Costain Group PLC (COST) Earnings Call Transcript & Summary

Ladies and gentlemen, welcome to today's Costain Q2 2021 Results Call. My name is Lydia, and I'll be coordinating your call today. [Operator Instructions] I will now hand you over to your host, Alex Vaughan, Chief Executive, to begin. Alex, please go ahead when you're ready.

Thank you, Lydia, and good morning, and thank you, everyone, for joining us. As Lydia said, I'm Alex Vaughan, Chief Executive of Costain, and I'm joined this morning by Helen Willis, our Chief Financial Officer. I'm going to start with a brief business overview, then Helen will present our financial results, and I will close with an update on the progress we are making in delivering our leading edge strategy and the outlook for the group. Following last year's results, I'm pleased to be able to report improving profitability in line with our plans, delivering an operating profit of GBP 11.5 million for the first half. Additionally, we have a healthy net cash position of GBP 113 million, up from GBP 102.9 million at the start of the year. Despite the background conditions resulting from the pandemic, we are continuing to operate effectively, and importantly, we're delivering our contracts to plan. We're winning new work and the right sort of work, building on the momentum from last year. We secured over GBP 330 million worth of new contract awards and extensions, as well as further positions on forward investment programs, more of which is in line with our strategic focus and encompasses our broader offer. Much of this new work stems from the sizable long-term framework agreements we have in place. And while we don't reflect a number of these frameworks in the order book, we're certainly seeing the benefits from them. Today, our level of tendering activity is very high, reflecting a combination of the significant market opportunity and the increasing demand for our integrated offer. That said, we remain disciplined in what we take on. In response to the growing and urgent focus on climate change and our collective need to eliminate our carbon emissions, we have continued to build a strong position across all of our markets as an important part of the answer in becoming a net 0 business and a shaper, creator and deliverer of green energy solutions. I'm going to talk more about the market opportunities later and why, right now, Costain is in a strong position to win more of the work we want. So overall, Costain is in good shape. The steps we've taken over the last 18 months to improve the business are delivering results, and I am confident we'll deliver significant growth in profits and margins this year and in the years ahead. Before I hand over to Helen, I want to say a little more about the actions taken to improve the business. I spoke about these in March, but today, I'm pleased to say we're seeing a step change in performance as a direct result of the measures we implemented. Our strong and effective work-winning approach is ensuring that we continue to secure good volumes of new work, and importantly, the right work. Whilst we've won a good number of new opportunities, we have continued to decline opportunities where we believe the terms and conditions are unacceptable. Overall, we've leveraged our bid discipline, our clear commercial expectations and how we manage our risks to secure good work with a compelling proposition. Our strong delivery culture is benefiting from our operational excellence model, risk and opportunity management behaviors and in how we proactively better manage change on our contracts. All of our work won since we implemented our new measures in the third quarter of 2019 is delivering to plan with our aggregate margins increasing. With the quality of the work secured, the broader nature of that work, including consultancy and digital work, as well as complex delivery programs and the behavioral and systematic approach to how we deliver these contracts, we are clearly a stronger and more resilient business, as well as being one aligned to meet our changing needs of our clients. I'll now hand over to Helen to take us through the financial results. Helen?

