Downer EDI Limited (ASX: DOW) is a maintenance and engineering contractor focussing on the mining, large infrastructure and rail sectors. On Monday the group announced the purchase of Tenix Holdings Australia for $300 million in a purchase that promises to address the forecast fall in earnings per share.
Strong Core Business
Downer's core business of infrastructure maintenance and maintenance of rail rolling stock remains surprisingly profitable and has picked up much of the slack from a decline in mining construction spend. Years of conservative growth saw the company's balance sheet exit the mining boom in excellent shape, and smart management diversified the company away from mining contracts into many long-term rail and infrastructure maintenance contracts.
Sensible Acquisition
The purchase of Tenix will boost Downer's exposure to the defensive energy, gas and water industries which will provide the company with a greater proportion of recurring income. Importantly, Tenix only generates around 15% of revenue from the mining and energy sector and the purchase will not require excessive gearing or the issue of shares.
Earnings Boost
Downer's management expects the purchase to be immediately earnings per share accretive, however the actual impact is unknown. For your interest, I did a little math to find out what MIGHT happen:
If the company was purchased on a P/E ratio of 10 (assuming a cheap price for low growth), net profit for the year could be increased by $30 million. Downer recorded profit of $215 million in the 2014 financial year and was expected to record a 5% fall to around $205 million this financial year.
The purchase will settle on October 31, indicating 8 months of contribution from Tenix, or a $20 million addition to profit, bringing the theoretical total to $225 million – a 5% INCREASE on last year. Now if we assume purchase costs of $5 million, net profit could fall to $220 million for the 12 months to 30 June 2015, or 51 cents per share (a 2% increase from 2014).
Cheap, Reliable Earnings
I'll be honest; I've never actually spent much time looking at Downer EDI. I always assumed they had massive exposure to mining and thus I wasn't interested. Its exposure will likely be around 30% of earnings following the purchase, which is manageable.
Based on my quick analysis, Downer is currently trading on a 2015 price to earnings ratio of just 8.2. Even if mining earnings fell to zero, the PE would increase to around 12 – not very demanding for a company with new growth and cost-out opportunities.
