Emeco Holdings Limited (EHL) Earnings Call Transcript & Summary

Good day. My name is Krista, and I'll be your conference operator today. At this time, I would like to welcome everyone to the Emeco Holdings Limited Fiscal Year 2023 Results Briefing. [Operator Instructions]. I will now turn the conference over to Ian Testrow, Managing Director and CEO. You may begin your conference.

Good morning, and welcome to Emeco's results for the 2023 financial year. With me this morning is Theresa Mlikota, our CFO, who commenced a new role in May and has hit the ground running. Getting straight into -- onto Slide #3. FY '23 really was a year of 2 halves, where we delivered very strong second half performance, as what was, as you're all aware, a difficult and disappointing first half. Off the back of exceptionally strong demand for our equipment and service, particularly in Rental and Force, we delivered record revenue of $875 million, which was up 16% on FY '22. Operating EBITDA of $250 million is in line with our guidance. Our second half operating EBITDA of $137 million was 21% higher than the first half and which delivered growth across each business unit. We have strong momentum for further growth in FY '24. The second half saw the anticipated turnaround in Pit N Portal that we flagged at the half. This is driven by actions we took to derisk and reset the business and the impact of successful renegotiation of rates and terms with a major customer. I'll leave Theresa to talk in more detail about the credit provisioning in a few minutes, but I want to stress that we've done a huge amount of work on counterparty risk, and we have strengthened our team and processes to ensure we are less exposed going forward. In this regard, some of you will be aware that we also terminated another project, Aurora, later in the second half and the financial impact of that is in this year's numbers. But I want to stress that no further provisions have been taken or are required. We have reset the business and putting measures in place to ensure that we don't repeat the same mistakes. Second half operating free cash flows were very strong at $44 million and shows the business' ability to generate strong cash flows moving forward. Our balance sheet remains strong at 1.1x, even after absorbing the credit losses. Our return on capital of 13% is well beneath where it should be, that is driven by Pit N Portal's underperformance. Excluding Pit N Portal, the core business that is Rental and Force generated a return on capital of 18%. Our balance sheet and cash flow have allowed us to invest in our business and deliver on our capital management policy. The Board has declared a second half capital management package of $13.8 million, which maintains a fully franked dividend of $0.0125 and includes a share buyback of $7.3 million. That's 35% of operating NPAT, which is the up end of our policy and demonstrates the Board's confidence in the business. On to Slide 4. Please note the second half of FY '23 is a turning point for the business with operating EBITDA up 21%; operating EBIT up 56%, operating NPAT up 95%, and the cash flow really kicking back after the poor first half. Slide 5 summarizes the key numbers that I've already talked to. For me, the main call out is a $44 million operating free cash we generated in the second half. After a tough first half, the business has really delivered a strong performance. On to Slide 6 and our outlook. Our outlook into FY '24 is positive with the momentum achieved in the second half driving earnings growth. Rental growth will be driven by increasing utilizations of the projects we worked hard to establish during the second half of FY '23. Force's contracted retail pipeline will underpin earnings growth. Pit N Portal's earnings will be high in FY '24 than '23. However, first half earnings will be lower than the second half of FY '23 as the impact of derisking flows through. Pit N Portal's earnings will improve in the second half of FY '24. We will focus on cost efficiencies and pricing to drive margins and return and the continuing high inflation environment. We have committed to an ERP upgrade, which is expected to be a 3-year project and will approve our financial and operating capability. We expect to spend about $8 million in FY '24, and this will be treated as a nonoperating expense. Leverage will remain at our 1x long-term target supported by our cash generation. Based on current utilization, this year, we will spend approximately $160 million in sustaining CapEx, which is in line with our depreciation. We've spoken at length about our track record of delivering high returns in our Rental business for our midlife asset rebuild model. This is a real competitive advantage for us as we're able to acquire midlife asset cores and rebuild them through Force to meet customer demand and facilitate growth. In FY '24, we will rebuild 5 789C trucks cores to replace cross-hired fleet. This investment will be approximately $7 million and generate IRR of 19%. In addition, we also found an opportunity to acquire 18 793D truck cores. We're really excited about this as they're very high-demand assets. So costs about $19 million, and we can rebuild each truck at approximately $1 million each. We'll do this to meet customer demand, which at the moment appears very strong. We expect an IRR of approximately 20% on this investment. Turning to Slide #7. By way of reminder, our FY '23 CapEx included the rebuild of cores acquired back in FY '22, which were deployed in new and existing projects throughout the year. The total cost of these trucks ended up being 1/4 of the cost of brand new trucks and will generate returns of over 20%. This is a great example of our mid-life asset rebuild model being implemented to meet customer demand and achieve strong returns. The new investment of 18 cores, I referred to earlier, will generate approximately 20% return and the total cost will be 30% of