Thank you, Alex. It's good to be able to report my first full set of results having joined at the end of last year. There's been a lot of activity this year to support Alex and the executive team to reinforce the measures put in place to better control our contract bidding and delivery. I'll start by taking you through the high-level profit and loss accounts for the half year. Adjusted operating profit was GBP 11.5 million for the first half of 2021 compared to GBP 5.7 million the last year. I'll give some more detail on the next slide to show how the divisions have performed. You will have seen from previous results announcements that in order to provide clarity on the performance of the group and divisions, we've reported profit on an adjusted basis as well as on a statutory basis. For this half year, there is only a very minor difference between statutory reported and adjusted operating profit. In 2020, the significant contract write-downs were against Peterborough and Huntingdon and the A465. And just to give you an update on these 2 contracts, we're progressing well on the A465 with completion scheduled for this autumn. The Peterborough, Huntingdon adjudication process is continuing and that's due to complete by the end of 2021, and there's no further update at this stage. The group had a tax credit of GBP 0.4 million, primarily from the impact of the rate change from 19% to 25% in 2023. This has now been substantively enacted and this is on deferred tax recognition. Adjusted earnings per share was 2.8p compared to 2.1p last year, and we're not recommending a dividend for this half year. Natural Resources have had a slow start to 2021, being just above breakeven for the first half, whilst Transportation had a strong half year with growth and margin improvement. Transportation division revenue was up circa 14% half year-on-year, and adjusted operating profit was up by GBP 10 million increasing margin to 3.8%. Growth within contracts that have moved into the construction phase plus the increases in volume in a number of contracts. The Natural Resources division revenue was down circa GBP 14 million half year-on-year. The significant growth and performance improvements that you view was more than offset by lower volumes of activity in the AMP7 water programs. And in Energy, we saw a deferment in the award of new contracts with these now awarded during the summer period. Deferred revenues are high for the second half of this year for both divisions, and hence, we are confident of our full year expectations. Transportation delivered a strong improvement in margin in the first half, and we're confident these levels will continue. In Natural Resources, as I've already mentioned, energy contracts are now being awarded. And from April and May, we've seen activity levels in AMP7 significantly increase as we progress year 2 of our programs. The balance sheet has strengthened with net assets increasing from GBP 156.5 million full year 2020 to GBP 190.8 million for half year 2021. This was driven in part by slightly improved working capital, higher net cash, as well as the pension surplus. Half year-end cash were strong at GBP 113 million, ahead of expectations and up from last year. The group's defined benefit scheme is significant, with assets and liabilities of about GBP 860 million and GBP 830 million, respectively. At the half year, the scheme was in surplus by GBP 20 million from an accounting perspective compared to a deficit of GBP 5.6 million at December 2020. After deferred tax, these are reported at GBP 23.5 million and GBP 4.5 million, respectively. The increased valuation was primarily driven by the remeasurement of financial assumptions. The last triennial valuation in 2019 has been approved and the deficit reduction plan was agreed [indiscernible]. This commits Costain to annual payments to GBP 10.2 million per annum, increasing with inflation, and you'll see this on the cash bridge to follow. As I mentioned, half year-end cash was strong. This is comprised of Costain cash as well as cash held in joint operations offset by borrowing. Cash held in joint operations have continued to decrease from GBP 61.1 million at December 2020 to GBP 57 million at the half year. And there is continued focus on prompt distribution from these accounts. The net cash balance is shown in the balance sheet with cash and cash equivalents of GBP 157 million, borrowings of GBP 43 million and fees of GBP 1 million. The group's average Costain cash balance has improved steadily over the last 18 months, GBP 56.3 million at half year 2020 increasing to GBP 73.8 million for full year 2020 following the capital raise in the year and further improving in the first half of 2021, increasing to GBP 102.9 million. The group has in place banking facilities of GBP 175 million, comprised of a revolving credit facility of 101 -- sorry, GBP 131 million and a term loan of GBP 44 million. These mature in September 2023 and refinancing activities will get underway soon with a hope to complete in early 2022. The highlight for me on this bridge is cash generation of GBP 24 million in the first half. This is a result of a relentless focus on cash collection and the resolution of compensation events. This is a detailed slide, so I'll first draw your attention to the cash movement on either side of the dotted box. Cash timing differences of GBP 17 million unwound at the start of the year, and there were GBP 13 million of timing differences, being early receipts from customers at the end of the half year. These will unwind during the second half, no early receipts or forecast for our year-end cash estimation. As I mentioned earlier, the agreed contribution payments to the pension scheme at GBP 10 million per annum and hence GBP 5 million for the first half. Last year, we took advantage of the government scheme to defer VAT of GBP 10 million, and this is being paid in installments that started in March of this year. The prompt payment code continues to be a real focus for us, and