The Australian manufacturing sector has evolved with highly technological and advanced manufacturing capabilities serving as a base for the global supply-chain. Rapid industrialisation and population growth are leading enablers for change in consumer spending patterns and demand for manufactured goods. The manufacturing sector proved to be resilient during the pandemic, contributing ~5.6% of GDP in September 2020 quarter. The modern manufacturing process and digitisation have been seen across the entire spectrum – from textiles to welding to medical technology and aerospace.

Figure 1. Manufacturing Showed Resilience During the Pandemic:

Source: Data from The Australian Bureau of Statistics, Chart Created by Kalkine Group

The manufacturing sector housed roughly 7% of the total employed workforce in Australia as of November 2020. Food manufacturing remained the top employing sub-sector with ~24% of the total workforce as of February 2020. Following the re-opening of foodservice chains and restaurants, food manufacturing gross value added (GVA) posted a sharp rebound in September 2020 to $7.12 billion, according to The Australian Bureau of Statistics. With just a 1% drop in labour force across the industries in November 2020, the manufacturing sector exhibited an 8.4% drop. The second wave of lockdown severely impacted manufacturing jobs in Victoria with significant falls than any other state.

Figure 2. Labour Force Split in Manufacturing: 

Source: Data from The Australian Bureau of Statistics, Chart Created by Kalkine Group

Australia is spearheading Industry 4.0 with robotics, advanced materials, artificial intelligence and machine learning, nanotechnologies for use in everyday life. Through soaps, tax incentives and a number of government programs such as the creation of a $100 million Advance Manufacturing Fund strengthen global competitiveness.

The Advanced Manufacturing Growth Centre (AMCG) was formed as part of the federal government’s industry and innovation agenda in 2015. The manufacturing sector continues to spend a sizeable R&D that make-up about 26% of total R&D spending by Australian businesses as per the data by the Department of Industry, Sciences, Energy and Resources.

As mentioned by The Australian Trade and Investment Commission, Australians exported $96.1 billion of manufactured goods, but only 5% of companies with advanced manufacturing capabilities drive nearly 54% of the sector’s entire R&D expenditure. Some of the companies that utilized advanced processes include Boeing and BAE Systems for specialist aerospace components; Ford, General Motors, and Toyota in the automotive sector; BASF and DuPont in the chemicals industry; and Siemens in energy and water treatment technology. There is so much left untapped to meet the overseas demand and to expand the export base.

Under the AMCG initiative, about 1,500 manufacturers are expected to get rolled-in for advanced manufacturing capabilities. Out of 78 projects, 10 stands complete, and the program is expected to create ~2,361 direct jobs and to generate ~$1.2 billion in revenues. Some of the completed projects include a palm biometric scanning solution, a rocket propellant and motor project, ‘smart’ sea bins, among others.

Figure 3. Milestone of The Advanced Manufacturing Growth Centre (AMCG):

Source: Data from The Advanced Manufacturing Growth Centre, Chart Created by Kalkine Group

The Morrison Government has started to invite applications for its $1.3 billion Modern Manufacturing Initiative (MMI) program. The program is expected to super-charge Australia’s manufacturing sector with next-generation processes and technologies that could boost exports and expand the economy with job creation. The program also earmarked $107.2 million to improve supply-chain bottlenecks and $52.8 million for the second round of funding under the Manufacturing Modernisation Fund. This is the first time the government is opening-up manufacturing for the space sector.

The MMI program covers the following sub-industries:

• Resources Technology & Critical Minerals Processing
• Food & Beverage
• Medical products
• Recycling & Clean Energy
• Defense
• Space

In addition, the 2020-21 federal budget provided $454.2 million to The Commonwealth Scientific and Industrial Research Organisation (CSIRO) over the next four years to spearhead the scientific research in Australia. The goal is to become a digital economy by 2030.  The 10-year program will build Australia’s reputation as a reliable and high-value manufacturing nation.  

Key Risks:

The manufacturing sector is yet to gain steam post-re-opening of the economy. Due to weak order book, slowdown in global demand, and inventory destocking, manufacturing sector sales de-grew by 1.6% in the September 2020 quarter over the prior year as per the data by The Australian Bureau of Statistics. Manufacturers continue to defer capex plans. The private capex spend data showed total new capex on plant and machinery plunged by 12.3% in September 2020 quarter over the last year. The uncertain global economy and supply disruptions posed a threat to capacity addition. This may affect revenues, going forward. The manufacturing sector is highly labour intensive, shortage of labour may affect the operating performance. In a separate report on business indicators, Australian manufacturers expressed difficulty meeting resource gaps with a shortage of labour force.