buying new trucks. The timing of this investment can be managed to rebuild the truck cores through Force to meet our customers' demand. We've said that our total spend for this year is expected to be between $24 million and $37 million, depending on how many trucks we rebuild in FY '24. We really like this flexibility as it enables to manage our capital investment according to market demand. It takes away the lumpiness you see in mining services where quite often our project wins result in huge capital bill. I think this is a feature of our business that differentiates us from our peers. We'll give you an update on this at the AGM in November. Now looking at our divisional performance. Slide 9 addresses our safety performance. Safety is our most important priority every day across the entire Emeco business. Our Total Recordable Injury Frequency rate is 2.9%. Regrettably, we recorded our first lost time injury in over 7 years during the second half. You heard me describe pride in our safety performance, this is a timely reminder that we can never be complacent and we have to implement ongoing improvements as part of our health, safety, environmental and training program. Turning to Slide 10 and Rental performance. Rental revenue grew 19% in FY '23 as we deployed fleet to meet strong customer demand and increased the number of fully maintained projects in line with our strategy. We deployed equipment to meet new work at 8 project sites for the year. Our gross fleet utilization increased to 93%, driven by this new work. Operating EBITDA grew 8% to $260 million. The second half performance was strong with operating EBITDA of $136 million, up 10% on the first half. As we called out in the first half, margins were impacted by the increase in fully maintained projects, use of cross-hired fleet to meet customer demand and the ongoing rising cost of both parts and labor. As mentioned earlier, our Rental and Force business is achieving a healthy 18% return on capital. Operating EBIT increased 17% in the second half to $75 million, and EBIT margins increased to 29%, which is tracking in the right direction. This positive momentum built up in the second half will continue in FY '24. We'll also see half-on-half growth as the second half is boosted by the deployment of growth assets. Slide 11 shows Eastern Rental's performance. The Eastern region delivered 22% revenue growth and 9% operating EBITDA growth for the year as we commenced new fully maintained projects. Second half earnings growth of 10% is a solid result. Strong demand will continue in FY '24, and we expect the majority of the growth 793D trucks that go to work in the Eastern region. On Slide 12 and the Western Rental. 15% revenue growth and earnings growth of 6% was delivered across the year with strong demand from iron ore and gold projects. Half-on-half operating EBITDA increased by 12% as equipment was put to work. Margins improved in the second half as we grew pricing on new projects and contractual rise and falls to offset the ongoing inflationary impact on parts and labor. FY '24, we'll see growth in earnings. Margins in the West is still lower than the East, and this is predominantly due to the greater proportion of single-shift projects in the West. Interestingly West still manages to achieve a healthy 18% return on capital, similar to returns in the East. We continue to focus on growing our double-shift projects in the West and see opportunities to do so in the second half of '24. On to Slide 13, in Force. Force continued its strong performance during the year, driven by the significant increase in retail activity as well as internal work. Retail revenue increased 73% to $156 million, and the operating EBITDA grew 30% to $12 million. Margins stabilized in the second half as we improved pricing and focused on the productivity and efficiency of our workforce. Force is at the heart of our competitive advantage with the quality and cost advantage of fleet rebuilds underpinning a midlife asset model. We've increased the proportion of Force build components used in our Rental fleet by 30%, which provides us both savings and security of supply in a tight and expensive parts market. We expect earnings growth in FY '24 from both retail and internal works weighted to the second half is typically the case with the Force business. Growth is underpinned by contracts for 55 retail rebuilds and internal activity continue to be strong. We expect this will be between 45 and 60 machines depending on the sequence of activity of the 793D cores in the workshops to meet Eastern region demand. Turning to Slide 14, and Pit N Portal. Year-on-year revenue declined by 10% to $224 million, reflecting the derisking and reset of the project portfolio that we talked about the first half result. The impact of lost revenue as well as one-off terminations, demobilization and restructuring expenses all hit the first half result, as you're well aware. The second half saw a turnaround in earnings with operating EBITDA of $14 million and margin back to 14%, which is driven by new projects and the improvement in the contractual terms with a key customer. I'll leave Theresa to go through the credit provisioning and the cash flow impacts. However, as noted, our risk and credit discipline also saw us terminate activities Aurora late in the second half. We've really improved our counterparty risk and credit management process to reduce risk exposure. Again, these issues were not performance-related, and we've acted decisively when terminating projects. We've cleaned up and rightsized Pit N Portal and put measures in place to ensure that we don't make the same mistakes moving forward. We believe it is important for Emeco to have an underground exposure given the growth and diversification this sector provides the group. We'll continue to evolve Pit N Portal to ensure it delivers adequate returns consistent with the rest of the business. Over to you, Theresa.

