Downer EDI Limited (DOW) Earnings Call Transcript & Summary

Thank you for standing by, and welcome to the Downer half year results conference call. [Operator Instructions] I would now like to hand the conference over to Grant Fenn, CEO. Please go ahead.

Well, good morning, everyone. Yes. My name is Grant Fenn, and I'm the Chief Executive Officer of Downer; and with me is Michael Ferguson, who is our Chief Financial Officer. Now I'll begin with the highlights of the last 6 months and the priorities for the remainder of the year, then Michael will go through the financials in more detail and I'll then discuss the outlook before we open up the call for your questions. So let's move to Slide 2, Highlights and Priorities. First of all, it's hard to talk about the last 6 months' results without acknowledging upfront the impact that COVID-19 and, in particular, Omicron has had on all businesses, including Downer, and governments. So workflows have been interrupted, supply chains also, and large numbers of employees and subcontractors absent. You know all this. And there's been a myriad of different regulatory requirements that have had to be navigated. So it's in this environment that we announce today's results. Now we're all hopeful that relatively soon, life will return to somewhat normality. Now I'd particularly like to acknowledge the outstanding efforts of our people and our customers. And they've continued to put in an amazing effort, remembering that the vast majority of Downer people don't have the option of working from home. They're out there every day making it happen. In summary, the results announced today are very good in a tough environment. We've been able to increase our core earnings and back it up with a strong cash conversion in the midst of widespread disruption. And of course, there are ups and downs within the portfolio, some parts of the business have been impacted more than others, but all are managing their service obligations very well irrespective of what's been thrown at them. It's also clear to me that in times like these, the benefits of our diversification come into their own. For the half, we've delivered 4.4% growth in core earnings with normalized cash conversion of 91.2%. Our core revenue has increased by 13.3%, which just highlights the inherent growth potential of our core markets. In normal times, we should be able to convert a higher proportion of this revenue into earnings. The group has never been stronger financially with gearing at just 16.5% and net debt at 1.5x EBITDA. We're all but complete on the construction of the new Sustainable Resource Center at Rosehill, and this will be the most efficient asphalt manufacturing and recycling plant in the country. We continue to fill out our asphalt manufacturing and services footprint with the acquisition of Fowlers Asphalting in Gippsland in Victoria, and we've been successful in resetting the reviewable services at Royal Adelaide and Bendigo Hospitals. Now this is an important milestone as the first long-term spotless contracts to be reset at their 5-year mark. With our pedigree in power transmission, renewable energy and battery storage, we are seeing substantial customer demand for decarbonization and new energy solutions across our customer base. And I'll talk a bit more about that as we roll through the presentation. Given the strength of the business, we've decided to increase the interim dividend from $0.09 to $0.12 per share. And we've spent $123 million so far in our market share buyback. The program has been suspended since 31 December just because of blackout with the results, but we'll now recommence buying back shares. Our priorities are straightforward. So navigating COVID-19 is still critically important, and that means maintaining our quality service delivery, working proactively with customers and minimizing the risk in new contracts. On the positive, COVID-19 has accelerated technology development, communication capabilities and infrastructure investment that will drive growth in our markets for the next decade at least. We're setting up the business to take advantage of those changes. And we've got to continue to drive our sustainability performance. We are a leader in ESG in our markets and have a lot to be proud of. If you haven't already, please have a good look at our Sustainability Report on our website. As many of you know, Downer’s Urban Services strategy delivers not only lower capital intensity, but also lower carbon usage. The divestments of our Mining and Laundries assets will reduce our Scope 1 and 2 emissions by 35% or around 206,000 tonnes of carbon dioxide equivalent in 2023. Importantly, the extensive capabilities we have across our group, particularly in HV power transmission and power generation, including renewables and battery storage, means we can help our customers decarbonize. The increasing focus on sustainability by our customers and capital providers is a real opportunity for us to differentiate ourselves, and