Wagners - Morgans

Building Materials│Australia│Equity research│January 30, 2018

Wagners Building the future

ADD Current price: Target price: Previous target: Up/downside: Reuters: Bloomberg: Market cap:

A$3.80 A$4.21 A$ 10.8% WGN.AX WGN AU US$495.8m A$613.2m US$2.55m A$3.35m 161.4m 47.2%

Average daily turnover: Current shares o/s Free float:

Vol m

Price Close

Relative to S&P/ASX 200 (RHS)

4.00

151.3

3.50

132.5

3.00

113.8

2.50 25 20 15 10 5

95.0

Dec-17

Dec-17

Jan-18

Jan-18

Absolute (%) Relative (%)

1M -4.8 -4.5

3M

recommendation and A$4.21 price target.

■ Highly adaptive, WGN’s business has been positioned to be able grow and shrink with each phase of the construction cycle in its home market of Queensland.

■ WGN will unlock growth from its re-entry into fixed concrete and aggregates following an end to a five-year non-compete.

■ The threat from imported cement is minimal, while the domestic market remains orderly and is expected to experience growth in Queensland.

■ We see now as an opportune time to invest in WGN, aided by powerful tailwinds.

Early cycle multiples rarely look attractive The positive demand fundamentals we see building in infrastructure, combined with WGN’s ability to flex into each cycle upturn, leaves us with the view that WGN still holds attractive value at current prices despite appearing expensive on FY18 multiples. Meanwhile, the cyclicality of earnings leaves construction materials stocks often appearing expensive at the bottom of each construction cycle and cheap at the top (true for WGN’s peers also). The pace of the rise in activity, combined with WGN’s ability to secure contracts, will dictate how much upside potential exists.

Playing a different game

Source: Bloomberg

Price performance

■ We initiate research coverage on Wagners Holding Company (WGN) with an Add

12M

Given WGN’s adaptive operating model, each construction cycle tends to deliver material EPS expansion with small changes in margins. This has positioned WGN’s business to remain fiercely competitive with its larger peers (who conversely aim to leverage off economies of scale) even in times of weak demand conditions. We view WGN’s high adaptability as a core strength that has allowed it to defend profitability.

Adrian PRENDERGAST

High earnings watermark

T (61) 3 9947 4134

Increased activity visible for FY18 and FY19, from: a) incremental cement volume growth, b) further work on the Toowoomba Second Range Crossing, c) expansion in CFT production capacity, and d) ramp up of recent haulage/crushing contracts, will grow earnings over the next two years. This growth could accelerate considerably depending on future potential projects being pursued by WGN, such as: 1) Cross River Rail Project, 2) Inland Rail Project, 3) Adani airport, 4) tendered for offshore LNG project, 5) rapid reentry into fixed concrete, 6) new windfarm project, 7) Surat/QLD CSG related work, and/or 8) overseas penetration of CFT/EFC.

E [email protected] Alexander LU, CFA T (61) 2 9043 7901 E [email protected]

Initiate coverage with an Add recommendation We initiate research coverage on WGN with an Add recommendation and A$4.21 valuation-derived price target. Supported by strong profitability, a conservative balance sheet capable of pursuing new growth, and solid execution track record, we see WGN as an attractive exposure to improving construction activity on Australia’s east coast, while developments on a number of catalysts could deliver further upside.

Financial Summary Revenue (A$m) Operating EBITDA (A$m) Net Profit (A$m) Normalised EPS (A$) Normalised EPS Growth FD Normalised P/E (x) DPS (A$) Dividend Yield EV/EBITDA (x) P/FCFE (x) Net Gearing P/BV (x) ROE % Change In Normalised EPS Estimates Normalised EPS/consensus EPS (x)

Jun-17A 192.7 40.12 15.18 0.09 40.38 0.00 0.00% 16.80 24.12 95.5% 9.65

Jun-18F 232.5 51.04 25.39 0.16 67.2% 24.15 0.07 1.82% 13.21 47.94 78.7% 7.88 35.9%

Jun-19F 311.0 65.00 31.56 0.20 24.3% 19.43 0.12 3.09% 10.29 25.03 61.6% 6.78 37.5%

SOURCE: MORGANS, COMPANY REPORTS

IMPORTANT DISCLOSURES REGARDING COMPANIES THAT ARE THE SUBJECT OF THIS REPORT AND AN EXPLANATION OF RECOMMENDATIONS CAN BE FOUND AT THE END OF THIS DOCUMENT. MORGANS FINANCIAL LIMITED (ABN 49 010 669 726) AFSL 235410 - A PARTICIPANT OF ASX GROUP

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Figure 1: Wagners Holding Company – Financial summary Profit and Loss (A$m) Revenue Other income Operating costs EBITDA D&A EBIT Net interest PBT Income tax Normalised NPAT Significant items Reported NPAT Reported EPS (cps) Norma l i s ed EPS (cps ) DPS (cps) Div payout ratio (%) Franking (%)

Jun-16A 195.3 2.6 -154.2 43.7 -15.3 28.4 -6.2 16.1 -4.1 18.2 -6.2 12.0 7.4 11.3 0% 0%

Jun-17A 192.7 2.7 -155.2 40.1 -11.8 28.3 -6.5 22.0 -6.6 15.2 0.2 15.4 9.5 9.4 0% 0%

Jun-18E 232.5 2.1 -183.6 51.0 -9.5 41.5 -5.3 36.3 -10.9 25.4 25.4 15.7 15.7 6.9 44% 0%

Jun-19E 311.0 2.1 -248.1 65.0 -14.5 50.5 -5.4 45.1 -13.5 31.6 31.6 19.6 19.6 11.7 60% 100%

Jun-20E 353.7 2.1 -284.2 71.7 -16.3 55.4 -5.4 50.0 -15.0 35.0 35.0 21.7 21.7 13.0 60% 100%

Cash Flow Statement (A$m) EBITDA Net interest Tax paid Changes in working capital Other operating cash flow Operating cash flow Capex Free cash flow

Jun-16A 43.7 -4.1 9.3 -1.0 47.9 -0.9 47.1

Jun-17A 40.1 -6.6 2.5 -0.9 35.2 -4.1 31.0

Jun-18E 51.0 -5.3 -10.9 -3.0 31.9 -21.2 10.7

Jun-19E 65.0 -5.4 -13.5 -5.3 40.7 -16.2 24.5

Jun-20E 71.7 -5.4 -15.0 -2.9 48.3 -14.6 33.8

Asset Sales/Purchases Other Investing cash flow

3.2 -

2.2 -

-

-

-

Investing cash flows Increase / decrease in Equity Increase / decrease in Debt Dividends paid Other financing cash flows Financing cash flows

2.3

-1.9

-21.2 2.1 -11.2 -9.0

-16.2 -18.9 -18.9

-14.6 -21.0 -21.0

Jun-17A

Jun-18E

Jun-19E

Jun-20E

6.3

7.9

13.5

28.3 12.4 0.9 47.8 108.8 8.2 117.0 164.8

33.7 15.3 0.9 57.9 120.5 8.2 128.7 186.6

11.1 33.3 44.4 55.9 0.9 56.8 369.6 -304.2 -1.8 63.6

Balance Sheet (A$m) Assets Cash And Deposits Debtors Inventory Other Current Assets Total Current Assets PP&E Other Non-Current Assets Total Non-Current Assets TOTAL ASSETS Liabilities Short Term Debt Other Current Liabilities Total Current Liabilities Long Term Debt Other Non-Current Liabilities TOTAL LIABILITIES Equity Issued Capital Retained Earnings Other Reserves and FX TOTAL EQUITY

Key Metrics/Multiples Normalised PE Reported PE EV / EBITDA EV / EBIT P/FCF FCF Yield Dividend Yield Normalised ROE Normalised ROA