Thank you, Ian, and good morning, everyone. A quick point to note before I start is that the presentation refers to operating results, which are reconciled to statutory results in the appendix to the presentation. Ian described FY '23 as a story of 2 halves, and you can see how this flowed through the P&L on Slide 16. Full year revenue growth of 16% was driven by the exceptionally strong first half with growth continuing in the second half, delivering record revenue for the year overall. Second half growth was tempered by the decline in PNP revenue, whilst both Rental and Force continued to deliver good revenue growth. You can see the significant growth in operating EBITDA and EBIT and a strong margin recovery in the second half with a 21% increase in operating EBITDA, and a 56% increase in operating EBIT. Depreciation stayed relatively stable across each half. This supported higher EBIT margins as the business continued to grow its less capital-intensive earnings through Force, PNP and fully maintained projects. Depreciation for the full year increased from $130 million to $146 million, largely in line with revenue growth. Costs continue to challenge the business with repairs and maintenance expense as a percentage of revenue increasing from 16% in FY '22 to 17% in FY '23 due to parts and labor cost inflation. The increased use of cross-hired fleet and subcontracted labor also impacted margins as the business met rising demand in the Rental business. As Ian noted, part of our capital spend is -- will be to replace cross-hired fleet with our owned equipment, which will improve margins and returns. Higher levels of Force workshop rebuild revenue diluted margins but positively contributed to return on capital. Finance charges also increased as a result of higher lease liabilities as well as higher interest costs on debt and supply chain finance drawn through the year. Corporate costs increased in line with revenue growth and the increased capability being added to the group. Operating NPAT of $59 million is down 14% for the year. However, you can see the material turnaround in the second half with a more than doubling of NPAT half-on-half. Return on capital was lower at 13%. This was driven by the poor performance of PNP. Excluding PNP, return on capital is 18%, which is well above our cost of capital. The graph on Slide 17 shows the FY '23 cash flow waterfall. Cash conversion of 103% is based on statutory EBITDA conversion to cash flow from operations. The outflow in working capital of $18.2 million relates to the nonrecovery of $23 million in PNP receivables that are now fully written off. Finance costs of $26 million are higher than the prior year as a result of higher leasing levels, higher average debt drawn and higher interest rates on the RCF. Cash was also paid for establishment costs on the RCF rollover. No taxes paid in the period as the group has carried forward tax losses, which are used to offset tax payable. The company has $312 million in carried forward tax losses after this year's offset. Sustaining CapEx of $154 million was funded from operating cash flow. This resulted in operating free cash flow of $52 million for the year, of which $44 million was generated in the second half. Cash outflows for dividends and buybacks totaled $20 million and debt and lease repayments totaled $19 million. Slide 18 is a new slide. This summarizes how we spent our capital during the year. The bulk of our net sustaining CapEx of $154 million has been spent in the core rental business. Sustaining CapEx was 106% of depreciation versus 119% last year. As Ian noted in the outlook slide, sustaining CapEx for FY '24 will be in line with depreciation at approximately $160 million. Ian has talked through the $22 million in growth CapEx invested this year and the returns that we expect to generate on core rebuilds using Force, which is both capital and cost efficient. We're confident that the capital we spend on growth will generate returns of around 20%. Moving to Slide 19. Our balance sheet remains strong with net leverage of 1.1x EBITDA. You can see the increase in plant and equipment reflecting sustaining and growth CapEx. Receivables have increased as revenue has grown, partially offset by recoveries and write-offs. You will note that our revolving debt facility is undrawn at year-end. Our $250 million medium-term notes have been established at an attractive fixed 6.25% interest rate and are noncurrent being due in July 2026. We have available liquidity of $142 million, including cash of $47 million. This is summarized on Slide 20. During the second half, Fitch increased our rating by a notch to BB- and Moody's also upgraded their outlook to positive on their B1 rating. Slide 21 represented extensively in our half year reporting about the one-off expected credit loss provision that was raised for $23 million in relation to the Minjar/Barto receivable. Since that time, we have collected $10.9 million against this, including $6.4 million recovered post balance date. The balance of that receivable is now fully written off. However, in the second half, we took action to secure and enforce our position at Aurora, where we were owed almost $10 million by placing that company into voluntary administration. The entity was subsequently placed into receivership by a secured creditor we've also written that amount of. The KMG contract was also terminated as part of the overall derisking and resetting of the PNP customer portfolio, and that debtor has been written off. The net impact is that the provision taken during the first half of $23 million was sufficient to cover all other written-off amounts. However, that same amount will not be collected as cash. As outlined in the first half result, there have been measures implemented to strengthen risk and credit management and to improve credit processes and customer selection. With the introduction of myself and our Deputy CFO, [ Judith Budia ]; and the addition of a dedicated credit manager, a comprehensive counterparty credit risk review has been completed, and we've set out our current receivables book on this slide. Our top 10 customers represent 64% of total revenue and 84% of debtors are considered blue chip or fully insured. It is the 16% that we are working with that are not insured or are underinsured. These accounts are actively managed to minimize the risk of any material credit default in the future. With that, I will hand it over to Ian.