we've consistently achieved the target of 95% of invoices paid within 60 days. The order book has remained steady at GBP 4 billion. Importantly, this includes GBP 0.6 billion secured for H2 2021 and GBP 1 billion already secured for 2022, giving us confidence for the second half and next year. As the shape of our business changes, it's important to recognize that the order book is changing in nature. We have taken the decision not to include the Smart Motorway Alliance in our order book, and hence, you have a preferred bidder position of GBP 1 billion that is over and above the order book of GBP 4 billion. We mentioned at the last full year results that we have also secured positions on framework agreements, and these were not valued in the order book. As we win new pieces of work on these frameworks, the value is then included in the order book. We're currently bidding on a number of such schemes that would, if successful, add to our order book significantly. And finally, it's important to recognize that consultancy contracts typically are bid and won on a shorter time scale and hence may not impact to a great extent on the order book. The bullet points on this slide are from the RNS, but for me, the important message is that we believe we are well placed to deliver on expectations for 2021. The balance sheet has been strengthened, and we continue to win work. Our pipeline of active business is very busy with a mix of work ranging from consultancy to large complex program delivery. Cash performance has been strong and we start the second half of 2021 with a significant order book and secured revenue. With that, I'll hand you back to Alex.

Thank you, Helen. Now I want to tell you about how we are building a business with strong market positions that will deliver higher and better quality earnings. We are making real progress with our leading-edge strategy and our client and market focus, our alignment in meeting our clients' changing needs and differentiated client positioning. This slide shows how through our market and blue chip client focus, we are continuing to develop some great relationships across transportation, water, energy and defense. Below the 4 market images, we have summarized the long-term investment programs that our clients are currently delivering. And below that, we've captured the position through key contracts won that Costain has built in these markets with our new additional wins in the first half highlighted in blue. All of the secured contracts show how we are shaping, creating and delivering new solutions for our clients. Examples of our new wins include new complex delivery contracts for Highways England, Network Rail and our water clients, as well as consultancy commissions for Network Rail, Highways England, Ofwat, a number of energy companies and defense organizations, and performance-enhancing digital solutions for Anglian Water and the Department for Transport. The enlarged strong base of work and client positioning secured demonstrates how under our strategy, Costain is strategically positioned in the key markets where through our broader offer, we are proactively meeting the changing needs of our clients. By focusing on the right markets, we are benefiting from strong market dynamics. Our blue-chip clients are looking for innovation and added value. We are working in partnership with them to deliver these, growing our positions in complex delivery programs and the higher-margin services of consultancy and digital solutions. The Intergovernmental Panel on Climate Change, IPCC, has recently issued its report on the causes and effects of climate change, and our clients are increasingly accelerating their plans to address this challenge and to avoid a global climate catastrophe. As a result of our positioning, we have secured leading positions as a business that is shaping the solution. Costain is now leading the South Wales industrial cluster and is a partner in the other industrial clusters, all part of the Prime Minister's 10-point plan. The government, only 2 weeks ago, updated their hydrogen ambitions and their plan. And in the period, we have secured further contracts, helping water companies generate hydrogen, airports evaluate the implications of hydrogen travel and energy companies explore the storage and blending challenges of hydrogen. We are also working with energy companies and the Department for Transport to pilot new green technology like the work we're piloting for the electrification of future highways. Costain's breadth and scale of impact in addressing decarbonization continues to increase. It will become a significant part of the group's business. The government has committed to leveling up our economy in its Build Back Better plan, and we continue to support this drive to enable economic growth across the U.K. through our involvement in the delivery of HS2, strategic highway schemes and Network Rail's optimization programs. Regulation is driving our clients to commit to improve the performance of their services through improving customer service levels, service quality and efficiency. As one of their strategic partners with a broad service offering, we are helping the water companies improve productivity, water quality, resilience and efficiency in their businesses. As a partner on the 2 major highway programs, we are helping Highways England improve the safety, productivity and reliability of travel on the strategic highway. In energy for clients, including Cadent and INEOS, we are supporting their asset health upgrades and optimization programs. And in a number of touch points across the Ministry of Defense's continuous at-sea defense program, we are working with our clients in delivering improvements to safety, time, cost and quality. Infrastructure is now increasingly targeting performance improvement through the exploitation of digital solutions, and we at Costain have positioned ourselves in accelerating this change through exploiting our domain expertise, insight and digital