Downer EDI has taken a ‘prepare for the worst, hope for the best’ approach to its guidance for FY23. The pipeline of infrastructure work ahead of Australia is large and will keep DOW busy for a long time which provides the comfort that the stock has a promising future.
Wet weather and Omicron impacted FY22 EBITA by more than $60 million. DOW should be able to claw back much of this through FY23f. With another La Nina weather event predicted for this summer, that is an awkward reality for DOW but beyond its control.
The impact of inflation is a less vexed question for DOW as 96% of its Services work-in-hand has some form of embedded price escalation mechanism. Similar price escalation factors are utilised in construction contracts. Labour shortages are more problematic given DOW has a workforce of ~33,000.
DOW has $36.1 billion of work-in-hand, most of which is Government or related work. That provides a degree of comfort that there is a large agenda of infrastructure work needed in Australia and DOW is well positioned to provide the necessary services.
With those elements in mind, DOW has provided FY23 underlying net profit guidance of 10-20% growth ($248-270 million est.) assuming no material COVID-19, weather, labour or other disruptions. That sounds highly malleable to us but is understandable. The guidance mid-point is about 7% below pre-result consensus forecasts and looks conservative. If the weather does its worst, we think the guidance almost certainly accommodates that event. The company’s experience in FY22 gives a ballpark indication of the magnitude of such events.
DOW’s balance sheet has net debt to EBITDA at 1.6x, well below its target range of 2.0-2.5x which provides plenty of flexibility. DOW said Q4 beat its expectations providing some momentum as FY23 gets underway. Demand remains robust, according to the company, across its existing contracts and the pipeline.
Investment view
DOW’s optimism is based on the extensive amount of government infrastructure work being planned. The recent Investor Day held by the company set out the multitude of opportunities available and how it plans to take advantage given its experience and capability. A sharper approach to contract management and negotiation should see DOW deliver well ahead of the 3-year 11% pa CAGR forecast by consensus.
Risks to investment view
Earnings would be dented if the economic infrastructure plan did not play out, or if COVID impacts continued to disrupt operations. We rate these risks as relatively low probability.
Recommendation
We have retained our Buy recommendation.
Figure 1: FY22 result
