GNG 0.55% $1.83 gr engineering services limited

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    GR Engineering (ASX: GNG)


    GR Engineering (ASX: GNG) had entered into contracts with BHP for the design and construction works of the West Musgrave Project in Western Australia. They had been working together since 2023, and in an announcement today, BHP suspended operations at its Nickel West and West Musgrave Project.


    With nickel prices plunging due to the supply glut and Indonesia publicly saying they will continue to flood the market, several nickel mining operations are becoming unprofitable. The total primary nickel stocks are forecasted to reach a four-year high in 2024, limiting significant price recovery for the rest of the year.


    As a consequence of BHP suspending operations, GR Engineering’s contract is up in the air, and shares are reacting. There are, of course, consequences.


    FY24 Dividends to Remain Healthy


    In the short term, there will be no impact on GR Engineering’s revenue and EBITDA guidance for the year ending 30 June 2024. The current forecast is for FY24 EBITDA to be in the range of $50 million to $51 million (FY23 EBITDA: $44.4 million). It will also be achieved from a lower revenue base compared to the prior year. The revenue guidance was recently reduced to a range of $415 to $430 million from a range of $500 to $530 million.


    With earnings guidance remaining the same, we can say with a high degree of confidence that GNG’s FY24 dividends will remain healthy.


    It is hard to say what is priced into GNG because it does not have analyst coverage. But based on GNG’s revenue outlook (taking the mid-point) and assuming that its margins remain the same from 1H24, that is, an NPAT margin of ~7%, we estimate full-year NPAT of $29.5 million – translating into an EPS of ~18 cents a share.


    We can expect GNG to continue to keep its dividends flat and payout 10 cents as the final dividend. This means that it would have to utilise a part of its cash reserves as it has done in the past. But with a very healthy $58 million in reserves, there is an incentive for the management to utilise it and keep shareholders happy.


    Based on these assumptions, it brings the full year FY24 dividend to 19 cps. At current prices, it is a fully franked dividend yield of around 9%.


    Long Term Implications


    In the long term, GNG said that based on the information it currently has available, revenue from the West Musgrave Project will be up to $80 million lower than expected in FY25. This is a sizeable dent in its future revenues and about 20% of its future NPAT (based on a historical NPAT margin of ~7%) – which will impact dividends. The share price reaction has been fair considering.


    GR Engineering has done good work on winning contracts, growing the business, and delivering value to shareholders. Given its track record, one contract suspension does not change our narrative. We can expect GNG to continue winning new contracts in FY25 as the mining industry capex remains healthy.


    The first order of business for GNG will be to try to replace the $80 million in revenues. The company’s revenue visibility remains strong based on the contracted and near-term pipeline of work, ongoing early contractor involvement works, and the high level of study work across a broad range of commodities. The contracted pipeline of work has also recently grown due to the award of the Kathleen Valley Lithium Backfill Project. Therefore, we can expect additional contract awards in FY25.


    It is also important to note that GNG’s core business and its key subsidiaries, GR Production Services Pty Ltd and Mipac Holdings Pty Ltd (including the recent acquisition of Paradigm Engineers Pty Ltd), are performing robustly. Each of these businesses is also forecast to achieve EBITDA growth (by margin and percentage) in FY24 compared to the prior year.


    For a more detailed look into GNG’s operations,our earlier report can be accessed by clicking here.


    Recommendation


    GR Engineering reported that its contract with BHP for the West Musgrave Project is up in the air as BHP decided to suspend its nickel operations. It will have no impact on GNG’s FY24 results as the suspension only comes into effect in FY25. Therefore, we can expect GNG’s dividends to remain healthy, forecasting a 10 cents final dividend.


    The long-term implication is that FY25 revenues can shrink by up to $80 million. While this is bad news, GNG has a solid track record of winning new mining contracts and growing the business. The pipeline of work is strong, and we can expect GNG to replace the loss with new contracts in time. As such, we think the volatility is a good buying opportunity for the long term, and we reiterate a “Buy.”


 
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