CIMIC Group, like others in the infrastructure construction sector, had a difficult 2020. The pandemic led to a delay in the awarding of new projects and a slowdown in revenue.
Its construction business also suffered from the delay of major projects including Melbourne’s North East Link and Sydney’s M6 Motorway.

"The company had work in hand of $30.1 billion at December’s end, adjusted for 50 per cent [mining services provider] Thiess sale," says Morningstar senior equity analyst Mark Taylor.

"On a like-for-like basis, this is an 8 per cent decline on the prior corresponding period, with temporary delay in the award of new projects due to covid-19."

But the tide could be beginning to turn, and shares are going cheap, says Taylor. CIMIC (ASX: CIM) is expected to benefit from numerous government stimulus packages in core construction and services markets. More recent substantial transport infrastructure contracts awarded include the WestConnex M4-M5 Link Rozelle ($1.95bn), the Brisbane Cross River Rail ($2.73bn) and the Monash Freeway stage 2 ($761m over 3 years). The 2020-21 Federal Budget featured a $7.5 billion investment in transport infrastructure around Australia as part of the covid-19 economic recovery plan.

CIMIC says the market outlook remains positive for construction and services, with new work recovering, and Taylor agrees, saying more opportunities exist through the company's strong private public partnership pipeline.

"At the current share price, CIMIC shares remain materially undervalued, in 5-star territory," Taylor says.

"A demonstrable pickup from the current slow pace of new contract awards is likely necessary to catalyse share price appreciation to fair value."

ASX Engineering & Construction Industry | Morningstar Coverage

Source: Morningstar

On Monday, CIMIC announced its specialist building company had been selected to deliver Brisbane's Ferny Grove Central development, with an accompanying modest rise in its share price. CIMIC expects the new Ferny Grove Central contract to generate roughly $100 million in revenue for CPB Contractors. Other recently awarded projects include an upgrade to the Queensland Bruce Highway and upgrades to the Gippsland line with Rail Projects Victoria and operation and maintenance of rail infrastructure for the NSW Country Regional Network.

CIMIC announced in February that it would voluntarily hand back about $20 million in JobKeeper subsidies received by some of its smaller subsidiaries during the pandemic in an apparent attempt to improve its relationship with government and win more infrastructure projects.

Mining exposure reduced

Taylor adds that CIMIC's reduced exposure to the mining sector should see it become more leveraged to the public infrastructure investment cycle. This followed the sale of its 50 per cent interest in Thiess to Elliott Advisors in October 2020. Taylor views this shift as positive given Morningstar's more sober outlook for the mining segment than the market has in general.

"In addition to the cash proceeds, the Thiess sell-down reduces CIMIC’s lease liability balance by approximately $500 million," he says.

"And capital intensity is likely to temper going forward with exposure to the equipment heavy mining contracting sector now lessened. This should enhance the rate of cash conversion."

Taylor also anticipates a full takeover bid for CIMIC is on the cards, with fewer and fewer shares up for purchase. In March, its major shareholder, Hochtief, took the opportunity offered by the market rout to increase its stake to 75.6 per cent from 72.7 per cent, and CIMIC itself is buying back shares under its on-market program, Taylor notes.

With a fair value estimate of $33.00, no-moat CIMIC is trading at a 47 per cent discount. The share price has been on a year-on-year decline since 2018.

CIMIC Price v Morningstar Fair Value | 5 Yr



Source: Morningstar

Swing to profit 

CIMIC disappointed the market in February, issuing guidance for 2021 NPAT of $400 million to $430 million. The market also reacted negatively to a 25 per cent decline in underlying 2020 NPAT to $597 million. This pushed CIMICs shares down 17 per cent to $21.56. They've since fallen further, closing at $17.4 on Tuesday. 

Statutory NPAT increased to positive $617 million from negative $1.04 billion on the divestment of 50 per cent of Thiess. The prior year included large Middle East exit costs following the sale of its 45 per cent stake in the BIC Contracting joint venture. 

Faced with a confusing picture of material gains and losses, Taylors says investors should pay attention to the company's cash flow statement, which was considerably better than expected.  

"Net operating cash flow fell to negative $265 million, including negative $1.5 billion lagged cash impact from the prior year's Middle East exit," he says.  

"And free cash flow increased to positive $1.3 billion from negative $262 million, including Thiess sell-down proceeds, again much better than we'd expected. 

"This enabled the group to retain a modest net cash position of $186 million despite $281 million in buybacks which reduced shares on issue by 4 per cent to 311 million."