know-how. Our new digital solutions are supporting the Department for Transport to deliver its net 0 strategy, Anglian Water to optimize its asset performance, Highways England to improve highway safety and journey times and Network Rail to improve track safety. It's a simple equation: take our expertise in complex program delivery and leverage it through consultancy and digital solutions, which means we can take full advantage of the changing market dynamics to be a partner who best meets our clients' changing needs. I'm going to give you 2 simple case studies of how this works, both demonstrated how we are building our competitive advantage and how we get more business out of our strategic client relationships. Network Rail are currently delivering their 5-year control period 7 plan. And as part of that, we're working with them in the delivery of an upgrade to the Gatwick Airport station to increase passenger capacity and speed of transition from the railway into the airport. As we've been delivering this upgrade through work being delivered through their consultancy framework, we have evaluated network optimization options to improve journey times. And a developed solution around Gatwick is now being delivered by incorporating it into the scope of the Gatwick station upgrade. And we are today currently continuing to support Network Rail on further optimization studies, working to significantly improve safety and to reduce time and cost through new solutions, leveraging our delivery know-how. United Utilities are responsible for water in the Northwest and are delivering their 5-year AMP7 program. Now we've been supporting them in the delivery of the 8-year managed service program, and working together, we are transforming their maintenance operations. Now whilst working with them, we've broadened our involvement as a valued consultant, helping with the early planning, development and optimization of some of their future programs and their wider operational challenges. Both of these case studies demonstrate our approach to client focus, our alignment to meeting their needs and our value as a proactive business partner. Our clients' needs are broad and changing, and our strategy enables us to be a valued and agile partner. Now central and core to our strategy and how we operate as a business is how we lead as a socially responsible and purpose-led business. As I've previously said, climate change is a priority for every one of our clients, for all of our staff, all of our families and for our government. The IPCC report issued in August set out the stark reality as to the causes and impact of climate change and the urgency in avoiding a climate disaster. We have continued to drive the implementation of our climate change action plan, and are working towards becoming a net 0 carbon business by 2035 for scopes 1, 2 and 3. In addition, as I've said, we are playing a highly active role in shaping, creating and delivering with solutions for a green energy future across transportation, water and energy markets. We are committed to leading on conducting business responsibly and we have aligned our purpose of improving people's lives to the United Nations Sustainable Development Goals as well as our focus on creating a green and sustainable future. We are ensuring Costain is a safe, inclusive and great place to work where everyone can be at their best and to enhance the value that Costain contributes to society. The safety of our people and our stakeholders is our #1 priority, and we are pleased to report that in over 15 million hours worked, there have only been 2 reportable accidents. Our accident frequency rate of 0.01 represents our best-ever safety performance and is industry leading. Social value continues to grow in prevalence to Costain, and we have worked hard to invest in the communities where we operate, support the Prince's Trust in coaching and mentoring disadvantaged young people into employment outcomes, volunteering over 1,000 working hours to good causes and spending over GBP 270 million with SMEs equating to 39% of our total spend in the first half of the year. As a result of our strategic position and alignment in meeting our clients' needs, we will continue to benefit from the long-term investment plans that are shaping the increased investment in the U.K.'s strategic infrastructure. Costain is strongly positioned as one of the U.K.'s leading smart infrastructure solutions companies, operating across transportation, water, energy and defense, supporting the delivery, enhancement and operation of the U.K.'s critical infrastructure. Our markets are shaped by the national infrastructure strategy, energy white paper, regulated private sector investment commitments and the defense spending review. These significant long-term investment programs are underwritten by government policy, regulation, legislation and a critical national need. We are evolving rapidly and driving the national need to level up our economy, return to growth and address climate change, as well as responding to growing customer expectations, improving standard, upgrades of aging assets and the need for efficiency and performance improvement. All present significant opportunities for Costain in meeting these changing needs and investment priorities. I want to leave you with some important messages to support my confidence in the business today. It's encouraging that all our contracts are operational and have effectively adapted to cope with this extended pandemic. We are benefiting from the strong actions, which have improved our business performance. We continue to secure good quality new work, much more of it incorporating a broader mix of our services. We have a strong net cash position. Our target markets remain resilient and positive. All of the above gives me confidence in delivering significant growth in profit for 2021 this year and beyond. Right. We'll now take questions, and I'll hand you over to our operator, Lydia, who will guide us through the Q&A. Lydia?

