##{"id":58809,"date":"2011-09-08T10:30:20","date_gmt":"2011-09-08T00:30:20","guid":{"rendered":"http:\/\/www.fnarena.com\/index.php\/2011\/09\/08\/top-picks-in-engineering-contracting\/"},"modified":"2011-09-08T10:30:20","modified_gmt":"2011-09-08T00:30:20","slug":"top-picks-in-engineering-contracting","status":"publish","type":"post","link":"https:\/\/staging.fnarena.com\/index.php\/2011\/09\/08\/top-picks-in-engineering-contracting\/","title":{"rendered":"Top Picks In Engineering & Contracting"},"content":{"rendered":"

\n\t– Engineering and Contractor sector results met expectations
\n\t– Weak macro outlook a threat to earnings
\n\t– Higher costs and margin pressures also an issue
\n\t– Brokers highlight their sector preferences<\/strong><\/p>\n

\n\tBy Chris Shaw<\/p>\n

\n\tFor Australian engineering and contracting companies the recent FY11<\/span> reporting season was largely a case of delivering results in line with expectations rather than beating market estimates. Earnings per share growth in average came in at 15.7% according to UBS, while balance sheets improved as debt levels declined.<\/p>\n

\n\tHighlights in the period were sales growth and some margin expansion, BA Merrill Lynch noting this was particularly the case for early cycle plays, these companies benefiting from higher capacity utilisation<\/span>.<\/p>\n

\n\tThe major issue to emerge from reporting season according to BA-ML is a worsening macroeconomic environment threatens to derail what are currently optimistic earnings growth forecasts. This suggests some economic stability and a re-acceleration of global growth will be the major sector driver from here, as at present it is difficult to justify being more optimistic regarding forecasts.<\/p>\n

\n\tFor BA-ML this uncertainty means late cycle plays offer the greatest opportunity to outperform as new contracts should deliver some increase in margins. In contrast, early cycle companies will be more heavily reliant on capex<\/span> to deliver incremental earnings growth.<\/p>\n

\n\tAt the same time, Deutsche Bank notes increasing levels of competition are generating some margin pressures on new contracts. This is especially the case in relation to electrical and mechanical work in the resources sector and infrastructure maintenance work.<\/p>\n

\n\tA key risk in Deutsche's view is labour<\/span> costs, as companies that need to increase their headcount in Australia in particular may experience additional margin pressure given the ongoing wage rises in recent years.<\/p>\n

\n\tThe other issue for Deutsche Bank is the prospect of a further deterioration in operating cashflows<\/span> across the sector in FY11<\/span>, thanks to both problematic contracts and weak market conditions. Deutsche sees scope for this trend to extend through FY12<\/span>.<\/p>\n

\n\tUBS is more positive, suggesting the outlook for the mining services industry in general could be strengthening given a solid level of contract announcements recently, contractors being locked in for significant periods of time and ongoing tendering activity on projects yet to reach a final investment decision.<\/p>\n

\n\tFor UBS, investors should focus on quality, growth and valuation when considering investing in the mining services sector. Building a matrix including these variables leads to NRW<\/span> Holdings ((NRW<\/span>)), Monadelphous<\/span> ((MND<\/span>)) and Fleetwood ((FWD)) generating the highest scores according to UBS. All three stocks score Buy ratings. <\/p>\n

\n\tElsewhere in the sector, UBS also has Buy ratings on Ausenco<\/span> ((AAX<\/span>)), Boom Logistics ((BOL<\/span>)), Bradken<\/span> ((BKN<\/span>)), Emeco<\/span> Holdings ((EHL<\/span>)), Industrea<\/span> ((IDL<\/span>)), Macmahon<\/span> ((MAH<\/span>)) and Mermaid Marine ((MRM<\/span>)).<\/p>\n

\n\tIn contrast, BA-ML's suggestion late cycle plays are now better placed means the broker's top picks in the sector are Bradken<\/span>, Sedgeman<\/span> ((SDM<\/span>)) and Mastermyne ((MYE)). Bradken<\/span> offers leverage to both capex<\/span> and increasing production volumes, Sedgeman<\/span> has a growing presence in offshore markets and Mastermyne has continued to win new contracts that are boosting earnings.<\/p>\n

\n\tDeutsche adjusted some ratings during reporting season, upgrading Boart Longyear ((BLY)) to a Buy while downgrading Transfield Services ((TSE)) to a Hold rating. <\/p>\n

\n\tThe upgrade for Boart Longyear reflects strong demand for its drilling services products and increasing productivity levels from new drill rigs, while the downgrade for Transfield was the result of the company's need for more capex<\/span> to obtain previous growth projections.<\/p>\n

\n\tBoart Longyear becomes the top sector pick for Deutsche Bank, while Buy ratings are also ascribed to WorleyParsons ((WOR)) and Leighton Holdings ((LEI)). The former is favoured for exposure to recovering oil and gas markets and the potential for a positive earnings surprise from further margin recovery, while Leighton is a Buy on valuation grounds as the current 15% discount to the market is unwarranted in Deutsche's view.<\/p>\n

\n\tFurther down the pecking order, Deutsche has Hold ratings on UGL ((UGL)), Downer EDI ((DOW)) as well as for Transfield. For UGL the stable earnings stream is attractive but this is priced in at current levels according to Deutsche, while a subdued outlook for Downer EDI's markets is likely to limit potential for outperformance. There is also ongoing risk relating to the execution and funding of the Waratah trains project.<\/p>\n

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