we will be slanting the business to the massive decarbonization effort that is required across the economy. On value, the challenge is clear. Now that we've finished our divestment with Mining and Laundries, we've got to invest in the right areas for competitive advantage and higher returns, improving our margins through technology and innovation and reduced costs and, of course, making sure that cash is king. And we'll continue to grow. So the revenue numbers and the increase in revenue in these difficult times shows that we will grow organically through increased customer spend in our market areas, but also through strategic acquisitions, like Fowlers, which we've done in the last 6 months. And just think for a minute of the size of effort required for the nation to meet its 2050 net zero target. The demand from our customers for decarbonization solutions has accelerated dramatically in just the last 3 months. All of our customers, private and public, have decarbonization targets. So what do they do? Who do they turn to? Within our suite of technical skills, we are in a prime position to grow our business in what will be a massive transformation effort. Governments can't or won't put numbers to what needs to be spent, it's too large, and this all lies ahead of us. Now I will now move to Slide 3 and our management of COVID in the last 6 months just to give you a sense of how businesses like ours are managing. So despite the obvious challenges, I am very pleased with how our management teams have organized our labor availability and equally as pleased with how our workforce has responded. On the labor shortages side, we had seen significant variation in the percentage of employees in isolation by business unit. And some of those are as low as 2% and others, at times, have been as high as 40%, particularly where there's been a high reliance on casual staff. On average, around 10% to 15% are off at the moment isolating for one reason or another. Now business continuity strategies have been generally well managed with percentage in isolation now stabilizing or declining in all of those areas. So things are getting much better. Pleasingly, we've had limited impact on our ability to service customers. Customer labor shortages on the -- so this is customers -- so on the customer side, the labor shortages are impacting workflow and delaying new projects. And you can see that as we roll through the individual divisions. But we think this will reverse as infection rates, as we can see, are in decline. On workplace management, the compliance effort has been quite complicated with different safe work requirements across each state and territory. Most states have been -- have seen multiple changes in rules or most days have seen multiple changes in rules and requirements across the states and New Zealand. Unfortunately, it's just something that has to be managed and thankfully, we are well versed in managing through change. There is undoubtedly a productivity impact increasing the cost of service, but we anticipate this will be temporary. Mitigating the ongoing risk of COVID is obviously key. Now we've long established safe -- COVID safe standards, practices and mature continuity plans, which have held us in good stead, and we share those and coordinate with our customers. We are proactive with our customers both on the service side but also commercially. We're focusing in on our supply chain management and are planning as far ahead as we can trying to predict bottlenecks and future shortages. Our workforce is directed to priority works, continuity of critical regulatory roles, particularly where we operate customer infrastructure and smaller work groups that are more severely impacted by staff shortages. And we're also using alternate contract partners or subcontractors where we need to. And on the contract management side, customers are generally supportive and are providing KPI relief where appropriate. In a number of cases, COVID-related variation claims over the last 2 years continue to progress. I would say that the volatility in materials and labor supply and pricing is making it difficult for everybody in the market to commit to costs and program timing for new contracts, and this is a key focus for our risk reviews. And generally, the circumstances are requiring a more collaborative approach to risk sharing with customers. Now that's not a bad thing. Now given the understandable interest in the prospect of much higher inflation levels and wage growth on the businesses, like Downer, I thought I'd include the following slide, which you may have seen from the last full year presentation. Now I'm not going to go through that slide in detail, but what you'll see is that long-term contracts adjust to the impact of cost increases, including wages. Now over the past decade, these adjustments have been generally detrimental to margins due to lower movement in CPI and wage indexes, in some cases, being outstripped by actual costs. Now I think