[Operator Instructions] Jonny, please go ahead.

I think that was me. Jonny Coubrough here. Alex and Helen, a few questions from me, please. Firstly, on the Transportation division, which clearly contributed a good H1 margin. Just keen to hear how ramp-up in HS2 has been. And I'd appreciate any detail that you can give on how the contract is performing in terms of where the margin is relative to the divisional margin? And how large a contribution do you expect that to be going into the next couple of years? Secondly, on the strategy, the emphasis now appears to be on providing an integrated offer perhaps rather than shifting from complex delivery at consultancy and digital services. Does this mean that you're no longer targeting separate margins between the 2? I think it was 3% to 5% for complex delivery and 8% for services. And if so, keen to hear what the implications there are for your group, 6% to 7% divisional margin target? And then the third one would be on net cash, which, as you mentioned, good level on an average basis in H1. What was the impact there in terms of VAT domestic reverse charge? Is that captured within the GBP 13 million timing impact?

Okay. Thanks, Jonny. If I can delegate the first question, which was around Transportation margins and the net cash to Helen, and I'll just pick up the second question that you had in there regarding the strategy. I think the focus on an integrated offer is really because we are now beginning to see our clients increasingly ask us to bring together all the varying elements of our capability into one overarching offer. So if I give you the work we're doing with United Utilities, as an example, on the MSP, they're wanting us to bring the consultancy piece upfront to help think about the transformational program that they're adopting. And then now they're beginning to ask us to bring our digital expertise in terms of the data that we collect and how their assets are performing and how their maintenance is running. How do we turn that into intelligent information that they can use within their strategy? So we're not moving away from continuing to drive consultancy as a stand-alone capability and digital as a stand-alone capability. But we are making sure that when we're putting a proposition in front of the client, that we are leveraging our full capability as a business to provide a truly outstanding capability that's moved forward. So we're continuing to target the growth of our margins to the target range that we've talked about. It's -- but it's also not just about margin. It's about the level of profitability and the opportunities we see ahead of ourselves, definitely more of that integrated offer and some of the HS2 future work programs that we're looking at leverage our complex program delivery, but really comes to life when we bring our digital capabilities together with that in terms of how we can integrate technology into the new solution. So just -- it's really confidence around we're continuing to pursue all of those individual areas of service at the margin range as we previously communicated. We're still driving a target towards the higher margin target that we've set out. But we are seeing clients now asking for a much more sophisticated integrated offer. With that, I'll hand back to Helen to answer the first 2 questions -- or the first and the third.

First and third. Thanks, Alex. So consultation HS2, we completed the early works and are now in the next stages of main work. I think the H1, H2 levels will be similar. We're fully ramped up in the first half and that contract is going well. There is upside potentially if we continue to perform well, but the margin range, I would say, is within our norms. So probably not much more to add there. Net cash, yes, it has been good. Our average monthly cash, as I mentioned, really strong and that's been consistent through the half year. On a reverse charge, it's not been significant for us. I think it has been mentioned, it's quite significant for some of our peers, but really a very small impact on that half year cash. There wouldn't really be an unwind of any import for H2. Is that okay?