Jun-17A 28.8 28.4 12.4x 17.6x 8.1x 7.6% 0.0% 23.9% 12.0%

Jun-18E 24.0 24.0 13.2x 16.2x 35.4x 1.7% 1.8% 32.6% 15.6%

Jun-19E 19.3 19.3 10.3x 13.3x 15.4x 4.0% 3.1% 34.9% 16.8%

Jun-20E 17.4 17.4 9.2x 11.9x 11.2x 5.5% 3.4% 33.5% 16.8%

Jun-17A 20.8% 14.7% 11.4% 7.9%

Jun-18E 22.0% 17.9% 15.6% 10.9%

Jun-19E 20.9% 16.2% 14.5% 10.1%

Jun-20E 20.3% 15.7% 14.1% 9.9%

Jun-17A 60.7 95.5% 48.9% 4.4x 1.5x

Jun-18E 61.2 78.7% 44.0% 7.9x 1.2x

Jun-19E 61.3 67.8% 40.4% 9.3x 0.9x

Jun-20E 52.1 49.9% 33.3% 10.2x 0.7x

DCF Valuation Operational CF Terminal CF Gross NPV

A$m 319.9 425.7 745.6

A$/share 1.98 2.64 4.62

Net Debt NPV

-60.3 685.3

-0.37 4.25

Margins (%) EBITDA margin EBIT margin PBT margin NPAT margin

Jun-16A 22.4% 14.6% 8.2% 9.3%

Gearing Net debt Net Debt / Equity Net Debt / (ND+E) EBIT Interest Cover (x) ND/EBITDA (x)

Premium(/discount) to SP

11.8% 9.0%

WACC (%)

A$m 65.0 12.0x 780.0 -60.3 719.7

A$/share

26.2

Multiple Valuation EV / EBITDA FY19F EBITDA Multiple applied Enterprise valuation Net debt EV / EBITDA valuation

45.1 20.5 0.9 80.0 122.3 8.2 130.5 210.4

51.3 23.3 0.9 101.7 120.6 8.2 128.8 230.5

PE Valuation FY19F NPAT Multiple applied Enterprise valuation Net debt EV / EBITDA valuation

A$m 31.6 22.0x 694.3 -60.3 634.0

A$/share

11.1 38.7 49.8 58.0 0.9 59.0

11.1 49.9 61.1 58.0 0.9 59.0

11.1 56.0 67.2 58.0 0.9 59.0

369.6 -289.9 -1.8 77.8

369.6 -277.3 -1.8 90.4

369.6 -263.3 -1.8 104.4

Premi um(/di s count) to SP Blended Valuation DCF EV / EBITDA PE Total valuation Premi um(/di s count) to SP Di vi dend Total expected shareholder return (TSR) Shares (millions)

4.83 -0.37 4.46

4.30 -0.37 3.93

3.4% Weight 33% 33% 33%

A$m 685.3 719.7 634.0 679.7

A$/share 4.25 4.46 3.93 4.21

17.4% 3.1% 20.4% 161.4

SOURCE: MORGANS RESEARCH, COMPANY

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Contents Section 1: Executive summary ....................................................................................................... 4 Five reasons to own WGN............................................................................................................. 4 Catalysts ....................................................................................................................................... 4 Company overview ........................................................................................................................ 4 Industry overview .......................................................................................................................... 5 Valuation snapshot ........................................................................................................................ 6 Key advantages ............................................................................................................................ 7 Growth opportunities ..................................................................................................................... 8 Proposed QLD cement import terminal ........................................................................................ 10 Snapshot of company financials .................................................................................................. 11 Key risks ..................................................................................................................................... 12 Section 2: Company overview ...................................................................................................... 13 SWOT analysis ........................................................................................................................... 14 Cement ....................................................................................................................................... 15 Concrete ..................................................................................................................................... 16 Reinforcing steel ......................................................................................................................... 16 Aggregates/crushing ................................................................................................................... 16 Transport/haulage ....................................................................................................................... 17 Global services............................................................................................................................ 17 New generation building materials (NGBM) ................................................................................. 18 Key markets ................................................................................................................................ 18 Distribution network ..................................................................................................................... 19 Company history ......................................................................................................................... 19 Intellectual property and protection .............................................................................................. 20 Section 3: Industry overview ........................................................................................................ 21 Barriers to entry........................................................................................................................... 21 There are significant barriers to entry in building materials: ......................................................... 21 Core products.............................................................................................................................. 21 Cement ....................................................................................................................................... 21 Concrete ..................................................................................................................................... 24 Aggregates.................................................................................................................................. 26 New Generation Building Materials (NGBM) ................................................................................ 26 Section 4: Demand environment .................................................................................................. 28 Key demand drivers for construction activity ................................................................................ 28 Broader Australian construction landscape.................................................................................. 29 New infrastructure boom gathering pace ..................................................................................... 29 Other growth opportunities in Queensland................................................................................... 31 Non-residential construction ........................................................................................................ 32 Residential construction .............................................................................................................. 33 Section 5: Key earnings drivers ................................................................................................... 34 Broadening and accelerating CFT growth .................................................................................... 34 Commercialisation of EFC ........................................................................................................... 34 Priority access to a dedicated wharf ............................................................................................ 34 Re-entry into fixed concrete......................................................................................................... 35 Crushing/haulage expanding ....................................................................................................... 35 Potential for high-margin offshore work ....................................................................................... 35 Section 6: Peer comparison ......................................................................................................... 36 Compares well versus larger peers ............................................................................................. 36 Balance sheet well positioned ..................................................................................................... 36 On the right side of the cycle ....................................................................................................... 36 Product offering comparison ........................................................................................................ 37 Section 7: Company financials..................................................................................................... 38 Profit & loss commentary............................................................................................................. 38 Dividend policy ............................................................................................................................ 40 Cashflow comments .................................................................................................................... 40 Section 8: Valuation & peer analysis ........................................................................................... 41 Peer comparison analysis ........................................................................................................... 41 Blended valuation........................................................................................................................ 42 Section 9: Sensitivity analysis ..................................................................................................... 45

3


Section 1: Executive summary Five reasons to own WGN 

Reason #1: Right time. Fuelled by a wave of infrastructure investment spanning a lot of the east coast of Australia, we see construction materials as a favourable market exposure with gains likely to be achieved broadly across the sector.



Reason #2: Right place. WGN’s business is focused primarily on engineering/infrastructure markets in South East Queensland (SEQ), which is just about to enter a growth phase.



Reason #3: Value still on offer. We expect WGN will flex its business into this next cycle and as a result further grow earnings in FY19, highlighting attractive upside not yet priced in.



Reason #4: Solid team. The robustness of WGN’s overarching strategy combined with the ability of its management team to execute have seen WGN defend its position in a fiercely competitive industry.



Reason #5: Positioned to grow. A highly flexible business with ND/EBITDA of just 0.8x has left WGN ideally positioned to pursue new growth as infrastructure construction accelerates in Queensland.

Catalysts Near-term catalysts that could be significant for WGN include: 

Toowoomba Second Range Crossing. Nearing completion with 12-18 months of construction left, but WGN has still been winning new work.



Cross River Rail Project. The $5.4bn rail project could drive higher earnings for key divisions, but also lift margins for smaller segments such as precast (where margins have suffered under lower utilisation).



Inland Rail Project. A mammoth infrastructure project that will go right past WGN’s Toowoomba operations. A strong medium-term catalyst that WGN could win significant work from over the next 3-5 years.



Adani airport. Dependent on the controversial Adani thermal coal mine progressing into development. Construction materials contracts to build the airport could deliver a $30-$40m contract to WGN, with related work to link airport infrastructure potentially multiples larger (access roads, associated infrastructure, etc.).



Wind farm projects. Surging east coast gas prices have driven a wave of new investment in renewables. We expect WGN is likely tendering for work to supply construction materials to new wind farm projects.



CFT (Composite Fibre Technologies) overseas penetration. While CFT crossarm and CFT projects sales continue to grow in Australia, tendering for offshore work (after the appointment of dedicated sales resources) could see WGN’s CFT division achieve materially larger earnings growth in the short term.