we're entering a phase where this could turn around where higher CPI and wage indices provide price rises that exceed actual cost increases in some cases. It will, of course, require close cost and labor management. But in my view, it is an opportunity that we haven't had over the last number of years. I will now turn to the performance of our 3 core businesses, Transport, Utilities and Facilities. So as you know, Transport is the powerhouse of the group, both in Australia and New Zealand, contributing half of the group's revenue. Now revenue was up 14.6% or $359 million with strong performances across the business units. EBITA was up 15.9% with increased contributions from rail and transit systems and projects. Now the results would have been better, but the Roads business, which was having a cracking half, was unfortunately impacted by terrible weather in the second quarter. Now we commenced the operation of Adelaide's Metro Trains and the Region 8 bus contract in Sydney, and both have started very well. I spent some time at the Brookvale Bus Depot last week, and it all looks very good. Now we're hopeful of being successful in other bus operations being tendered in Sydney at the moment. We've also recently picked up the Transurban CitiLink road services contract in Melbourne, which is very pleasing. And as I said, the new Rosehill Sustainable Resource Center is in commissioning. Now it's a game changer for us being the most efficient asphalt and recycling facility in the country. And we've also, as I said, acquired Fowlers Asphalting in Gippsland in Victoria, further strengthening our geographic footprint in bituminous products and services. So now to Utilities. Now it contributes 15% in group revenue, and we've got a well-balanced portfolio across power and gas, water and telecommunications. Revenue was down 5.6%, $51 million, due to lower volumes and a change in mix away from higher margin, minor capital works. Now these are all COVID-related. We think the change is temporary, but it certainly had an impact on the half. EBIT (sic) [ EBITA ] was down 26.5% or $12 million as a result of the mix and volume change with a more significant impact in New Zealand. On the bright side, we are winning good business in Australia and New Zealand, and our customer feedback is great. We've recently been awarded a key 3-year Chorus Field Services contract in New Zealand, further extending our leading market position there. And we're also now converting decarbonization opportunities for our customers in what we are calling new energy, and this will grow. So let's now go to Facilities. So Downer is the largest integrated facilities provider in Australia and New Zealand with strong positions in a number of government areas, including health, education, defense and social housing. We're also the leading provider of asset maintenance and specialist services to Australia's critical economic infrastructure, including oil and gas, power generation and industrial sectors. Facilities contributes about 35% of group revenue. Now revenue for the period was up 22% driven mainly by COVID-related volumes in health and education. And as you know, there's been a lot more work in that area, also industrial maintenance in Australia compared to the prior comparative period and building projects in New Zealand. There was a strong earnings performance from most areas, but EBITA was up just 7.5% due to COVID impacts on 2 areas. So project volumes in asset and development services and in lower levels of work in power and energy. Again, the impact is temporary, it's COVID-related, and the projects will return. On the positive side, we were awarded the $1 billion New South Wales Police property portfolio capital works contract during the period, and this was very pleasing. I'm also pleased to report that we've successfully renegotiated the Royal Adelaide Hospital contract and the Bendigo Hospital contract, and this is quite a milestone. We've also now exited the majority of our hospitality contracts. And finally, like Utilities, our Facilities business is very well positioned to meet our customers' requirements to decarbonize. So now to work-in-hand. Downer's work-in-hand is a substantial $35 billion, and 92% of this is government related. The pie chart on the right of the slide shows that 91% of our work-in-hand relates to services contracts, predominantly long-term contracts servicing critical infrastructure. Around 9% of our work-in-hand is attributable to construction and only 1% of our $35 billion of work-in-hand relates to what we'd call lump sum construction contracts. And of course, we manage the risk in those very, very heavily. The extended profile of our workbook, as you can see there, also provides stability and confidence and our relative market position is strong and improving. So I'll come back in a moment. I'll hand over to Michael now who will present the financial results, and I'll come back a little later to talk about the outlook. Over to you, Michael.

