUY

 

Chart: Share price over the year to 29/07/2011 versus ASX200 (XJO)

Investor Centre: Downer EDI

Company news: Downer EDI Limited

For shareholders of Downer EDI (DOW), the last 18 months have been challenging to say the least.  After more than doubling in a year to hit a high of $9.35 in late December 2009, shares of DOW have since fallen 59 per cent to be sitting at just $3.83. The stock has recently clawed its way back from a 12-month (and near record) low hit in April to be up 12.3% over the past three months.

A string of bad news hasn’t helped. Shortly after announcing that DOW was taking a massive $A250 million provision due to delays in delivering trains for Sydney’s suburban rail network, ligation funder IMF announced that a shareholder class action suit has been launched against the company.

The ongoing saga with the Waratah project in New South Wales has cost DOW dearly through delays in delivering trains and cost blowouts, although things have taken a turn for the better in recent weeks – it announced this week that it has completed and delivered its second train to RailCorp.

Description

Downer EDI consists of a group of companies that specialise in the engineering, construction, telecommunications, mining and resource sectors in the Asia Pacific region. Revenue for 2010 was $6.1 billion, operating cash flow of $377 million and liquidity in excess of $800 million ($385 million in cash plus current credit facilities). What’s more work in hand is a whopping $20 billion. The Downer Group includes consulting, engineering, mining, rail and works – the latter providing services for development and maintenance of infrastructure.

The Downer Group includes:

1. Downer Consulting – which delivers ‘front-end’ engineering design and consulting capabilities

2. Downer Engineering – which provides engineering services from design and planning through to operation and maintenance with prime activities in contracting, services and projects.

3. Downer Mining – a major provider of mining, mine planning and mine management services.

 4. Downer Rail – a leading provider of passenger and freight rolling stock and associated maintenance services in Australia

5. Downer Works – which provides services for development, asset management and maintenance of public and private infrastructure

Financials

‘Downer Group expects to deliver underlying EBIT of around $300 million for the Full Year and underlying NPAT of around $169 million,’ states DOW in its half year earnings report. It says that underlying results reflect previous guidance of a softer first half and that it had strong growth in Mining, Rail and Engineering but softer Works Revenue in both Australia and NZ.

Underlying EBITDA for the half year to December 31 2010 of $228.7 million (up 3%) and underlying EBIT of $132.4 million (down 5.5%) impacted by weather, lower and deferred government expenditure, margin pressure and a small number of underperforming contracts within the Engineering division. Underlying cash flow very strong at $185.9 million (140.4% underlying EBIT). Work-in-hand remains very strong at $20.5 billion, split between Mining $7.6 billion, Engineering $2.2 billion, Rail $5.4 billion, Works $5.3 billion.

Financials for DOW:

 

2008A 2009A

2010A

 Sales Revenue ($m)

5,444.6  5,841.9 5796.3

 EBITDA ($m)

 399.99 447.66 480.79

 EBIT ($m)

 282.43 305.89 320.63

 Reported NPAT ($m)

 154.7 178.0 3.0

 Price/Earnings

 13.0 9.6 12.6

 Dividend Yield (%)

 3.7 5.2 8.1

 Net Profit Margin (%)

 2.8 3.0 3.4

 ROE (%)

 12.9  13.4 15.9

 Net Debt/Equity (%)

 28.5 38.5 40.6

Link to company Earnings Report: Downer EDI Half Year Earnings Report – to December 31st, 2010

Analysts’ views

Simon Bond of RBS Morgans has a buy on DOW. Although the engineering company’s share price has been punished after several writedowns regarding the Waratah train project in New South Wales, he expects several near-term catalysts – most notably Waratah’s second train acceptance by RailCorp – to begin the process of unlocking significant value in the business. ‘A good opportunity exists here,’ says Bond.

DOW raised $250 million earlier this year to shore up its balance sheet and is disputing $154 million in penalties for delays. And Steven Hing of Zodiac Securities believes there’s a chance of success. Irrespective of the outcome, Hing says DOW offers viable businesses that should continue to benefit from the mining boom.  He says that this company is resilient as shown by its strong underlying businesses meeting challenges in the past. Bluntly, he points out: “This company has other businesses besides trains.”

Analyst Carey Smith of Alto Capital, who currently has a Buy recommendation on Downer EDI believes the markets have overreacted to a short-term issue. His view is that the group currently offers top value for the longer-term investor.

Meanwhile Goldman Sachs has done some modelling and thinks that DOW is likely to become a takeover target and Patersons has listed the engineering company as one of its high conviction calls and its preferred exposure in the Capital Goods sector.

Based on Thomson Reuters data, three analysts have a buy on DOW, seven have a hold and two have a sell.

Conclusion

Although Downer EDI continues to struggle with the Waratah project, the company’s strong balance sheet, ample liquidity and strong underlying business suggests that the market may be overreacting. It must be noted that Downer EDI has strong businesses outside of the Waratah rail project and at its current share price brokers think that the risks appear limited.

A string of new deals and progress with the Waratah project announced over the past month illustrate that DOW is getting back on track:

29/07/2011 – Downer Signs Managed Services Agreement with Hewlett Packard

28/07/2011 – Second Waratah Train Presented to RailCorp

26/07/2011 – Downer Wins contract to Develop Coal Handling and Preparation Plant for Xstrata Coal

25/07/2011 – Downer Secures Maintenance Contract With Western Australia’s Public Transport Authority

01/07/2011 – First Waratah train receives certificate of Practical Completion

29/06/2011 – Downer secures $50m contract with Rio Tinto Iron Ore

 

>>Back to the newsletter to view other articles – July 30th 2011

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