EFC (Earth Friendly Concrete) commercial agreement. WGN is progressing an MoU with Indian major JSW, exploring the application of WGN’s EFC product in JSW’s existing concrete operations. While timing is uncertain and we have not factored it into our base case, advancing this JV into a formal commercial agreement would be a strong positive for WGN.

Company overview Wagners Holding Company (WGN) is a leading Australian construction materials and services provider. It is also an innovative developer and producer of newgeneration building materials (NGBM). The company focuses on the manufacture and sale of construction and building materials. WGN offers a wide

4


and highly integrated range of construction and building materials products and related services, including:

Cement; Mobile/on-site concrete; Precast concrete; Fixed concrete; Quarries/crushing; CFT; EFC; Transport/haulage services; and Reinforcing steel.

Industry overview Surge in transport infrastructure: A key demand fundamental development has been the material surge in planned infrastructure spend, with particular focus on (concrete-intensive) transport infrastructure (roads and railways). Both the federal and Queensland governments plan to materially boost investment, which we expect, for Queensland, will result in a 51% year-on-year increase in major project expenditure across all sectors in FY18. The wave of infrastructure will be felt across the majority of Australia’s east coast. This is a core positive for WGN, as it takes the focus of some of its direct competitors away from QLD – potentially easing the degree of competition for new work. Figure 2: Major Australian transport infrastructure projects

SOURCES: MORGANS, COMPANY REPORTS

5


Barriers to entry: There are significant barriers to entry in the building materials sector that make it difficult for new entrants to gain a foothold, including:

high capital intensity; fragmented demand split between population bases; highly competitive industry of strong domestic and global players; and a conservative customer base that typically forms long-term relationships with major participants. Given the high barriers to entry, we view having a robust and differentiated strategy (and effective management to execute) as critical. We believe WGN has both, with a solid track record and robust strategy that has allowed it to emerge as the only independent major construction materials participant in its home market of Queensland.

Valuation snapshot Our 12-month valuation for WGN is A$679.7m, or A$4.21ps. Methods used to arrive at our valuation include a DCF and comparable analysis of PE and EV/EBITDA multiples. Figure 3: Blended valuation A$m

A$ per share

EV/EBITDA valuation (12.0x FY19F EBITDA)

719.7

4.46

PER valuation (22x FY19F NPAT)

634.0

3.93

DCF valuation

685.3

4.25

Blended valuation

679.7

4.21


We view WGN as having a favourable margin, growth and balance sheet advantage over the majority of its peer group, while we balance these positives given WGN’s smaller size. Figure 4: Peer comparison of EV/EBITDA vs ND/EBITDA (x) 25.00x VMC US 20.00x

JHX AU

MLM US

EV / EBITDA

RWC AU 15.00x

EXP US DLX AU

ABC AU

BLD AU CRH ID

TITK GA LHN SW HEI GR

WGN AU

10.00x GWA AU

CSR AU

FBU NZ

5.00x

-

0.50x

1.00x

1.50x ND / EBITDA

2.00x

2.50x

3.00x


6


Figure 5: Comparative company analysis Market Company Construction Materials Australian CM Comparables: Wagners Holding Company Adelaide Brighton** Boral Ltd Offshore CM Comparables: LafargeHolcim HeidelbergCement AG CRH Plc Taiwan Cement Martin Marietta Materials Vulcan Materials Co Eagle Materials Inc Titan Cement Co AVERAGE MEDIAN

Ticker

Currency

Market

Enterprise

EV/EBITDA

P/E

ND/EBITDA

Dividend Yield (%)

Cap ($m)

Value ($m)

FY19

FY19

FY19

FY18

WGN AU ABC AU BLD AU

AUD AUD AUD

618 4,151 9,261

679 4,565 11,595

10.60x 11.93x 11.65x

19.70x 21.06x 20.57x

0.92x 0.78x 2.13x

3.0% 4.0% 3.7%

LHN SW HEI GR CRH ID 1101 TT MLM US VMC US EXP US TITK GA

CHF EUR EUR TWD USD USD USD EUR

35,703 17,857 25,848 141,041 15,160 18,674 5,829 1,927

55,193 29,023 33,006 220,101 16,775 20,780 6,475 2,909

9.47x 8.92x 10.15x 10.17x 17.25x 20.73x 12.92x 9.92x 12.23x 10.39x

19.01x 15.92x 18.90x 18.81x 35.28x 47.45x 23.72x 28.67x 24.91x 20.69x

2.52x 2.73x 1.64x 2.02x 1.70x 1.72x 1.36x 2.25x 1.88x 1.87x

3.6% 2.8% 2.3% 5.3% 0.8% 0.7% 0.3% 2.0% 2.6% 2.6%

CSR AU FBU NZ JHX AU DLX AU GWA AU RWC AU

AUD NZD AUD AUD AUD AUD

2,452 5,161 9,372 2,865 742 2,258

2,510 7,177 8,212 3,249 817 2,493

6.38x 9.11x 17.93x 12.35x 9.58x 16.91x

12.57x 16.08x 29.99x 19.50x 14.26x 28.67x

0.03x 2.48x 1.17x 1.43x 0.89x 1.60x

5.4% 5.4% 2.0% 4.5% 5.5% 2.3%

USG US IPX US

USD USD

5,867 4,430

6,311 3,980

10.23x 6.38x

24.08x 13.67x

0.92x -0.45x

0.7%

Wienerberger AG

WIE AV

EUR

2,613

3,595

8.67x

20.65x

1.55x

1.8%

Compagnie de Saint Gobain

SGO FP

EUR

26,524

33,708

7.93x

16.33x

1.29x

2.8%

10.43x

19.27x

1.08x

3.0%

9.35x

17.91x

1.21x

2.6%

Building Products Australian BP Comparables: CSR Ltd** Fletcher Building James Hardie Industries** DuluxGroup** GWA Group Reliance Worldwide Corp Offshore BP Comparables: USG Corp Louisiana-Pacific Corp

AVERAGE MEDIAN *EV based on mid-point of Morgans blended valuation range **ABC, CSR, JHX, DLX multiples adjusted to a June-end equivalent

Prices as at 29 January 2018. SOURCES: MORGANS, COMPANY REPORTS

Key advantages Powerful earnings tailwind. WGN stands to benefit from a surge in government and private expenditure planned for Australia (with WGN’s home market in SEQ a particular target for investment bolstered by state government spending plans). WGN’s sales revenue has demonstrated a historical correlation to overall Queensland major project expenditure, which is a positive considering the magnitude of spend already approved for between 2018-2021 and beyond.

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Figure 6: Queensland major projects (A$m)

SOURCE: QLD ENGINEERING CONSTRUCTION OUTLOOK

Long-term offtake: Signed in 2011, WGN has a 20-year take-or-pay cement offtake agreement with construction materials peer Boral. The agreement accounted for ~45% of WGN’s cement volumes in FY17 (225kt). The contract has fixed volume and price growth mechanism built into it that helps underpin WGN’s forward earnings expectations and underlying profitability during periods of demand/price volatility across construction materials markets. Overweight infrastructure; underweight residential. WGN’s FY17 revenue was split between 55% infrastructure, 30% non-residential, and 15% residential construction, with a notable undersized exposure to residential construction activity. This could see WGN outperform its key peer group (all of whom hold much higher exposure to residential activity and more exposure to infrastructure). Figure 7: Revenue split by end market (%) F-1 66%

70% 60%

55%

50% 40%

34%

31%

30%

30%

22% 20%

15%

16%

15%

13%

10%

3%

0%

0%

Infrastructure/engineering

Residential

BLD

Non-Residential

WGN

Other

ABC SOURCES: MORGANS, COMPANY REPORTS

Growth opportunities More ‘big projects’ – FY19 far from peak profit potential The downcycle in Queensland construction that resulted from the end of the mining boom (and following LNG explosion), has seen an absence of projects of significant scale that normally drive WGN's earnings. As a result, even with an uptick in work expected for WGN in FY19 (from higher cement, aggregates, transportation, crushing, and CFT volumes), we still consider it a typical year with considerable upside potential from the prospect of larger contract wins (such as Cross River Rail Project, Adani airport, Surat CSG, and/or Inland Rail Project). 8