Thanks, Grant, and good morning, everyone. Slide 10 provides a summary of the group's financial results, including statutory and underlying financial performance, cash flow performance and key balance sheet metrics. I'll talk through the detail of each in the following slides, commencing with group underlying financial performance on Slide 11. On a consolidated basis, the group reported total revenue of $6 billion for the 6 months to 31 December 2021. This was 2.3% lower than the prior corresponding period, predominantly due to the impact of the divestment program. Similarly, EBITDA and depreciation have also declined 24% and 30%, respectively, due to the impact of the divestment of Laundries and Mining. Underlying EBITA declined 17.8% to $182 million with an EBITA margin of 3%. There is a detailed breakdown between core earnings growth and the loss of noncore earnings set out on the next slide. Margin reduction has been driven by COVID disruptions and the losses incurred in the Hospitality business. Net interest expense reduced by 11.6%, reflecting lower debt levels and an improved average cost of funds. We expect this to continue to trend down following the successful refinancing of our sustainability linked loan in November. The effective tax rate of 28% remains slightly below the Australian statutory tax rate of 30% due to nontaxable distributions from joint ventures and a lower corporate tax rate in New Zealand. Downer delivered an underlying NPATA of $97.6 million, which is 18.1% lower than the prior corresponding period. Return on funds employed increased 1.4 percentage points to 11.3%. The Downer Board has declared an unfranked interim dividend of $0.12 per share. While this represents a payout ratio of 87% of underlying NPATA, it is consistent with the final FY '21 dividend and considered appropriate given the group's strong liquidity position at 31 December. Downer expects to return to frank dividends either for final FY '23 or interim FY '24. Moving now to Slide 12, outlining the business unit performance. Downer's core Urban Services businesses delivered EBITA of $238 million, up $10 million or 4.4% on the prior corresponding period. Grant has discussed the performance of the core business in the earlier slides. Consistent with Downer's new structure following the divestment program and as flagged at our FY '21 full year results, this is the first reporting period we have disclosed our core business under the simpler Transport, Utilities and Facilities segments. The most notable impact of this change is the inclusion of Asset Services in the Facilities result and the transfer of Downer's Defense Consulting business from Utilities to Facilities. We have also adjusted the comparative periods for consistency with the reconciliation included on Slide 25 of the supplementary information. Noncore business EBITA resulted in a net loss of $4.4 million for the half. This includes the contribution from the Mining businesses, Open Cut East and Otraco, up to their divestment dates of $8.1 million offset by the loss from Hospitality of $12.5 million. The result reflects -- the Hospitality result reflects the significant impact of COVID during the period at a number of venues, most notably the prolonged lockdown affecting the Melbourne Cricket Ground. Included in the result is approximately $8 million of monthly minimum guaranteed customer payments that were paid under the MCG contract that were not incurred in previous lockdown periods. Downer has now completed its contract at the MCG and handed over to the new catering services provider at the end of January '22. Downer has now exited all but a small number of hospitality contracts with the remainder expected to be sold or run off before the end of FY '22. Corporate costs rose by 8.8% to $52 million. Whilst we have reduced our head office costs during the half as part of the divestment program, the full benefit of these reductions has not flowed through the first half as yet. We have also seen continued increases in other costs, particularly insurance and IT security costs. Slide 13 lists the 5 items that reconcile Downer's statutory result with the underlying result. The net impact of these items results in the statutory profit exceeding the underlying profit by $1.4 million. The first item relates to the noncash fair value movement on the Downer contingent share obligation liability arising from options issued as part of the Spotless minority acquisition. The fair value of these options are required to be recognized as a financial liability at issue date, with the future movements being mark-to-market through earnings. As a result, we have recognized a noncash charge of $5.4 million for the half year. The second and third items relates to divestment and exit costs and portfolio restructure costs incurred as part of Downer's divestment program, totaling $51.3 million. Divestment and exit costs include the difference between the proceeds received and the carrying value of the divested assets, including an allocation of IT systems and property costs. Portfolio restructure costs include redundancy costs incurred as the group reduces its management layers and corporate headcount as part of its post-divestment restructure. It is expected that the write-off of these costs will lead to future annual savings of approximately $8 million through reduced amortization, leasing and employee costs. The fourth item relates to bid costs relating to Queensland's rollingstock expansion program. $2.8 million in bid costs were incurred during the period, and we have highlighted this item as we expect total bid costs to be material for FY '22. The final item relates to the compulsory acquisition of land by Sydney Metro at Downer's Rosehill asphalt and recycling facility. The transaction has resulted in Sydney Metro reimbursing Downer on a like-for-like basis for the actual costs incurred on the construction and commissioning of a replacement facility. Downer expects the compulsory acquisition and reinstatement of operations at the new site to be cash neutral in net terms. The replacement facility is expected to be completed by May 2022 with no expected disruption to operations. The $60.1 million aftertax gain during the period is reflective of the difference between the historical written down book value of the existing facility and the reimbursement of costs for the replacement facility and relocation costs. Turning to cash flow on Slide 14. Total operating cash flow was $270.4 million, resulting in a statutory cash flow conversion of 85.1%. Adjusting for the remaining payments recognized in FY '20 and funded as part of the July '21 capital raising, underlying conversion was 91.2%. Pleasingly, Downer's portfolio transformation continues to drive lower capital intensity with net capital expenditure for the core business of $65.2 million. Downer has also invested $22.8 million in IT-related capital with just over half of this focused on improving Downer's cybersecurity. Total funds from operation were $78.7 million. Below funds from operations proceeds from divestments totaled $247.6 million for the period, whilst the repayment of borrowings relates to the early repayment of Downer's medium-term note due in March 2022. Cash applied to the share buyback program was $99 million. The group also acquired Fowlers Asphalting during the period. Cash held at 31 December was $676.7 million, which, when combined with undrawn facilities of $1.4 billion, provides us with significant liquidity of $2.1 billion. As Grant indicated, Downer's balance sheet is in good shape with net debt-to-EBITDA of 1.5x, well below our target range of 2 to 2.5x. The successful refinancing of our sustainability linked loan during the period and prudent debt management have seen our weighted average debt duration extend from 3.8 years at 30 June 2021 to 4.2 years. We have included further details on cash flow, debt maturity and balance sheet in the supplementary information on Slides 21 to 24. Thanks very much, and I'll now hand back to Grant.