Figure 4: Key Risks in Manufacturing Sector: 

Source: Analysis by Kalkine Group

Outlook: As per the National Circular Economy Roadmap by CSIRO, Australia is expected to benefit from the advanced manufacturing process in waste recycling with a recovery rate of 5% to add $1 billion to GDP. The government’s ban on the export of waste is expected to create an opportunity that turns landfills into economic returns. As the government is keen on developing trade relations with new free trade agreements, the usher to enhance the innovative process through MMI program will increase value-addition and boost exports. The purchasing manager index posted the highest growth, reaching 57.2 points in January 2021, as per IHS Market, as compared to 55.7 points in the preceding month. The surge in the index was lifted by inflows of new orders, which rose to a 3-year high. The reading above 50 indicates the economy is in expansion mode. The favourable index may return to healthy exports, going forward. Considering the above facts and trends, we have figured out 4 stocks on ASX that are set to see the momentum from the development.

(1) Synlait Milk Limited (Recommendation: Buy, Potential Upside: Low Double-Digit)

(M-cap: A$ 869.95 Million, Annual Dividend Yield: 0%)

A Surge in Demand for Milk Products During the Pandemic: Synlait Milk Limited (ASX: SM1) is a dairy processing company engaged in the manufacturing nutritional solutions, value-added products and, specialty ingredients. The company saw a surge in volumes in both consumer-packaged infant products and Lactoferrin. Fresh milk and cream sales completed a full-year of production and posted an increase of 13% during the pandemic. Sales grew by 27.1% in FY20 due to positive volume movement and focus on high-margin products. The company expanded its production capacities and added inventories to cater to a surge in demand for infant-based powders.

EBITDA margin contracted to 13.3% in FY20 due to an increase in selling and distribution costs, primarily employee costs and investment in technology and new distribution lines. The decline in net profit (by 8.5% in FY20 YoY) reflects higher depreciation and financing costs. Operating cash flows declined to NZD 127 million and a cash balance stood at NZD 5.9 million due to significant investment in growth projects (Synlait Pokeno and the acquisitions of Dairyworks and Talbot Forest Cheese). It plans to raise equity funding to the tune of NZD 180 million through private placement. The leverage ratio increased to 3.1x as of July 2020, led by the issuance of subordinated notes and ESG-linked loans.

Outlook: SM1 raised forecasted milk price for the 2020/2021 season to NZD 7.20 kgMS (up from NZD 6.40 kgMS) due to a strong increase in commodity dairy prices. For FY21, the company is expecting consumer-packaged infant formula volumes to be lower than FY20 by ~35%. Its net profit after taxes will be half that of FY20 results.  

Valuation Methodology: EV/EBITDA Multiple Based Relative Valuation (Illustrative)

EV/EBITDA Multiple Based Relative Valuation (Source: Refinitiv, Thomson Reuters)

Note: All forecasted figures and peers have been taken from Thomson Reuters, NTM-Next Twelve Months

A-VIX vs SM1 (Source: Refinitiv, Thomson Reuters)

Stock Recommendation: The stock posted negative 3-month and 6-month returns of ~27.42% and ~32.71%, respectively. It is currently trading closer to the 52-week low price of $3.950, indicating an accumulation opportunity. The stock slightly fell below the market volatility index due to commodity dairy prices. We have valued the stock using the EV/EBITDA multiple based illustrative relative valuation method and arrived at a target price of low double-digit upside (in percentage terms). We believe that the stock might trade at a slight discount as compared to its peer median EV/EBITDA (NTM Trading multiple) as the management projected FY21 sales volume of consumer-packaged infant formula business to be lower than FY20 by ~35%. Further, its net profit after taxes will be half that of FY20 results. For this purpose, we have taken peers such as Australian Agricultural Company Ltd (ASX: AAC), Murray Cod Australia Ltd. (ASX: MCA), Huon Aquaculture Group Ltd. (ASX: HUO), to name a few. Considering the stable revenues of the business, growth from acquisitions, financing flexibility, valuation, and the current trading levels, we give a “Buy” recommendation on the stock at the current market price of $3.970, down by 0.252% on 22^nd February 2021. 