CFT adds ‘X factor’ One of the largest potential growth kickers we see in WGN is the CFT business. While base case assumptions would see sales continue to accelerate at a gradual pace across CFT crossarms and projects, we also recognise realistic scenarios where this sales growth rate could materially accelerate. The prime reason for this view is WGN’s strong share of new power line crossarm sales (50% market share of crossarm sales in Australia), and the fact that WGN so far has a market share of ~10% of total existing crossarm sales (which WGN estimates at ~6.5m units) leaving significant room for increased market penetration. Adding to this, a large and growing proportion of ~6m existing timber and steel crossarms are approaching (or have already passed) their useful life in Australia. Figure 8: CFT crossarm sales scenarios Australian crossarm market Addressable crossarm market

6,500,000

Replacement rate of addressable market WGN CFT crossarm sales to date

3% 650,000

WGN market share - installed

10%

WGN CFT crossarm sales to date (FY17) WGN market share - new sales

90,000 50%

97,500

14.6

Crossarm % Total CFT % Group EBITDA Group EBITDA 3.7 5.7% 9.3%

4%

130,000

19.5

4.9

7.6%

11.2%

5%

162,500

24.4

6.1

9.5%

13.1%

6%

195,000

29.3

7.3

11.4%

15.0%

7%

227,500

34.1

8.5

13.3%

16.9%

8%

260,000

39.0

9.7

15.2%

18.8%

9%

292,500

43.9

11.0

17.1%

20.7%

10%

325,000

48.8

12.2

19.0%

22.6%

Crossarm replacement rate 3% per annum

Units

Revenue

EBITDA


Mining recovery WGN has already gained from a turnaround in commodity prices, having signed three new long-term transportation/haulage contracts with three separate mining companies over the last c12 months. We see this growth as opportunistic on WGN’s part, with the company mobilising existing fleet to add new business in an area which we view as attractive in terms of margin and return on investment. We view this as an area for potential further growth not currently factored into our base case or WGN’s forecasts. Gas/renewables boom We observe a potentially larger opportunity for growth building in Queensland gas. Our research on the east coast gas market highlights that the current gas supply deficit could become more severe under a number of potentially likely scenarios (i.e. higher Asian LNG prices incentivising Gladstone-based LNG producers to redirect more gas supply offshore). In our view this is likely to result in increased investment in Queensland’s prominent CSG plays (mainly the Surat basin, but also potentially the Bowen and Galilee basins) over the coming decade. WGN is well placed to service the gas industry, with its mobile/on-site concrete business having already worked in the Surat CSG fields for a number of years. The surge in east coast electricity prices has also driven investment in renewable energy generation. The wind and solar construction drive that has resulted presents another demand kicker, in our view.

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Figure 9: Overview of Queensland construction pipeline by region (A$ billions)

SOURCES: IBIS, ABS

Re-entry into fixed concrete At present, WGN supplies its ready-mix concrete to project-based customers through its fleet of mobile and on-site concrete batching plants. However historically WGN was also a significant participant in downstream fixed plants throughout SEQ, until selling these assets to Boral in 2011. With the December 2016 expiry of a non-compete agreement (attached to the historical fixed concrete transaction between WGN/Boral), WGN now plans to utilise its downstream expertise to open up a new avenue of growth for its construction materials business. At the heart of these plans is WGN's intention to maximise: 1) cement volumes sold, and 2) increase downstream control and create greater marketing optionality for its cement (by placing cement tonnes into the downstream market itself). We view this as an opportunity for WGN to increase cement sales, which would see the Vertical Roller Mill (VRM) at Pinkenba ramped up closer to full utilisation. We also expect it provides long-term optionality for WGN to plan for a post-Boral offtake future (post-2031).

Proposed QLD cement import terminal Southern Cross Cement At its November 2017 AGM, building products supplier Brickworks Limited (BKI) announced it had been granted approval to develop a cement import terminal within the Port of Brisbane, along with joint venture partners Neilsen Group (WGN customer) and Neumann Group. The proposed terminal is only at an early stage of predevelopment, with BKI making preliminary estimates of: 

Capex: A total construction cost for the terminal of circa A$50m



Timing: Development and commissioning timeframe of 18 months



Capacity: Combined cement demand from the JV of 200,000 tonnes per annum

Our view on import terminal We consider BKI’s early estimates to be bordering optimistic, and see the more probable outcome from a development scenario for the terminal as less positive: We view A$50m as a low capex estimate for a 150-200ktpa cement terminal on a greenfield site that likely needs significant earthworks first. We expect either: 1) capex to stay low and Southern Cement to use specialised cement ships (which will save capex but hurt margins), or 2) capex to rise from the current A$50m estimate as the scope of work increases to include all of the necessary infrastructure and extra earthworks such as piling (if necessary). Option 2 would see the capex budget potentially rise, but then allow for use of cheaper bulk 10


shipping. It is hard to envisage effective import of cement without the use specialised port or vessel infrastructure (increasing either the capital intensity or operating cost structure of the proposed terminal). Key to the 18-month expected timeframe will be the joint venture's ability to arrange necessary financing, sanction the project, secure cement supply from a producer (most likely Chinese), and construct the terminal. We estimate BKI and Neumann’s cement demand at ~40,000 tonnes each per annum, and Neilsens at ~105,000 tonnes. The JV parties will need to sustain elevated cement demand to prevent the return on investment in the cement terminal from deteriorating. Implication for WGN The worst case scenario for WGN, if the import terminal proceeds, is a circa 20% decline in cement volumes (~105,000 tonne per annum), although we expect there is a high probability that WGN will be able to place these tonnes elsewhere. Prior to the announcement of the proposed import terminal, WGN had outlined plans for a very slow re-entry into fixed concrete. This gradual growth back into fixed concrete was aimed at creating the least amount of disturbance for WGN customers like Neilsens, who also compete in downstream construction materials markets. Namely, WGN planned to roll out two new fixed concrete batch plants per annum over the next five years. With Neilsens now exploring the possibility of an import terminal, there is no longer any need for WGN to tip toe its way back into downstream. As a result we expect WGN to accelerate a reduced 2-3 year roll out of fixed concrete plants. This would give WGN the ability to replace any lost volumes from a Neilsens departure in circa FY20 (plugging a potential hole in earnings). Wider risk from imports The ever present risk of cement imports has loomed for several years, but so far failed to materialise meaningfully. Examples where cement is being imported include a repurposed aluminium facility in WA, Holcim import activities into New Zealand, and Adelaide Brighton cement imports from South Australia into Victoria. We see these as cases where specific conditions justified the investment, WA being comparatively isolated in terms of construction materials supply, Holcim seeking to cut its cost structure in NZ, and ABC looking to leverage off its advanced operational facilities in South Australia. However generally we do not anticipate imported cement to be competitive against domestic supply. Factors such as currency exposure, uncertainty around consistency of imported cement quality, and the great technical difficulties of transporting the heavy construction material, leave us with the view that local integrated cement producers will maintain the upper hand in the competitive landscape.

Snapshot of company financials Growth in earnings is a feature of WGN’s historical and forecast financials. While the company forecasts revenue to have declined by a -3.0% CAGR between FY15 and FY18F, EBITDA during the same period is expected to have a positive 17.0% CAGR (FY15-FY18F), while EBIT is forecast at a 21.0% CAGR. EBITDA/EBIT margins both expanded significantly between FY15 and FY17. Despite lower revenues during this period, WGN’s EBITDA margin grew from 15% to 22%, while the EBIT margin expanded from 7.0% to 14.7%. In FY18, the company expects further incremental margin growth, with WGN forecasting EBITDA/EBIT margins of 21.8% and 17.7%, respectively.