Yes. Thanks, Michael. So the key messages and outlook. With the arrival of Omicron, it's been a tough 6 months to navigate or a tougher 6 months to navigate than we expected in August 2021. Despite the challenges, Downer has delivered solid earnings and strong cash conversion for the first half of 2022. Our market positions and diversity give us strength that others don't have and confidence through to the other side of COVID-19. Our brand and our relationships are very strong. The financial capacity of the group has never been so robust with gearing at just 16.5% and net debt-to-EBITDA of 1.5x. In August '21, we predicted that our core Urban Services revenue and earnings would grow in FY '22. In the first half, our core revenue was up 13.3% and earnings were up 4.4%. But the impact of Omicron on the supply chain, work volumes and mix is difficult to predict and presents risk for the second half, so we'll not be providing specific earnings guidance. We'll do our best to manage that risk with our customers, and we'll provide an update at our Investor Day in April. So thank you, and that's the end of the formal presentation, and I'll hand over to the moderator to organize the questions. Thanks.

[Operator Instructions] The first question today comes from Rohan Sundram from MST Financial.

Grant, I'll start with a question just on the environment. Labor supply issues and COVID impacts aside, how would you describe activity levels in the half? Taking on board your comments, would you expect material improvement in the second half? And are you seeing that pick up from rising government spend in your activities?

Look, I think what I'd say is for the -- particularly the second quarter, so this is the second part of the first 6 months that we've just seen, Omicron, just the impact of that on sort of customer, the outflow of work, et cetera, had quite an impact. But I sense from each of the businesses that that's starting to turn around, and we see it in our own business. So the issues related to absenteeism because of COVID, et cetera, and isolation seem to be changing. So there's no issue with the underlying demand for services. It's really being able to get it out the door. And I think that's starting to come back is what we're seeing.

And one final one for Michael. Post the reset in the Royal Adelaide contract, what's the -- are you able to provide indications around the cash burn, monthly or annually, for that contract?

Post the reset?

Yes, post the reset.

Yes, it will earn money. It will be cash positive for us.

Yes, we should see normal returns off the back of those resets.

The next question comes from Adam Martin from Morgan Stanley.

Just around the labor shortages, can you just elaborate that one a bit more? I mean you talked about it sort of varying quite a bit. Can you just talk through why it does vary a lot to -- just give us some context around some of the business units, please?

Yes. Sure. So where you've got a more significant number of casual employees, it seems to be more pronounced in those areas. So if we look at Utilities, which has been our most impacted outside of Hospitality, in the metering services there -- that's where, at times, we've been 40% short of where we would normally be. Now, of course, we rearrange our work, et cetera, to manage that, but it's generally where that's the case. And it can be more acute where you have smaller work crews. So if you think you've got work crews, maintenance work crews on, whether it be power lines or whether it be even pavements, when you've got 6 or 7 people and 2 or 3 are out, then that's where the impact has been. But generally, we've been managing this very well. So it's -- as I say in the presentation, we've not really seen service degradation from those. We've been able to manage in large part with our customers to make sure that everything is run well. And of course, as I made clear there, it is starting to turn, and that started 2 or 3 weeks ago. So we've stabilized, and those issues are declining.

Okay. That's good context. Just in second question, just regarding the Transport division, you've sort of called out I think customer volumes across these Eastern states. Can you just give a bit more context on that one as well and just whether there are signs of that improving over the next 6 to 12 months?

On Transport, I think I said -- yes, so Transport generally was very good. So I called out there that our Roads business -- Road Services business was having a cracker half, but it did get impacted by a lot of weather, which we've all been experiencing in the second part of the half, that's just been the case of it, and that's been in the Eastern states. Now all that will return. The work doesn't go away. It's got to be done. So if we end up with a good period between now and the end of June, that will be great. Our Rollingstock business did well and our Projects business did well in there. So I'm not sure where -- it wasn't disruption, it was really weather in those areas.

So that should really improve going forward assuming the weather's not too bad going forward. Is that your sense? Or...

Yes. Well, I just look at -- our Roads business is doing very, very well, and we were in for a very, very good half. But I just look at -- we don't call weather out very often. We probably had 7 or 8 full years where we've not been calling weather out, but it just was such an issue for us in the last. So we just -- it's off quite a bit as a result of that. And so we'll just see what happens in the second half.

