The Downer EDI Ltd (ASX: DOW) share price is down around 40% in the last 12 months, making it one of the worst performers in the S&P/ASX 200 Index (ASX: XJO). However, thereâs one fund manager who thinks itâs an excellent contrarian opportunity.
The optimistic fund manager is Allan Gray Australian managing director and chief investment officer Simon Mawhinney. He presented at the Allan Gray Orbis Investment Forum in Brisbane last week.
Before getting to why Mawhinney believes in the services company, let’s check Allan Grayâs overview of what the ASX 200 share does.
What does Downer EDI do?
Downer âbuilds, operates and maintains infrastructure and industrial assets in Australia and New Zealandâ across three segments.
In the transport segment, it carries out routine road maintenance services, manufactures and supplies bitumen-based and asphalt products, designs and manufactures rail systems, and operates and maintains rail fleets.
According to the company, its utilities segment operates and maintains power and gas network assets, provides water solutions for municipal and industrial water users, and operates and maintains works across fibre and copper networks.
Finally, its facilities segment provides outsourced facility services to customers across the defence, education, government, healthcare, resources, and hospitality sectors.
Much of the work the company performs is directly or indirectly for governments.
What has gone wrong?
Mawhinney has acknowledged âa lot of [Downer’s] work is essentially âlabour for hireâ and there is often little to differentiate competitors. This is reflected in relatively low margins across the industry”. The fund manager also said much has gone wrong for the business, though itâs not all the companyâs fault.
Part of its issues has been its acquisition and divestment strategy, seemingly paying too much for its purchases and selling businesses for too little.
Whatâs good about the ASX 200 share?
Still, the fund manager believes the business is cheap and it performs âessential work that society needsâ.
Mawhinney suggested if the company overhauls its culture and reaches a target margin of 4.5%, it would be cheap. If the target margin was achieved and the enterprise value remained at around $4 billion, the company âwould trade at around 8xâ. This compares to a broader market average of 17x to 18x, around half the marketâs multiple of after-tax earnings.
He believes, under the right leadership, the company âshould be able to generate modest profits with little riskâ. The fund manager explained:
And there is reason for optimism here. Shareholder frustration has led to significant change to its management ranks and board composition. This is likely a first but large step towards an institutionalised culture of accountability that should greatly reduce the risks of entering loss-making contracts in future. The company is in the process of simplifying its business and reducing its exposure to risky contract work. Over the coming three or so years, the new management team should be able to replace the companyâs work-in-hand contracts with new and renewed contracted work that considers the risks that ensue and the returns on offer.
The fund manager acknowledged there are risks but said all other investments also come with risks, and Downer is priced accordingly. Even if its margins were around 3% in the future, it would still trade in line with the broader ASX share market. Mawhinney added:
Downer presents itself to us as a company with a very asymmetric payoff profile in favour of owning the shares with quite a lot of upside. Itâs not without risk, all companies have risk.