11


Figure 10: Profit & loss summary $m

FY15A

FY16A

FY17A

FY18F

FY19F

Revenue

250.7

195.3

192.7

232.5

311.0

353.7

Cost of sales

-99.7

-84.1

-83.8

-91.8

-124.0

-142.1

Gross profit

151.0

111.2

108.9

140.7

186.9

211.6

6.0

2.6

2.7

2.1

2.1

2.1

-120.2

-70.0

-71.4

-91.8

-124.0

-142.1

Other income Operating costs EBITDA

FY20F

36.8

43.7

40.1

51.0

65.0

71.7

-19.1

-15.3

-11.8

-9.5

-14.5

-16.3

EBIT

17.6

28.4

28.3

41.5

50.5

55.4

Fair value adjustments on derivative instruments

-3.7

-2.7

2.5

-

-

-

-13.9

-3.5

-0.0

-

-

-

-

-

-2.3

-

-

-

Net finance costs

-7.3

-6.2

-6.5

-5.3

-5.4

-5.4

Profit before tax

-7.3

16.1

22.0

36.3

45.1

50.0

2.4

-4.1

-6.6

-10.9

-13.5

-15.0

-4.9

12.0

15.4

25.4

31.6

35.0

n.a.

-22.1%

0.0%

0.0%

-1.4%

n.a.

60.2%

56.9%

0.0%

0.0%

56.5%

60.8%

Depreciation & amortisation

Impairment of property, plant & equipment Onerous contract expense

Income tax expense NPAT Key financial metrics Revenue growth (%) Gross margin (%) Gross margin growth (bp)

n.a.

-3.3

-56.9

-

56.5

4.3

EBITDA growth (%)

n.a.

19.0%

-8.3%

27.2%

27.3%

10.3%

EBIT growth (%)

n.a.

61.5%

-0.4%

46.8%

21.6%

9.7%

NPAT growth (%)

n.a.

100.0%

28.0%

65.1%

24.3%

10.9%

0.1466

22.4%

20.8%

22.0%

20.9%

20.3%

n.a.

7.7

-1.6

1.1

-1.1

-0.6

7.0%

14.6%

14.7%

17.9%

16.2%

15.7%

n.a.

7.5

0.1

3.2

-1.6

-0.6

EBITDA margin (%) EBITDA margin growth (bp) EBIT margin (%) EBIT margin growth (bp)


Key risks 

Lumpy revenue: The project-focused nature of WGN’s operating model does leave the business exposed to higher volatility in earnings during certain periods.



Queensland residential slowdown: While holding a comparatively smaller exposure relative to its peers, a sharper-than-expected slowdown in Queensland residential construction activity would have a negative impact on WGN’s earnings.



Customer risk: WGN has two major cement customers. While one of these customers (Boral) is secured under a 20-year take-or-pay offtake agreement, the other major customer is not which does pose some risk.



Key man risk: A large part of WGN’s success can be attributed to the track record of key members of its board and management team, leaving the company exposed to key man risk.



Raw material cost risk: WGN is exposed to potential price (and foreign exchange) volatility relating to its use of imported raw materials that could drag on earnings expectations in a scenario of greater-than-expected cost inflation.



New product risk: The construction industry is notoriously slow to adopt new technology, despite the strong argument for innovation in a number of areas. This could impact the effectiveness of WGN’s plans (and investment) in ramping up volumes from its NGBM division.

12


Section 2: Company overview WGN is a leading Australian construction materials and services provider. It is also an innovative developer and producer of new-generation building materials (NGBM). The company focuses on the manufacture and sale of construction and building materials. Figure 11: WGN FY17 revenue by product

Figure 12: WGN FY17 revenue by market



WGN offers a wide and highly integrated range of construction and building materials products and related services. 

Cement. WGN’s largest segment by revenue. The company currently produces 0.5mtpa of cement at its modern cement grinding facility in Pinkenba, Queensland (with production capacity of 0.8mtpa).



Mobile/on-site concrete. WGN operates a mobile and on-site concrete batching and crushing fleet, used to service a wide range of customers often in remote locations.



Precast concrete. WGN operates a large precast concrete manufacturing facility, which is used to produce predominantly larger precast concrete products.



Fixed concrete. A growth avenue for the business. WGN plans to reestablish a fixed concrete network, with the first two sites due to be operational by Q4 FY18.



Quarries/crushing. WGN has three strategically-placed long-life quarry assets, with aggregate production sold externally and utilised to support WGN’s own downstream operations. WGN also operates a large mobile crushing and screening fleet.



CFT (Composite Fibre Technologies) and EFC (Earth Friendly Concrete). Industry leading composite fibre building products produced from a new CFT facility at Wellcamp, Toowoomba. WGN also produces an environmentally friendly concrete substitute called EFC.



Transport/haulage services. WGN has a large fleet of prime movers and trailers, again servicing both external customers and WGN’s own operations.



Reinforcing steel. Produced at WGN’s Wacol precast facility as well as from a dedicated operation in Toowoomba, manufacturing custom-made sections of reinforcing steel for use in precast products.

13


Figure 13: WGN overview Wagners Divisions Construction Materials & Services

New Generation Building Materials (NGBM)

Products / Services Cement ▪ Cement

Other construction materials

Project materials & services

New Generation Building Materials (NGBM)

▪ Precast concrete

▪ Mobile & on-site concrete

▪ Composite Fibre Technology (CFT)

▪ Aggregates

▪ Bulk haulage/transportation

▪ Earth Friendly Concrete (EFC)

▪ Reinforcing steel

▪ Crushing services

▪ Fixed concrete SOURCES: MORGANS, COMPANY REPORTS

SWOT analysis WGN is in a unique position within Australia’s building materials sector. Below we consider the strengths, weaknesses, opportunities and threats facing WGN’s business. Figure 14: SWOT analysis SWOT Analysis Strengths ▪ High barriers of entry ▪ Long-term take-or-pay cement offtake contract with Boral underpins cement volumes ▪ ▪ ▪ ▪ ▪

Strong and well established reputation Demonstrated management track record Flexible business structure Undersized exposure to residential construction versus peers (where activity is slowing) Strong balance sheet capable of supporting growth Weaknesses

▪ Smaller business versus its peers in construction materials ▪ Revenue of some parts of the business can be lumpy ▪ Unknown rate of penetration for CFT into new markets / products ▪ EFC profitability not yet demonstrated ▪ Earnings exposed to cyclical forces ▪ Fierce competition with strong domestic and global players pariticipating in key market Opportunities ▪ Strong infrastructure pipeline in SEQ ▪ ▪ ▪ ▪ ▪ ▪ ▪

Fixed concrete re-entry could be a good source of earnings growth - and help expand customer book Mining sector has entered recovery phase which will lead to higher activity East coast gas shortage could fuel boom in upstream gas investment in new and established CSG plays in Queensland Priority port access at Pinkenba (lower opex) Increased CFT crossarm market penetration New market/product access for CFT Wider applications and growth for EFC Threats

▪ ▪ ▪ ▪ ▪ ▪

Sharper-than-expected downturn in residential construction activity Loss of major customer contract in cement Loss of key management Greater competition from import composite products Rising input costs (clinker, gypsum, glass fibre, etc.) CFT/EFC fail to grow as expected SOURCES: MORGANS, COMPANY REPORTS

14


Cement WGN changed direction in 2011, when it divested its fixed concrete network (and associated assets) to peer Boral. Operating under non-compete conditions following the transaction for the last five years, WGN has focused primarily on cement, mobile/on-site concrete operations, offshore projects, and its expanding NGBM business. Cement is a key product for WGN, accounting for 48% of FY17 revenue. Underpinned by a long-term offtake agreement (expiring 2031), cement is a high-margin business that has posted steady volume and price performance over the last decade. WGN estimates that 90-95% of its cement is sold within a ~400km radius of its Pinkenba cement grinding facility. Pinkenba operation The centrepiece of WGN’s operational network, Pinkenba is a modern cement grinding facility located in Brisbane (developed in 2007), which includes Queensland’s only VRM. Management has estimated that operating a VRM (as opposed to a typical horizontal mill) has generated energy cost savings of 1520% per annum, which is material considering the large amounts of power used in grinding clinker. WGN’s VRM has grinding capacity of 0.8mtpa. There is also an idled ball mill located at Pinkenba with production capacity of 0.5mtpa (that acts as back-up). Figure 15: Overview of Pinkenba cement facility