The next question comes from Shaurya Visen from Goldman Sachs.

I just wanted to get some more color on your guidance. So you have mentioned that the new COVID situation poses risks to edge. But again, one edge you have delivered, right? So both core earnings and revenues were up year-on-year. So is it fair to conclude that your prior guidance on year-on-year increase of earnings and revenues still holds?

Look, I think you can imagine, as you roll through into these presentations and the words that you put them have all been well worked. I think what I've got there is really what I want to say. And that is that the facts are that our first half has been a good performance in the core business, right? So we've had good revenue growth, which just -- look, the revenue growth in here just shows in those core areas that -- we often talk about growth here. There's a lot of organic growth. There's a lot of money being spent here, there's no doubt about it. Omicron has had an impact. There's no doubt about that either, right? Productivity-wise. Now just how all of that comes together for the second half, we've sort of put in those outlook statements. So I don't want to go any further than that other than to say that, of course, there's risk depending on what happens, and it's been a volatile situation over the last number of months, and let's hope it's not in the next 6 months. But you'll have as good an idea as I do on the volatility of government decisions and the like, right? So we'll see where we go.

The next question comes from Andrew Hodge from Credit Suisse.

I just had a couple of questions. First one just around the reconciliation from [Audio Gap] and the portfolio restructure. So you have to just talk me through -- I just figured bid costs for a contract are an underlying part of the business. Just want to understand why you've excluded those as a reconciliation.

Yes, you want to do that?

I mean I think it's just the size of them. So the majority of all the Downer bid costs that we spend across the group, which is obviously many, many millions of dollars, has just flowed through the underlying result where we're bidding this major rollingstock program. It's going to have a material amount of bid cost. It's unusual to any other project that's going on in the group. We're just flagging that the impact of that on the full year is going to be much higher than $2.8 million.

Okay. Great. And then just in terms of the portfolio restructure costs, I think you alluded to it, but can you confirm that all of those were in businesses that are outside of what you consider the core Urban Services business?

Yes, and the corporate restructure that we've done to rightsize the business to deal to a more refined portfolio.

Yes. And then just one final question, just in terms of the buyback, $100 million in the half, consistent with the previous half. So I guess, just going forward, we figure you do $100 million for the next couple of halves to finish out the stated level that you've got in the market?

Yes. So somewhere around there. I mean the volumes vary depending on our decisions to buy and diligence in the business and all those things. But yes, we'll -- that would be a reasonable run rate assuming that there's something -- there's not something more accretive that we would apply some of those funds to.

[Operator Instructions] The next question comes from John Purtell from Macquarie Group.

Just had a few questions, if I can. Maybe just a first couple for Michael. Just in terms of the amortization add back, it's comparatively less this period. So what was driving that? And is that now sort of a go-forward level?

Yes. It will diminish slightly, I think, from here, John. But the majority of that number came about following Spotless. And so we allocated the intangibles to customer contracts and brands and whatnot in the front end of the significant amount of that, that was allocated to the contracts on foot as wound out over the sort of 5 years or so between now and then. So there was a big step off for the first round of the intangibles that were attached to those contracts that we acquired.

Okay. Second question, the $12 million loss there in Hospitality, you obviously flagged that you've exited a range of contracts. So should we expect to see a much lower loss in the second half?

Yes. We were out of the MCG from January. So there will be a little bit of drag into the January results. And then the biggest contribution to that, John, is the minimum guaranteed payments that we are required to pay, whether the contract operates or not. So there's about $8 million of that relating to the MCG in the half. We've been fortunate enough to have that relieved during previous lockdowns. We weren't for this period. So they will go and there'll be sort of trail losses, which we would expect to be minimal in the second half.

Okay. And just the final one. Grant, you mentioned that you're sort of entering a phase where CPI rises, potentially allow for some pricing improvement maybe, I suppose, on top of inflation there. But really 2 parts to the question. Firstly, the contract structures that you have in place, which you've called out, have good CPI recovery. Are they working as they should base on everything you're seeing at the moment? And secondly, that opportunity that you see, I mean, is that more around a rational -- a more rational environment in terms of, I suppose, labor being a bit scarce. So the participants such as yourselves are pricing that a bit more rationally?

