The recent Investor Day held by Downer EDI emphasised the extensive opportunities ahead as government spending on infrastructure and defence remains heightened. DOW’s broad reach across these and other areas positions the company for meaningful earnings growth over the next few years.
Looking through the noise of the last year, including COVID-19 and widespread wet weather, DOW management remains upbeat and positive about its earnings prospects over the next few years. This is predicated on an elevated and enduring level of government expenditure on infrastructure and defence. We note the Federal Government’s 2022-23 budget for new road and rail projects amounted to $18 billion while spending on Defence is expected to double to $4 billion per annum.
But DOW’s expertise extends into other areas such as utilities and facilities that can also benefit from a normalisation of economic activity and hopefully, some dry weather to get projects moving.
The key points from the Investor Day included:
- Improved project performance on just a handful of key projects will have meaningful implications at group level.
- The transport construction book is heavily risk-managed and could have been much larger. The Parramatta Light Rail project is set to complete in mid-2022 on time and on budget.
- Major tender opportunities include the Queensland Train Manufacturing Program. DOW is one of three parties tendering for 65 train sets and 15 years of maintenance. The Auckland Light Rail is still in planning phase.
- A selective approach to new contracts and a focus on escalation clauses has helped to mitigate supply chain and labour inflation.
- The outlook for bolt-on acquisitions with a focus on road services (such as asphalt plants) and defence.
In addition to the scope of work available, DOW has plenty of room for margin growth from improved contract performance and mix, greater cost efficiencies, and some cost-out following recent divestments (Mining, Laundries).
DOW excitedly noted that its exposure to a net zero emissions future is extensive given its expertise in power generation, power transmission and distribution, energy management and transportation. This could feasibly lead to strong and sustainable medium term earnings growth beyond FY23f. The company believes it is in the right place at the right time to capitalise on a vast array of opportunities.
Investment view
DOW indicated core EBITA was down 4.7% year-on-year so far in FY22f implying a 20-25% decline in the March quarter. This is the impact of Omicron and wet weather which DOW estimates has cost $50-60 million in EBITA. These effects are now dissipating so that the rest of FY22f should experience very strong growth in catch-up and new work.
The investor presentation underlined how extensive the opportunities are for infrastructure spending in Australia over a long horizon, particularly as the country transitions the economy to a lower emissions pathway. DOW certainly has many of the skills and project management expertise to participate vigorously in this feast of activity.
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.
