Ventia IPO: Morningstar gives the ASX's newest member the thumbs up

Morningstar analysts maintain infrastructure services provider Ventia is undervalued despite rising 24% in its first day of trading.

In a research note, senior equity analyst Mark Taylor said the company's long-dated maintenance contracts, stable customer relationships and capital light business will produce reliable income for investors.

Add in a dividend payout ratio forecast for north of 80% and it’s easy to see why shares could find a place in an income investor’s portfolio.

Taylor initiated coverage of Ventia (ASX: VNT) on 8 November, recommending investors consider investing if it aligned with their investing goals.

Shares closed trading on Friday at $2.10, representing a 25% discount to Morningstar's fair value of $2.80.

“There is an annuity-style income to the investment proposition, with maintenance cash flows proving comparatively resilient to external shocks, and capital requirements typically favourably low,” Taylor says.

The road to the ASX has been bumpy. The company filed a prospectus in preparation for its initial public offering in late October. This first attempt to woo investors fell flat in the face of tepid interest from the market.

Ventia’s backers sweetened the offer this week slashing the initial public offering (IPO) asking price to $1.70 from the earlier range of $2.75 to $3.15.

The reduced offer price forced major shareholders CIMIC (ASX: CIM) and Apollo Global Management to shelve plans to sell down their roughly 90% combined shareholding. They will now sell just 2% each, leaving them holding 65.6% of the newly listed firm.

Taylor suspects IPO fatigue was behind the lacklustre initial response. But disappointment for the IPO’s backers is good news for investors. He predicted fewer shares and a sizable discount would support the share price.

“There could be a strong open when the shares commence trading on 19 November. It wouldn’t be a surprise to see $2.00 plus,” he said in a note Tuesday.

Initial trading bore out his thesis. Shares rose 24% when Ventia debuted on Friday.

Money raised in Friday’s offering will be used to pay down debt. The strengthened balance sheet will give the firm flexibility to pursue growth, says Taylor.

Ventia provides the services required to maintain infrastructure assets, ranging from operations to facilities management. The firm services half of Australia’s private motorways and tunnels and almost three-quarter of all defence force sites.

Four reasons to like Ventia

Taylor’s case is built on four points. Maintenance services is growing. Ventia has strong relationships with a diverse customer base. The company is capital light. Ventia earns most of its revenue via long term contracts with built in mechanisms for raising prices.

The result is a stable stream of profits. During the pandemic, the company grew earnings at an annualised rate of 3.8%. Ventia expects net profits after tax to grow 16% in 2021 to $123 million. Taylor forecasts earnings to increase at an annualised rate of 5.5% through 2025.

“We view longer-term earnings growth prospects as reasonably attractive,” he says.

The broader maintenance services sector is primed for expansion thanks to Australia's growing population, increased outsourcing and environmental regulation. BIS Economics forecasts Ventia’s total addressable market to grow from $62 billion this year to $79.9 billion in 2025.

Ventia traces its corporate lineage back to the founding of Transfield in 1956. Decades of operations have built close relationships with clients who trust the company to manage sensitive and complex projects, says Taylor.

As a result, contract renewal rates have sat at more than 80% since 2016. The average term is over five years and most contain mechanisms for lifting prices.

To keep costs down, Ventia operates a capital-light business model. It relies on a pool of subcontractors that it scales up and down depending on need. Capital expenditure is usually less than 1% of revenue.

Stable income is good news for dividends. Ventia is targeting a pay-out ratio of 60% to 80% of underlying net profits after tax and amortisation. Taylor forecasts dividend yield to rise from a partly franked 9.2% in 2022 to 10% fully franked by 2026.

Competitive strengths but no moat

Despite its strengths, Taylor has not awarded Ventia a Morningstar economic moat.

He says the fragmented maintenance services market makes it hard for the provider to build a competitive advantage in any one area even as it faces off against tens of competitors.

Ventia operates across four sectors, Defence & Social Infrastructure, Infrastructure Services, Telecommunications and Transport. BIS Oxford Economics estimates counts 22 distinct competitors across those four sectors.

“The market is fragmented, with a diverse range of service providers, both domestic and international. This makes it difficult to drive home competitive advantage comprehensively,” says Taylor.

Taken together, Ventia’s market share hovers around 7.5%, according to figures from BIS Oxford Economics. In defence and telecommunications that rises to 22% and 13%, respectively.

To compete the company offers a wide variety of services across New Zealand and Australia. Taylor notes that breadth and scope helps win work while making it difficult for Ventia to build competitive advantages in any one area.

“It must still provide a wide offering within maintenance services across a fragmented and variable landscape. We think this works against a moat,” he says.

Ventia does have an edge in areas such as essential infrastructure and telecommunications, where the need for scale and expertise keeps out competitors. However, these areas only make up a part of its business.