Yes. So first on the contract structures. Look, it's -- you don't enter into long-term contracts without being covered for cost increases, right? So now in -- you'll see in that slide that I put up there, the very, very vast majority of -- in fact, all of the longer term contracts have these types of mechanisms, and they range from general CPI to other more targeted indices and on the wages similarly. Sometimes wages will go up by CPI, and sometimes they'll go up by wage taxation, and that's a matter of negotiation at the time that the contracts are formed. So all of them adjust the prices to these things. Now with low inflation, low wage growth over the last periods, that's been quite difficult to manage, right? So you're constantly under the hammer to make sure that you're getting more efficient in the way that you operate, et cetera, during periods of low price increase. And I'm really just saying here that with a higher CPI and likely higher wage index, we will see higher prices. Now -- for our services. What that does mean, though, is that you've got to manage your costs. And often, the basket of costs that we actually have is different to CPI. So you're managing those things. And also the basket of wages is different to CPI. And you've also got potentially 3-year enterprise agreements that won't get renegotiated for quite a period of time. So it's those arbitrage positions that really I'm talking about here, and I'm hopeful that Boston has been difficult over the last number of years with low index increases that may change. Of course, it's got to be managed, John.

Yes. And just sorry, just a final one, if I may. Just harking back to a few of the earlier questions. So essentially, Grant, you're sort of viewing a range of these impacts is temporary. Is that the correct read? And in terms of your ability to source labor and retain labor in a tighter environment, you feel comfortable around that?

Absolutely. Look, I do think that's all -- this is temporary. The -- it's hard right now when you're putting results out of the past 6 months, it's hard to look forward. But if you look forward, we look at the opportunity that's been created here. There's that much that's going on in our markets that if we hadn't had the Omicron and we were all sitting back here in sort of July without that, and we thought we were through, everyone's vaccinated, then we wouldn't be sitting here talking about the issues, but we will get through this. And the underlying demand for the services and the amount of money that's being spent is very positive. Right now the cost to serve and the issues around labor and supply chain, they will ease. It's already easing on the labor side. And I think the labor -- the supply chain will ease as well. So I just -- it is temporary. And we can already see that in what's going on. So I'm very positive. I'm not negative at all. In fact, I'm very positive. And I do believe that a lot of the changes that have occurred with COVID are net benefit, right? So it's going to drive our markets over the next decade, and we'll be -- we're right in the thick of where we should be.

The next question comes from Scott Ryall from Rimor Equity Research.

Grant, I was hoping to focus on the Utilities division, please. Could you just talk a little bit more about the -- reconcile maybe the comments about the mix changes that have impacted earnings, the fact that you think that's temporary. But then cross checked with the work-in-hand, which is -- that's the only division where work-in-hand has fallen quite significantly between the end of fiscal '21 and December. Can you just talk about that firstly?

Yes. So in Utilities, we do a lot of maintenance work. So this is maintenance on poles and wires. We do a lot of work in telco, a lot of work in water, right, across the country. So those contracts typically have a base maintenance level. So you're doing certain things out in the -- across the operations to maintain that. But coupled with that, you have a lot of what we call small capital works, right? And sometimes, not that small, right? So -- and they're typically higher margin parts of that work. Now you get that work because you've got your base contracts and you're sitting on those panels. We've seen with Omicron, in particular, as the issues of that, and it's not really our issues, but certainly in the flow of work, we've seen that mix change, right? So less work in that, minor capital works across most of that, in particular, in water. All right? So what that means is that -- and it's temporary, right? It will change as labor shortages, particularly in our clients and also our own, subside, which we think will happen relatively soon. That's the situation.

Just jumping on the...

And sorry, it's not just in Australia. It's also in New Zealand. We've seen the same impact, right? So a lot of these -- a lot of the water authorities of the back of government positions on workers that have pulled back quite significantly, right? And they've done it specifically to support the COVID push.

Okay. But then reconciling that with the work-in-hand pull as well?

Yes. I think -- if I can jump in on that one, Grant. The segment reallocation we did, we put the Defense Consultancy business out of Utilities into Facilities. And so there's been a work-in-hand transfer. We can come back to you with the details of it, but that's part of the reason as well.

Yes, there's nothing -- so I'll just say that our Utilities business is going very well, okay? Now I know it's been down in earnings by that amount, you'd say, oh, gee, it's not that well. But they are not permanent issues. They will be temporary. We're winning very good work, right? And our customers are telling us we're doing a very good job. So I'm very happy with the way that business is going.