SOURCES: COMPANY REPORTS

Long-term offtake agreement Signed in 2011, WGN has a 20-year take-or-pay cement offtake agreement with construction materials peer Boral (ending in 2031). The agreement accounted for ~45% of WGN’s cement volumes in FY17 (225kt). The contract has fixed volume and price growth mechanism built into it, which helps to underpin WGN’s forward earnings expectations and underlying profitability during periods of demand/price volatility across construction materials markets. Raw materials WGN currently sources all of its clinker (key cement ingredient) from low-cost Asian suppliers under a rolling three-year agreement. WGN also owns a 60% interest in Independent Flyash Brokers (IFB), a flyash joint venture, which holds a secure long-term supply contract to receive raw flyash from the Millmerran Power Station.

15


Concrete Mobile/on-site concrete WGN operates a number of on site, wet and dry mix mobile batching plants (with 3 capacity up to 120m per hour), primarily used on major construction projects. WGN often cross-markets its products. For example, it often uses cement and aggregates from its own operations in its mobile/on-site concrete operations (unless a remote location prevents it). Precast concrete WGN operates a major precast and pre-stressed concrete business from its Wacol facility, situated 21km south west of Brisbane. The operation has one of the only high-volume tunnel segment facilities in Queensland, giving WGN a competitive edge in its home market. Similar to its mobile/on-site concrete business, WGN’s Wacol precast operation sources materials from other parts of its business (such as reinforcing steel and cement). Fixed concrete With the five-year non-compete period having expired in December 2016, WGN now plans to re-enter the fixed concrete business. This is likely to see the earnings mix of the business change notably over coming years as WGN rolls out new fixed batching sites. The company plans to commission the first two of these plants in Q4 of FY18, with a third planned to come online in FY19. In total WGN plans to develop up to 10 plants, which it expects will be capable of using 125kt of cement per annum. Strategically, the return to fixed concrete will give the company greater control over the downstream placement of its cement volumes. Importantly the re-entry to fixed concrete will boost optionality and customer book spread.

Reinforcing steel WGN’s reinforcing steel business produces custom-made sections of reinforcing steel used in the manufacture of precast products at Wacol, specifically precast panels, segments and pre-stressed concrete beams.

Aggregates/crushing WGN has three strategically-placed long-life quarry assets, with aggregate production sold externally and utilised in WGN’s own downstream operations. WGN also operates one of Australia’s largest mobile crushing and screening fleets, which primarily services the mining and construction industries.

16


Figure 16: WGN map of key operations


Transport/haulage WGN operates a large fleet of prime movers and trailers, again supplying both external customers and WGN’s own diversified operations. The haulage services are aimed mainly at servicing the mining sector (bulk resources and base metals).

Global services Global services is one of the most dynamic areas of WGN’s business (on the traditional construction materials side of the business at least). WGN has been able to secure projects ranging across: mobile concrete, aggregate production, quarries, materials handling, project consulting, and the supply of plant, equipment and labour to offshore customers. WGN’s first offshore project was a concrete supply contract executed in New Caledonia in 2001. Since then, WGN has secured further work across the United States, Russia, Mongolia and Papua New Guinea on contracts operated by global major companies such as ExxonMobil (on the PNG LNG project) and Shell. These offshore projects tend to be attractive in terms of margins and have low capital risk (with most contracts typically including the requirement for up-front payment to cover WGN’s initial capital investment in the project). Figure 17: WGN offshore projects


17


New generation building materials (NGBM) WGN established its NGBM business in 2002. The business produces a range of industry-leading products, including composite fibre building products and an environmentally-friendly concrete substitute (called Earth Friendly Concrete or EFC). NGBM accounted for 12% of group revenue in FY17, and 10% of EBITDA. To date the majority of NGBM sales has been from CFT, although management hopes to commercialise and ramp up its EFC product. Composite Fibre Technologies (CFT) WGN produces its composite building products from a new CFT facility located at Wellcamp, Toowoomba, where it operates three fibre spinning machines (using a ‘pultrusion’ process) with plans to bring a fourth (larger) line online in the near term. The main application for CFT is making composite fibre power pole crossarms. In FY17, CFT crossarms represented ~65% of NGBM revenue, with the remainder coming from custom projects (primarily walkways and bridges). WGN estimates that it has supplied a total of 650,000 crossarms to date which the company expects represents approximately 10% of the total crossarms market, while also estimating that it has a 50% market share of all new crossarms orders in Australia (with the remainder of the market mostly being timber crossarms, along with some steel). The company estimates the total size of the Australian crossarm market at 6.5-7m installed units (the majority of which is approaching or is beyond their useful life), highlighting the opportunity remaining for greater market penetration. CFT holds substantial advantages over traditional materials, including: 

Superior strength. CFT is much stronger than timber and even some forms of steel.



Much more durable. Composite crossarms have a longer lifespan (40 years) versus timber alternatives and require little maintenance.



Better against corrosion. Greater resistance than timber/steel alternatives to rust, chemical attack and corrosion.



Much lighter. CFT is materially lighter than traditional alternatives (making it a viable solution for projects in remote locations).



No tracking. With the addition of WGN’s proprietary resin coating, CFT crossarms do not suffer from ‘tracking’ (a process of combustion where corrosive material builds up on the surface of a steel or timber crossarm over a period of time, eventually leading to a combustion event where electrical current travels over the built-up material). Tracking is a common cause of power outages and can even start bushfires.

Earth Friendly Concrete (EFC) EFC is a concrete substitute that replaces the use of cement with a commercial geopolymer. The key benefit offered by EFC is: 1) the substantial reduction in carbon emissions (the process of manufacturing clinker is a carbon intensive process. Clinker is a key raw ingredient used to manufacture cement), and 2) improved performance with EFC stronger and more durable than conventional concrete. EFC does not currently contribute to earnings.

Key markets 

South East Queensland (SEQ). WGN has developed its operational and distribution capabilities around a geographical focus on SEQ, which remains its key market and location of the company headquarters.



North Queensland. Supported by WGN’s distribution assets in Townsville and Cloncurry, in addition to being a focus for WGN’s mobile/on-site concrete, business, transportation/haulage fleet, and aggregates/crushing services.

18




Offshore. Global markets are a source of growth for CFT. WGN has also (periodically) captured opportunities for material offshore contracts in mobile/on-site concrete that have been lucrative for its business.

Distribution network WGN distributes its cementitious products from three sites: Pinkenba (servicing SEQ), Townsville (servicing Northern Queensland), and a depot at Cloncurry. Figure 18: WGN distribution network


Company history A family business, WGN was founded in 1989 by John, Denis, Neill, Joe and their father Henry Wagner. This continued a long-held family tradition in concrete, quarries and transportation. WGN started with a single concrete batching plant in Toowoomba, and has gradually been built up into a leading Australian construction materials and services business.

19


Figure 19: WGN company timeline


Intellectual property and protection A large part of WGN’s business strategy is focused on innovation, in both product development and operational practices. As a result the company has considerable intellectual property, particularly in its NGBM division. Instead of attempting to protect its IP through applying for patents, WGN elects to protect its trade secrets through careful management of its facilities and operational processes.

20


Section 3: Industry overview WGN operates in the Australian building materials industry, as a manufacturer of cement, concrete, aggregates, precast concrete, reinforcing steel and composite building materials. The company also operates mobile/on-site concrete batching, crushing and bulk haulage services.