(2) Nanosonics Limited (Recommendation: Buy, Potential Upside: Low Double-Digit)

(M-cap: A$ 1.90 Billion, Annual Dividend Yield: 0%)

Growth in Installed Base of Trophon: Nanosonics Limited (ASX: NAN) operates as a life science company that develops and commercializes a range of disinfection and sterilization technologies that are utilized for infection control and decontamination. The global installed base for infection control solutions reached 23,720 units in FY20, up from 13% over pcp. This was driven by Europe, Middle East, and Asia-Pacific. NAN experienced lower offtake from end-customers with pandemic-led de-stocking in H2 FY20. As a result, its capital revenues declined by 9% over pcp. But overall revenues grew by 18.7% in FY20 over last year, led by consumables and services revenues. EBITDA margin contracted to 16.2% due to planned R&D in growth projects. Free cash flows surged to $20.9 million in FY20, led by a surge in customer receipts. The cash balance stood at $91.8 million supporting expansion and investment growth projects.

In the last update, NAN reported a 25% increase in unit purchases of consumables in the four months of FY21 to October 2020. The new units installed base for Trophon is at 91% in the same period over last year pcp.

Outlook: While the installed base likely to grow, Trophon capital revenue is likely to be affected in H1 FY21 due to limited hospital access, particularly in North America. Consumables sales are likely to continue to recover and end-customer sales for FY21 to be consistent. 

Valuation Methodology: EV/Sales Multiple Based Relative Valuation (Illustrative)

EV/Sales Multiple Based Relative Valuation (Source: Refinitiv, Thomson Reuters)

Note: All forecasted figures and peers have been taken from Thomson Reuters, NTM-Next Twelve Months

A-VIX vs NAN (Source: Refinitiv, Thomson Reuters)

Stock Recommendation: The stock posted negative 3-month and 6-month returns of ~2.78% and ~8.30%, respectively. It is currently trading slightly above the average of the 52-week high price of $8.250 and the 52-week low price of $4.010. The stock performed well over the market volatility index. We have valued the stock using the EV/Sales multiple based illustrative relative valuation method and arrived at a target price of low double-digit upside (in percentage terms). We believe that the stock might trade at a slight premium as compared to its peer average EV/Sales (NTM Trading multiple) as the global installation of Trophon is reaching 91% of pre-COVID. Consumables sales are likely to continue to recover and end-customer sales for FY21 to be consistent. For this purpose, we have taken peers such as Cochlear Ltd. (ASX: COH), Polynovo Ltd. (ASX: PNV), ImpediMed Ltd. (ASX: IPD), to name a few. Considering the growth in Europe, Middle East, and Asia-Pacific markets, strong cash balance, valuation, and the current trading levels, we give a “Buy” recommendation on the stock at the current market price of $6.300, down by 0.474% on 22^nd February 2021.  

(3) Austal Limited (Recommendation: Buy, Potential Upside: Low Double Digit)

(M-cap: A$ 898.89 Million, Annual Dividend Yield: 3.20%)

Support Revenues Drove Growth: Austal Limited (ASX: ASB) operates as an emerging defense prime contractor. The company develops and supplies vessel platforms to defense forces and installs and maintains military communications, radar, command, and control systems. ASB delivered 3 vessels to the US market and 6 vessels to Australasia in FY20. Its US shipbuilding margin near the middle range of guidance for FY20. Australasia experienced strong GCPB and CCPB ISS contract performance. Its EBITDA margin at 8.3%, up from 7.2% in FY19 led by the support service segment of the US and Australasia market. In the recent development, ASB reached an agreement to acquire Australian-based BSE Maritime Solutions Group for $27.5 million. The acquisition to boost repairs and support revenues of Australasia business. ASB closed the full-year with a cash balance of $396.7 million as of June 2020.

Outlook: ASB is expecting FY21 group revenues at $1.8 billion, lower than FY20. It had forecasted EBIT for FY21 at $125 million, lower than $130 million in FY20. The new business, BSE Maritime Solutions, to provide ship lift capability in the north-eastern region of Australia. It is expecting to generate an EBITDA of $5 million in FY21. More ships are expected to be delivered to the Commonwealth of Australia. ASB is implementing US $100 million upgrades to the US shipyard to meet the new navel steel vessel program demands.