Okay. And then can I just ask a follow-on then. You talked about the significant growing opportunities in energy transition and decarbonization, which absolutely, I get the tailwind there. But when do you think, in the Australian and New Zealand market, this actually becomes a meaningful work-in-hand and earnings opportunities for Downer? What's the kind of time frame you're thinking about? I know you're...

Yes. So it will depend -- it's different depending on the business unit, right? So if we look in our transmission business, it's already becoming. So there's a lot of transmission work that's starting to come on deck, right? There's a lot of stuff that we're bidding, and that will just get bigger, right, over time. And we're talking there's billions of dollars of projects. I don't know whether you saw in the paper this morning, we've got quite a push that it's too slow. So that will be very quick. In our customer base, whether it'd be in Facilities or in Utilities, we're already seeing a lot of attention being taken to reducing their carbon footprint. Now what we really mean here is that they're using their estates to generate power, right? So already now, we're starting to build solar farms, et cetera on our Utilities customers' and Facilities customers' estates. Now that's early days. If you think about the fleets, we're starting now to be developing electric vehicle facilities. We're doing that with Keolis Downer in our buses. All of this is to come. We're at the start of this. Just exactly how quickly it moves, we'll need to see. We've got to build the transmission and the power infrastructure first, I guess. There's no doubt about that, but it's starting to happen. In 3 years' time, I'd like to think it's a significantly larger part of our business than it is now. It certainly will be in our projects business in transmission.

The next question comes from Nathan Reilly from UBS.

Just picking up on the, I guess, the core Urban Services revenue growth, 13% revenue growth there on what sounds to be a very, very tough half. But just can you give us a sense of, I guess, what level of revenue you could in service, just given your own bioavailability challenges. Just trying to get a sense of, I guess, the underlying run rate and growth there, just absent any of the challenges around labor that you've seen?

Yes. Look, I haven't done the alternative position. But if you look at Utilities, we're down $51 million in revenue there for a start, right? We would have expected an increase. We've had weather impacts in our Roads business, we would have expected more out of that, right? So just for a start.

Got it. Okay. And I guess the extension of that, just given you've obviously had a pretty challenging margin outcome there, and that's a reflection of the productivity challenges that you've faced with both your own lower labor availability and also client availability. But you say as the workers do come back to work, is there anything that gives you cause for concern around your ability to, I guess, recover on the margin front? Is there anything, I guess, permanent around productivity or the cost base, which gives you some concern?

Look, there's nothing that I can point to, but it will require management. We need to get back to making sure that all of our operations are as efficient as they can be. That's just the way it will need to be. That will be where the pressure is applied.

And Nathan, the hospitality result had a pretty significant impact on the margin. So that business did about $90 million of revenue for the $12.5 million loss. So that's 20 to 30 basis point explanation as to the difference in margin period-to-period.

Yes. That's why. And so even in Facilities, our asset and development services, right, it's got a lot of revenue, and it was impacted very significantly. It's a business that does a lot of small work, particularly in air conditioning. And it suffered very significantly with lockdowns, right? So just productivity wars. And that will return. So that will improve.

Okay. And finally, look, this is a question around sort of corporate overhead, but I think it also extends to, I guess, business overheads at the segment level. Michael, you called out there that there's been some inflation around IT and IT security and also some insurance charge inflations. I think that's really masking a little bit of cost reduction in that corporate line. But are you at a level now, post the divestments that you've undertaken, where it's appropriate to maybe go and look at the overall cost base?

Yes. We started doing that, Nathan, and we'll -- we're still providing transitional services to the majority of the divested businesses. And so we're recouping some of that, but we're not recouping all of the cost of that. We've done some reduction at the corporate layer that I suspect in the second half, once the majority of these transitional services are behind us, we'll look at that again. And then there's a few sort of IT security costs and cyber insurance and the like are going up pretty significantly, and they're obviously critical costs for the business. There's been a little bit of turnaround or sort of negative impact for us the way you account for some of these IT projects now with the expensing of it, you save some, but we've had a bit of a turnaround or a negative impact to that as well. But yes, to answer your question, we're certainly going to continue to look very closely at overheads.

At this time, I'm showing no further questions, I'll hand the conference back to Mr. Fenn for closing remarks.

Well, thanks very much for your interest in Downer's results. And please, if you have further questions, if you can pass them through to our Investor Relations team, and we'll do our best to answer them as soon as we can. So thanks very much.