Since contracts were awarded on the $50 billion Gorgon Gas project, stocks have rallied hard, particularly the ‘big-three’ primary beneficiaries: Leighton Holdings (LEI), United Group Limited (UGL), and Downer EDI (DOW).
Admittedly, there are many Gorgon contracts yet to be awarded, but of the whopping $8 billion in traditional downstream engineering work up for grabs by Australian engineers over the next seven years – the big-three have already received just under half ($3,625 billion).
Between 2010 and 2014 the $2 billion in contracts already awarded to Leighton’s will go on site preparation/earthmoving, the construction of accommodation, marine jetties, and other civil works. And while work on Gorgon for either Downer EDI or United Group won’t start until full-year 2012, they’re expected to earn $675 million and $950 million respectively in mechanical and electrical engineering work.
Given the magnitude of these orders, Citi Smith Barney’s best estimates suggest that LNG alone could boost the annual revenue of these three stocks by a sizable five percent over the next seven years. And despite their recent share price run-up, Roger Leaning head of research with ABN Amro Morgans says there’s still sufficient upside for investors to enter these three heavy-weights at current levels (on a 12 month outlook).
He expects productivity improvements, greater clarity around billable hours, margin expansion, improved efficiencies and upside from other LNG projects to trigger a re-rating on the big-three by up to 30 percent within six to 12 months.
Gorgon aside, Citi’s estimates suggest other LNG projects could be worth an additional $2 billion for Leighton by full-year 2014, and an additional $700 million and $1 billion for both Downer EDI and United Group respectively.
Beyond the big-three, another listed stock that already received a piece of Gorgon’s pie is Mermaid Marine Australia (MRM). The boom in offshore gas and oil exploration contributed significantly to the tug operator’s 48 percent increase in profit to $26.5 million for the year to 30 June, on revenue up 10 percent to $163.9 million. And at $100 million, the Gorgon contract is estimated to be worth more than a quarter of Mermaid Marine’s value.
Transport solutions provider, Toll Holdings (TOL) has also received $180 million Gorgon contract for the receipt, warehousing and movement of goods.
Included within a long list of other contractors likely to benefit from Gorgon are: Industrial maintenance provider, Transfield Services (TSE), Monadelphous Group (MND), and Programmed Maintenance Services (PRG).
Beyond Gorgon, notable beneficiaries from other large LNG projects include rival engineering heavy-weights, Worley Parsons (WOR), and Clough Ltd (CLO). Worley’s key role in both Woodside’s $12 billion Pluto and PNG projects is expected to generate an additional $800 million through to full year 2015.
Meantime, Clough recently won a $64 million contract on PNG LNG, and a $540 million engineering, procurement and construction management contract as a part of the $2.7 billion Kellogg Joint Venture. Having boosted its order intake by 39 percent to $714 million in the full year to 30 June, Clough now looks well positioned to benefit from other major LNG projects, further upside from Qld coal seam gas, and domestic gas projects in WA.
Given the lofty multiples on Leighton (P/E 17.2X) and Worley’s (P/E 17.5X), Citi’s preferred engineering/contractor sector exposures are Downer and United Group. Having raised its target price to $9.60 from $9 due to forecast changes, Citi has a buy on Downer EDI. Included amongst Downer’s impressive numbers in FY 2009 were: EPS growth of 12.8 percent, P/E at 14X, return on equity (ROE) at 15 percent, plus a dividend yield of 3.6 percent. In contrast, Citi has raised its target price to $14 from $13 on United Group, while maintaining its hold recommendation on the stock.
Based on their discounted valuations relative to the sector, the favoured stocks of Graeme Carson analyst with Patersons Securities are both Downer and Transfield Services. Beyond LNG and coal-seam gas, he says another significant upside for Downer is in public-private partnerships (PPP) on myriad big infrastructure projects, including Sydney’s integrated metro network. “We also like Transfield Services management’s efforts to reduce debt, and expect the stock to add more infrastructure projects to its core maintenance business,” says Carson.
Meanwhile, included within the ‘blue-sky’ yet to be factored into the upside of major engineering firms are opportunities within large-scale water projects. Water contributes around 10 percent of profits for Leighton, Worley Parsons, Downer EDI, Transfield Services and slightly more for United Group, and Citi expects these stocks to benefit from future desalination plants, wastewater treatments and pipeline projects.
While Leaning still believes Leighton, Downer and United Group are worth buying at current levels – on a 12 month outlook – he urges existing shareholders to maintain a core holding, while taking profits on recent gains. He recommends using the profits to lock-in exposure to contractors most likely to capitalise on the on the next round of contract awards once mineral, metal and green-fields projects are back on the table.
Leaning claims that a reacceleration of the Chinese economy, a slow reigniting of the US housing cycle, and an increase in infrastructure spending globally supports the view that commodity prices have embarked on another cyclical upswing. “Once mineral, metal and green-fields projects are back on the table; I expect four key stocks to be early beneficiaries: Coal processing plant builder/operator, Sedgman Ltd (SDM); provider of analytical laboratory testing services, Campbell Brothers (CPB); service provider to the resources sector, NRW Holdings (NWH); and product provider to industrial/mining industries, Alesco Corporation (ALS).”
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Source: Citi (2009A)
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