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Citigroup says buy this small cap for the government budget bonanza

The share price of Decmil Group Limited (ASX: DCG) may have surged 46% over the past year but Citigroup believes there is a lot more upside to the small cap engineering and construction stock given its exposure to the domestic infrastructure boom.

Shares in Decmil are up 3.5% at $1.18 in late afternoon trade when the All Ordinaries (Index:^AORD) (ASX:XAO) index has only managed a 0.1% gain ahead of the release of the federal budget tonight.

Investors are sitting on the sidelines until they hear what Treasurer Scott Morrison has to say but Citigroup doesn’t think investors should wait to buy Decmil after the broker initiated coverage on the stock with a “buy” recommendation and $1.45 price target.

“We see Decmil as well placed to capitalise on increased infrastructure spending in Victoria and the expected increase in mining construction expenditure, underpinned by the proposed A$9 billion of greenfield iron ore projects,” said Citigroup.

“While the stock has re-rated over the past year, we see the stock as undervalued at 35x FY19e PE, given 35% EPS [earnings per share] growth expected in FY20e.”

Decmil has already secured a number of contract wins in Victoria to build roads on the back of the state government’s recent decision to spend an extra $4.3 billion on road projects.

Citigroup believes that the company is currently bidding on road projects worth around $600 million and the broker expects management to win $350 million of such work in the next financial year or two.

It’s not only the state government that is spending big on infrastructure. The federal budget is also tipped to inject an extra $8 billion into the state for road and rail projects, including Melbourne’s North-East Link and a rail link of Monash University’s Clayton campus, according to a news report from the ABC.

Don’t be surprised to see extra sweeteners thrown in by Treasurer Morrison too as this is the last budget he will hand down before the federal election and the LNP will want to leave us with a warm fuzzy feeling.

On top of public infrastructure, Decmil is also in a good position to win extra work from the resurging iron ore mining industry given its strong track record in delivering non-process infrastructure (NPI) construction projects in Western Australia.

This means Decmil will likely win a large share of the $900 million in NPI work from BHP Billiton Limited (ASX: BHP), Rio Tinto Limited (ASX: RIO) and Fortescue Metals Group Limited (ASX: FMG), added Citigroup.

Another reason to feel bullish towards Decmil is the broker’s belief that margins have bit a bottom and are set to recover. Group earnings before interest, tax, depreciation and amortisation (EBITDA) margin is forecast to expand to 5.3% by FY20 from 0.4% in FY17.

Decmil isn’t the only one in the sector that has found favour with investors. NRW Holdings Limited (ASX: NWH) and Emeco Holdings Limited (ASX: EHL) have also re-rated for similar reasons.

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Motley Fool contributor Brendon Lau owns shares of BHP Billiton Limited and Rio Tinto Ltd. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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