The DOW result has a few moving parts, that make the result look somewhat unflattering. We are much more comfortable.
Firstly, Probuild going under earlier in the year results in a non-off hit; there’s not a lot DOW can do about that.
Secondly, the absolute level of NPAT and EBIT declined due to divestments, namely the exit from non-core mining, from laundries, and from legacy engineering work.
DOW have been shrinking to greatness for some time, and mining is horrendously capital intensive, and we are glad they are out of it; we want a capital light business model.
Thirdly, weather and COVID. Again, there’s not too much to be done about either of those. Managing margin on projects and contracts is hard if people don’t show up to work, and DOW is a people business.
Fourthly, the cashflows weren’t great. For the past half a decade or so, DOW’s cashflows have substantively improved, so we are prepared to give them the benefit of the doubt on this 81% cashflow conversion rate, given the above issues.
At times, a declining earnings quality can indicate that the cycle has turned, DOW in their commentary and outlook are quite adamant that work is plentiful, which matches what we hear from other contractors.
So, we’ll put the relatively poor conversion down to weather, COVID, and the other above moving parts for now.
Fifthly, relatedly, to the outlook. It’s strong. DOW gives us a solid exposure to the green electrification theme, gives us inflation protection through their CPI adjusted contract structures, provides us exposure to long dated fairly predictable government funded revenue streams, all with an under-geared balance sheet and a solid yield.
So, happy holders for now. We think we are buying bottom of the cycle margins…
…at great starting valuations.
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