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Analyst report
Stocks to rebut US recession engineering sector
February 6, 2008
Brendon Lau, ShareAnalysis
There are very few corners of the market where investors can hide from the recent sharp bout of volatility. But instead of hiding, long-term investors could use the dips to buy into quality stocks that are well positioned in sectors that are still showing signs of growth even in the face of a possible US recession; one of these sectors is construction and engineering.
However, this does not mean the sector will not face headwinds from the current economic jitters and credit crunch. In fact, some companies in this space could be impacted by decreased deal flows and pressure on margins after having enjoyed near perfect macro-economic conditions over the last three years.
The risk of decreased deal flow could stem from a reduced rate of growth in mining volumes, shipment delays and port congestion. The risk of margin contraction could stem from high input prices, equipment supply shortages and skilled labour shortages. Naturally, some engineering contractors will be better able to weather these challenges better than others.
At the upcoming reporting season, we are expecting poor performance for those stocks that have suffered under these headwinds, such as Boom Logistics (BOL) and Emeco (EHL), and strong results for those stocks that, to date, have remained resilient, such as Leighton Holdings (LEI) and United Group (UGL).
Over the longer term, we continue to believe the Australian macro economy and global demand for resources should stay robust. At the same time, the need for upgrades and extensions to public sector infrastructure in Australia remains paramount.
The importance of these infrastructure projects was underscored in the FY08 Federal Budget when the government announced that it will invest $19.1B in road and rail infrastructure under the second AusLink national land transport plan (AusLink 2) and around $3.2B in other local roads grants over five years from FY10. The government also announced increased funding under AusLink 1 by $695M (including $250M in FY07), bringing investment in land transport infrastructure to $15.8B over the five years to FY09.
Meanwhile, emerging economies from Asia to the Middle East are also enjoying a construction boom of their own, and a mild US recession is unlikely to make much of an impact. Furthermore, news last week that China's GDP grew by 11.2% in the 4Q, its fastest rate in 13 years, is adding credibility to the "decoupling theory".
The robust demand for engineering services in these overseas markets is one reason why most major Australian contractors continued to undertake acquisitions and JV agreements in the early part of the 1H08 financial year. However, the tighter credit market conditions and the increased cost of debt have notably reduce M&A activity across the sector in more recent times.
Despite these challenges, we believe there is still scope for further sector consolidation, and we continue to expect acquisitions to be an important driver of growth, particularly for cashed-up companies operating in this space.
Out of all the engineering construction stocks we cover, two that may be of interest to you are Leighton Holdings (LEI) and United Group (UGL).
LEI will report its 1H08 result on 14 February. We are forecasting an adjusted NPAT of $272.1M, up 48.9% on the pcp. LEI continues to be supported by a strong pipeline of work, with significant growth prospects underpinning the company's expansion strategy into India and the Middle East. We have a BUY on LEI (Technical Recommendation: BUY).
UGL will report its 1H08 result on 11 February. We are forecasting an adjusted NPAT of $81.6M, well up by 134.5% on the pcp. In a performance update to the market on 29 October 2007, management provided reassuring information about the strength expected in the 1H08 result across all divisions. UGL also noted the encouraging prospects for the services business in Asia, with a number of major tenders for new property services under review. UGL is in our Growth and Balanced portfolios. We have a BUY on UGL (Technical Recommendation: HOLD).
Brendon Lau is the editor of ShareAnalysis, a premium retail investment service offered by Aegis Equities Research. Click here for your free trial.
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Please note that CompareShares.com.au simply publishes analyst reports on this page. The publication of these reports does not in any way constitute a recommendation on the part of CompareShares.com.au. You should seek professional advice before making any investment decisions. |
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