Ann: Half Year Accounts, page-18

"revenue stays flat"

Is this a surprise to you? Have you seen that mining capex in Australia is still at record highs? It sure isn't a surprise to the market.


So yes, engineering & construction revenues continue to fall, as expected. But the maintenance & service revenues look quite stable, and may actually be on the increase. These are now over half of total revenues. Only 3 years ago, for the 6 months ending Dec 2013, these were only 25% of total revenues.

So E&C revenues have fallen by over 67% from their heyday peaks. Even if E&C revenues were to fall a further 50% from here (representing a total drop from peak levels of over 80%), in the next few years, the impact to total revenues would be a 23% decline (if M&S can remain steady). On the other hand, if M&S grows by, say, 15% in then next few years, then the aggregate revenue decline will be about 15%, even after a further 50% contraction in E&C revenues.

"margins tighen"

Despite the increasing share of M&S activity, the gross margin is holding steady at a little over 10% (and has actually improved on the 6 month period ending Jul 2016). Operating margins have declined further, yes. But this appears not to be so much the result of shrinking revenues, but rather a deliberate ramp-up (mainly increased employee numbers & business development & tender activities).

So this may auger well for the future.

This has resulted in the EBIT margin falling to about 5.6%. And it means that at current the share price (close to $13) is is trading on EV/EBIT multiple of about 14 (based on my estimate of underlying/operating earnings). Or a "net-cash adjusted earnings yield" (0.7xEBIT/EV) of about 5%. Or a grossed-up dividend yield to EV of about 6.5%.

However, it should be kept in mind that the EBIT number is lower than the cashflow generation, as D&A expense is based on heyday book values. The above EBIT value assumes D&A to the tune of about 1.5% of revenues. Capex is currently running at below 0.5% of revenues! If we assume capex of 0.5% of revenues, then we get a cashflow yield to EV [#] of 5.8%.

To be fair, however, these capex levels are not representative of what will likely be required on a sustainable basis. If we assume capex of about 1% of revenues (seems more plausible) will still get a cashflow to EV yield of about 5.4%.

That, of its own, may not seem all that cheap. But when you consider that the business is generating these sorts of returns at a time of extreme stress, and that the business has a demonstrated ability to pay the lions share of its earnings as a dividend without incurring any performance penalty or without having to seek fresh debt capital, then I think it starts looking more attractive.

When conditions improve, op leverage should be quite noticeable, on the upside (as I've already said, costs are currently running head of prospective revenues). On the other hand, if conditions remain stagnant and the light-at-the-end-of-the-tunnel vanishes, management has room to reduce costs to famine levels (to this point management has actually not done much about trimming the fat at all).


[#]:
=0.7 x (EBIT+D&A-capex)/EV
= 0.7 x (EBIT + 1.5% x rev - 0.5% x rev)/EV
=0.7 x rev x (5.6% + 1.5% - 0.5%)/EV
= 0.7 x rev x 6.6% /EV = 0.7 x $1,250m x 6.6%/EV
, where $1,250m = current annualised revenues