Barriers to entry There are significant barriers to entry in building materials: 

High capital intensity. Cement manufacturing is a capital-intensive business, with substantial investment required to establish operations (including clinker grinding and distribution capabilities).



Fragmented demand. The capital-intensive nature of construction materials, combined with the high transportation costs/difficulty and Australia’s widely dispersed population, has led the industry to target specific end-markets (usually cities and regions with a large enough population to sustain significant construction activity levels).



Highly competitive. The building materials sector is dominated by a small number of participants. The major participants tend to be vertically integrated, technologically advanced, enjoy economies of scale, and possess highly autonomous operations.



Conservative customers. Marketing is a critical factor in building materials, with most participants holding long-term relationships with large customers. This presents a natural barrier to new entrants seeking to capture market share.

Given the high barriers to entry, we view having a robust and differentiated strategy (and effective management to execute) as critical. We believe WGN has both, with a solid track record and robust strategy that has allowed it to emerge as the only independent major construction materials participant in its home market of Queensland.

Core products WGN’s core products are cement, concrete, aggregates and composites.

Cement Cement is the main ingredient used to produce concrete, which is used widely in construction applications. Based on IBISWorld data, the Australian market currently consumes 10.7mt of cement per year, with roughly one quarter of this volume consumed in Queensland. Australia's top five cement manufacturers account for an estimated 69% of industry revenue according to IBISWorld estimates. This high concentration of cement production is the result of heavy consolidation, large barriers to entry, and high capital intensity involved in manufacturing cement.

21


Figure 20: Overview of Australian construction materials

SOURCES: MORGANS, COMPANY REPORTS, IBIS, ABS

Key SEQ cement players Within its key SEQ market, WGN is one of three key cement players. The other two are Sunstate Cement and Cement Australia. Sunstate Cement is a subsidiary jointly owned by Boral and Adelaide Brighton with installed cement grinding capacity of 1.5mtpa, while Cement Australia is jointly owned by global majors Heidelberg (through subsidiary Hanson) and Holcim and has installed capacity of 1.2mtpa. This compares to WGN’s production capacity of 0.8mtpa. With FY17 sales of 0.5mt, we estimate WGN has an approximate 30% market share of the SEQ cement market. Figure 21: South East Queensland (SEQ) cement production capacity


Based on the installed production capacity of the SEQ participants being well in excess of current utilisation rates, it is our view that the local market still has surplus cement supply. We attribute the low utilisation rates to lower cement demand following the end of the major build-out associated with the last mining boom and the massive LNG development phase at Gladstone, which is now also finished.

22


Figure 22: QLD major projects by region (ex-telco) ($m)

Figure 23: QLD major projects mix (ex-telco) (%)



Resilient Queensland cement prices Despite the slowdown in Queensland’s construction activity, prices have remained stable, with the Brisbane cement products price index increasing at a CAGR of 1.9% between FY11 and FY17. We expect this is a result of state-bystate demand and orderly competitive dynamic (with key participants appearing to prefer reducing output rather than cutting prices). Despite slower construction activity, Australian consumption of cement, slag and flyash (key concrete ingredients) has maintained a CAGR of 2.1% between 2006 and 2016. Figure 24: Brisbane cement products price index

SOURCES: ABS DATA

Stable volumes for WGN The flat demand growth in Queensland’s construction activity has not been a large factor for WGN, with the company steadily growing cement volumes from 409kt in FY15 to a company forecasted 553kt in FY18. We partly attribute the strong cement volume performance from WGN to a long-term offtake contract with Boral, which covers approximately 45% of WGN’s cement production and includes both a volume and price growth mechanism. Figure 25: WGN cement volumes Cement volumes (kt) Volume growth (%) Cement revenue growth (%)

FY15A

FY16A

FY17A

408.8

481.5

505.8

FY18F 552.8

15.10%

4.80%

9.30%

10.8%

2.4%

8.2%


23


Queensland construction prepares to shift gears We are seeing tangible signs of an upturn in cement demand conditions in Queensland, with positive fundamentals building on a substantial pipeline of planned infrastructure investment. As a result we expect Queensland cement demand growth CAGR of +8% during the FY18-21 forecast period. Figure 26: Queensland construction activity outlook

SOURCES: QLD ENGINEERING CONSTRUCTION OUTLOOK

Concrete Ready-mix concrete Ready-mix concrete is manufactured through a batching process, where aggregates and other extenders (such as flyash) are blended with cement. Water is then added to the mix in a transit-mixer on a truck that is used to transport the concrete to the customer. The distribution range of ready-mix is limited by the fact that industry standards require ready-mix concrete to be poured from the concrete truck within 90 minutes of water being added to the mix. Like cement, the concrete market is also highly concentrated. This is not surprising given the large amount of vertical integration (and consolidation) across the Australian construction materials market – and supports WGN’s plans to re-enter the downstream fixed concrete business. The concrete market is dominated by Boral, Hanson, Holcim, Adelaide Brighton and Barro Group. We estimate that the Australian ready-mix concrete market will produce 23.9 million cubic metres of concrete in 2017. Domestic ready-mix production volumes have grown at a steady CAGR of 0.5% between 2010 and 2017, and are expected to accelerate to a CAGR of 1.9% between 2017 and 2022 (based on IBISWorld forecasts).

24


Figure 27: Ready-mix concrete production in Australia (millions of cubic metres)

SOURCES: IBISWORLD

Precast concrete Precast concrete products are produced from pouring concrete into a reusable mould off-site, and is then cured in a controlled environment. Precast concrete products include girders, beams, decks, bricks, blocks, pavers, culverts, pipes, posts, railway sleepers, and tunnel segments. Less concentrated than cement and concrete, outside of WGN, other notable precast concrete producers include Adelaide Brighton, Fletcher Building, CSR, James Hardie, Holcim, Brickworks, and Austrak, and BCP Precast. While the precast concrete products market is highly competitive, products made by the various participants tend to vary and focus on specific/limited precast product ranges. Wacol typically produces concrete products that are larger in size (given its facilities production and storage capabilities), such as girders, beams, decks and tunnel segments.

25


Figure 28: Australian precast concrete products

SOURCES: COMPANY DATA

Aggregates Aggregates is a broad group of materials used to produce concrete (comprising 60-75% of concrete volume), asphalt, landscaping, construction, road base, rail ballast and several other applications. Generally aggregates are mined from quarries and produced by crushing quarry rock, boulders, cobbles, or large-size gravel. Vertical integration is again a feature of the aggregates industry, with large building materials players the major participants, such as Adelaide Brighton, Boral, Hanson and Holcim. In addition to supplying their own needs, producers also sell aggregates as construction products and landscaping supplies. Major customers include downstream construction firms, cement and concrete manufacturers, residential and non-residential building contractors, and landscaping suppliers.

New Generation Building Materials (NGBM) A key growth focus for WGN is its innovative NGBM segment. The business focuses on the manufacture of composite fibre building products (CFT) and Earth Friendly Concrete (EFC). There is a large and growing need for sustainable construction and building materials, which WGN is keen to address through innovation of its range of green building products. Currently a smaller segment in terms of earnings contribution, but WGN’s NGBM business has already posted significant growth and the company hopes it will ratchet up the earnings capability of this business as it expands into new global markets and increases its range of applications. 26


Figure 29: CFT crossarm


Figure 30: CFT road bridge


27

Figure 31: CFT walkway



Section 4: Demand environment Demand for building materials is driven by construction activity, which is commonly broken down into three areas: 1) Engineering/infrastructure construction: Infrastructure, mining and heavy industrial construction. 2) Residential construction: Houses, units, townhouses and apartments. 3) Non-residential construction: Offices, shops, hotels, industrial premises, hospitals and entertainment facilities. WGN’s FY17 revenue was split between 55% infrastructure, 30% non-residential, and 15% residential construction, with a notable undersized exposure to residential construction activity. Figure 32: Australian construction activity breakdown - 2017 Non-residential construction 16.1%

Engineering /infrastructure construction 42%

Residential construction 41.9%

SOURCES: IBISWORLD

Key demand drivers for construction activity Engineering/infrastructure construction: 

Population growth (greater need for infrastructure assets such as roads, railways, water facilities, and energy services).