Valuation Methodology: Price/Earnings Multiple Based Relative Valuation (Illustrative) 

Price/Earnings Multiple Based Relative Valuation (Source: Refinitiv, Thomson Reuters)

Note: All forecasted figures and peers have been taken from Thomson Reuters, NTM-Next Twelve Months

A-VIX vs ASB (Source: Refinitiv, Thomson Reuters)

Stock Recommendation: The stock posted negative 3-month and 6-month returns of ~13.94% and ~29.63%, respectively. It is currently trading close to its 52-week low price of $2.250, indicating an opportunity for accumulation. The stock slightly fell below to the market volatility index. We have valued the stock using the Price/Earnings multiple based illustrative relative valuation method and arrived at a target price of low double-digit upside (in percentage terms).  We believe that the stock might trade at a slight premium as compared to its peer average Price/Earnings (NTM Trading multiple) given the dominant leadership position in government defense contracts and the positive impact of the BSE Maritime Solutions. For this purpose, we have taken peers such as Orbital Corporation Ltd. (ASX: OEC), Electro Optic Systems Holdings Ltd. (ASX: EOS), PTB Group Ltd. (ASX: PTB), to name a few. Considering the performance of the GCPB and CCPB ISS contract, expansion of EBITDA margin, solid cash balance, valuation, and the current trading levels, we give a “Buy” recommendation on the stock at the current market price of $2.470, down by 1.200% on 22^nd February 2021.

(4) Cleanaway Waste Management Limited (Recommendation: Hold, Potential Upside: Low Double Digit)

(M-cap: A$ 4.65 Billion, Annual Dividend Yield: 1.92%)

Improvement in Health Services Waste Segment: Cleanaway Waste Management Limited (ASX: CWY) provides waste management services. The company offers recycling, bathroom hygiene, liquid and, hazardous waste, and wastewater management services. CWY experienced an 8.3% drop in industrial & waste services revenues. While Liquid Waste & Health Services grew by 3.8% in FY20 over pcp. Trading revenues of commodities from wastes declined owing to weak commodity prices. Integration of Toxfree business realized synergies of $35 million in FY20. Upgradation of SKM assets completed and contracts secured. EBITDA improved particularly in H2 FY20 on the back of cost savings measures and improvement in collections (specifically QLD). Net profit was impacted by a loss of sale of buffer land and loss of control of Cleanway Resources.

In the H1 FY21 update, CWY reported net revenues of $1.07 billion, in-line with last year. All of its divisions experienced an uptick in margins. Operating cash flows increased to $202.4 million, up by 28.8% over pcp. It has completed the acquisition of Grasshopper Environmental in NSW and Stawell landfill in Western Victoria. Group-wide EBITDA margin improved by 60bps to 24.6% in H1 FY21. Free cash flows surged 12.3% to $117.9 million. It had closed the period with a cash balance of $31.8 million as of December 2020.

Outlook: CWY remains confident that full-year underlying EBITDA for FY21 will be moderately higher than FY20.

Valuation Methodology: EV/Sales Multiple Based Relative Valuation (Illustrative) 

EV/Sales Multiple Based Relative Valuation (Source: Refinitiv, Thomson Reuters)

Note: All forecasted figures and peers have been taken from Thomson Reuters, NTM-Next Twelve Months

A-VIX vs CWY (Source: Refinitiv, Thomson Reuters)

Stock Recommendation: The stock posted 3-month and 6-month returns of ~-5.51% and ~+0.45%, respectively. It is currently trading above the average of the 52-week high price of $2.665 and the 52-week low price of $1.395.  The stock performed well over the market volatility index. We have valued the stock using the EV/Sales multiple based illustrative relative valuation method and arrived at a target price of low double-digit upside (in percentage terms).  We believe that the stock might trade at a slight discount as compared to its peer average EV/Sales (NTM Trading multiple) as the volatile commodity prices impacted its commodity trading business and affected realization at the company’s industrial waste services business. For this purpose, we have taken peers such as HRL Holdings Ltd. (ASX: HRL), Bingo Industries Ltd. (ASX: BIN), Access Innovation Holdings Ltd. (ASX: AIM), to name a few. Considering the margin expansion, benefits of the acquired businesses, valuation, and the current trading levels, we give a “Hold” recommendation on the stock at the current market price of $2.230, down by 1.328% on 22^nd February 2021. 

Disclaimer  

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