Level of government funding for infrastructure development.



Private sector funding for infrastructure development.

Non-residential construction: 

Population growth (demand for social infrastructure).



Demographics (aging population increases demand for health/aged care).



Private sector access to finance.

Residential construction: 

Population growth.



Housing affordability.

28


Broader Australian construction landscape Mining/LNG hangover wears off Over the last decade we have seen booms in two of the three construction markets in Australia, engineering/infrastructure and residential construction. Pushed to lofty heights by the major build-out that accompanied the last mining boom, Australian engineering/infrastructure construction activity peaked in 2013 at A$135bn (and accounting for 53% of total construction spend). We attribute the downturn that followed this boom to: 1) Miners shifting gears and entering capital preservation mode amid falling commodity prices (shelving investment plans); and 2) Completion of work developing several large-scale LNG projects. Figure 33: Australia wide construction activity (A$m) 160,000

300,000

140,000

250,000

120,000 200,000

100,000 80,000

150,000

60,000

100,000

40,000 50,000

20,000 -

FY12

FY13

FY14

FY15

FY16

FY17F

FY18F

FY19F

Residential Building

Non-Residential Building

Engineering Construction

Total Contruction (RHS)

FY20F

FY21F


Residential activity cushions previous downturn While the downturn in engineering/infrastructure expenditure across Australia has been significant, contracting 30% between 2013-16, the decline has been largely offset by a subsequent boom in residential construction activity (which expanded by 25% over the same period), fuelled by a combination of monetary policy conditions, rising offshore demand for property, and surging property prices. The boom in Australian residential property markets was important for national cement consumption during a time of rapid decline in infrastructure/engineering spending. Between 2006-2016, demand growth for cement/slag/flyash was maintained at a 2.1% CAGR with cement prices remaining stable.

New infrastructure boom gathering pace With the boom in residential construction activity now starting to moderate, the construction market is making a timely shift back to infrastructure/ engineeringrelated construction activity. This is fuelled by both the Queensland state and Australian federal governments. Federal government spending spree The federal government, in its second budget, unveiled plans for a A$75bn spend on infrastructure over the next 10 years (particularly focusing on roads and railways). At the heart of the federal government plans is a A$10bn National Rail Program, which will help promote economic activity in regional centres by improving links to major cities through the new development and upgrade of rail networks. 29


Queensland state government in on the action Of even larger significance, to WGN at least, was the release of the Queensland labor government’s state budget in June 2017 – where plans to spend A$42.75bn on infrastructure projects across Queensland over the next four years were announced. Figure 34: Major Australian transport infrastructure projects

SOURCES: CIM, MACROMONITOR

A lot already in the pipeline This surge in infrastructure investment comes in support of (and in addition to) a substantial pipeline of projects already working their way through various stages of pre-development and early construction. We expect total major project expenditure in Queensland will grow 21% in 2017 to A$4.9bn, and will then grow a further 51% in 2018. WGN’s construction materials revenue has already started to firm on the back of the increased Queensland activity. Going forward the opportunity for WGN to capture new business on the continued rise in major projects seems probable, with the supportive tailwind contributing to company FY18 construction materials revenue forecast of A$215.6m (22% above sales of A$177m in FY17).

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Figure 35: QLD major projects (A$m)


Other growth opportunities in Queensland Mining recovery WGN has already gained from a turnaround in commodity prices, having signed three new long-term transportation/haulage contracts with three separate mining companies over the last c12 months. We see this growth as opportunistic on WGN’s part, with the company mobilising existing fleet to add new business in an area we view as attractive in terms of margin and return on investment. We view this as an area for potential further growth not factored into our base case forecasts. Gas/renewables boom? We also observe a potentially larger opportunity for growth building in Queensland gas. Our research on the east coast gas market highlights that the current gas supply deficit could become more severe under a number of potentially likely scenarios (i.e. higher Asian LNG prices incentivising Gladstonebased LNG producers to redirect more gas supply offshore). In our view this is likely to result in increased investment in Queensland’s prominent CSG plays (Surat, Bowen and Galilee) over the coming decade. WGN is well placed to service the gas industry, with its mobile/on-site concrete business having already worked in the Surat CSG fields for a number of years. The surge in east coast electricity prices has also driven a wave of investment in renewable energy generation. The wind and solar construction drive that has resulted presents another demand kicker, in our view. Figure 36: Overview of Queensland construction pipeline by region (A$ billions)


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Non-residential construction Australian non-residential (commercial) construction completed in 2016 totalled A$36.3bn, having grown at a CAGR of 1.6% between 2013 and 2016 on softer business conditions. WGN does not expect a marked improvement in conditions and forecasts marginally slower growth between 2017 and 2021 with a CAGR of 1.4%, to A$37.3bn. Figure 37: Australian non-residential construction expenditure

SOURCES: ACIF

Queensland non-residential construction activity totalled A$7bn in 2016, and is expected to post the fastest non-residential construction growth in Australia at a CAGR of 2.6% between 2017 and 2021 (based on Australian Construction Industry Forum (ACIF) forecasts). Figure 38: Forecast non-residential construction expenditure by state

SOURCES: ACIF

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Residential construction The Australian residential market has expanded strongly in recent years, growing from A$53.6bn in 2013 to over A$71.9bn by 2016, a CAGR of 10.3%. During this period Queensland’s residential market has grown at a rate above the national level, increasing from A$9.5bn in 2013 to A$14.0bn by 2016, a CAGR of 14.0%. Figure 39: Australian residential construction activity

SOURCES: ACIF

With Australian residential activity having peaked in 2016, we expect activity will slow over the coming years. For Queensland, ACIF forecasts a CAGR of -2.0% between 2017 and 2021. Figure 40: Forecast residential construction expenditure by state

SOURCES: ACIF

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Section 5: Key earnings drivers Broadening and accelerating CFT growth We consider CFT the real ‘X factor’ for WGN’s earnings profile, with sales growth starting to accelerate and the company intending to ramp up CFT activity through more active marketing of its crossarms and composite projects locally and offshore (with WGN now marketing its composite products across Europe and North America). Figure 41: NGBM revenue and EBITDA (A$m) 30

27.3 25

23.1

22.1

24.2

23.1

20

15

10

5

2.9

2.1

1.9

1.3

2.2

0 FY15

FY16

FY17

NGBM revenue

FY18

FY19

NGBM EBITDA


Commercialisation of EFC EFC is starting at a low base, contributing an immaterial amount to NGBM sales in FY17. We see long-term potential for EFC, which could progress towards viability through a number of potential paths: 1) progression from MoU into a commercial agreement with JSW out of India, 2) changes to Australia’s industry standards allowing construction materials to be ‘cement free’, and 3) penetration into another offshore market.

Priority access to a dedicated wharf With operating expenses the single largest sensitivity to earnings, the addition of a dedicated wharf on site at Pinkenba is likely to improve earnings materially. At present, WGN imports raw materials through the multi-user terminal at the Port of Brisbane. This however brings with it operational inefficiencies, such as: 

Extra haulage. The multi-user terminal sits 5.1km from Pinkenba. As a result WGN has to collect raw materials deliveries from the terminal and then haul them back to Pinkenba.



Double handling. Multiple deliveries and handling of these raw materials also creates indirect inefficiencies across the process, including the need for larger working capital.



Potential demurrage. Congestion from multiple vessels attempting to use the multi-user terminal has at times caused extra costs for demurrage.

Priority access to a dedicated wharf would solve all of the above and in our view reduce operating expenses by at least A$3-$4 per tonne. WGN expects to have a signed user agreement in place in the short term outlining the fee structure and terms for use of the new wharf. The port will have ample capacity for other third-party users with WGN’s raw material shipments expected to utilise