Thanks, Theresa. And now on to Slide 23. I'm sure you're all familiar with our strategy. So not [indiscernible] we are fully aligned to each of the pillars that support Emeco to build a sustainable and resilient business that generates value for our shareholders. FY '23 has had its difficulties as we've derisked Pit N Portal, but the actions we have taken have been necessary to reset the return profile of the business as well as enhance the credit quality of our customer base. Our value proposition continues to resonate with customers with increasing work in Force, more fully maintained Rental projects and growing EOS technology adoption. As Theresa has said our balance sheet is strong, we will generate strong cash to support capital management and our growth initiatives. Moving on to Slide 24 and sustainability. Emeco strives to create a sustainable business, which continues to deliver creative solutions for our customers. A family feel for our people, support for our local communities and value for our investors. We made good progress with the Board supporting and approving the ESG strategy in February and with the establishment of the ESG committee in March to discuss, shape and measure initiatives to assist in establishing systems to report on the progress and compliance with TCFD. We're investing in our EOS technology to support our fleet to be as efficient as possible and to manage and reduce emissions. We've also started work on developing our current Scope 1 and Scope 2 emissions. We also formed the Reconciliation Action Plan, which is currently under review. Now lastly, on the Slide 25, we'll summarize our operational priorities for FY '24. Our primary objective remains to drive the performance of our core Rental and Force business as we continue to navigate through the current environment of strong demand for our fleet and services while managing ongoing inflationary pressures. Paramount is driving the advantage of our midlife asset model to deliver strong returns on any growth investment. We'll continue to build on the reset of Pit N Portal in order to achieve acceptable returns. We think there's significant opportunity to drive EOS further after securing 4 major projects this year and especially with our carbon module, which allows customers to monitor and manage emissions data in real time. With that, I'll hand over for questions.

[Operator Instructions] Your first question comes from the line of Jakob Cakarnis from Jarden.

Just wanted to get some commentary from you, please, the trajectory for EBIT margins -- sorry, EBITDA margin for the Rental business. Can you just talk to some of the cost pressures that you faced first half, second half and just how those are looking as you head into '24, please?

Yes, Jakob. We've mentioned it's an inflationary market, and we have seen increases in parts, particularly over the last [ 19 ] months. That eased a little bit in the last half, but labor is definitely tight. As we've ramped up a bunch of Rental projects, we have to use more subbies than we have done in the past. And so there's been a bit of cost pressure from that. We see opportunities to replace those subbies with our employees, which is our model, and that will reduce costs. And the other opportunity to reduce cost is to reduce cost-hired with -- of other people's equipment. For the demand that we're seeing in our Rental business at the moment, we've had to rent equipment of others because the customer just wants to deal with us. Our utilization is strong. And as you've seen from our leases, we're bringing in some additional equipment. That equipment will be used initially to replace cross-hires which should improve our margins. So in an inflationary environment, with our rise and falls in place, we've opportunities to reprice when we put [ new -- gear ] out to work. I'm feeling pretty good about at least on the margins moving forward in our Rental business.

Ian, is it fair to characterize it then that maybe the second half of '23 could be a trough in EBITDA margins then for the Rental business?

Yes, I think so. I believe so, yes.

Okay. And then you've said that you're going to deploy those new truck cores within the Eastern division. Is there any issue that we need to think about for utilization rates within that as those new cores come in to work? Or is it very much additive to meet the demand that you guys have?

It's [indiscernible] meet demand. The 793Ds are absolutely prime assets in demand from our customers. And if you look at the 789 and 793s that we're investing in growth, that's absolutely for utilization for us. We're actually importing those cores from [indiscernible]. So they'll arrive around at the end of the first half, and then we'll rebuild them in the second half. I mentioned that we expect to get a 19% to 20% return on 789s and 793s. So I think any uptick from that growth fleet will be seen in the back end of the second half. But we're really excited by that. We're communicating well with our customers. We expect them to go to work, 789s were initially based across our equipment. So -- but this is absolutely a core business for us as evidenced by the cores we picked up from the BHP auction a couple of years ago successfully we're able put out to work. Customer acceptance is strong and our returns are strong. So -- yes, we're really excited about demand.

[Operator Instructions] Your next question comes from the line of Nicholas [ Rawlinson ] from Jefferies.

You called out the second half skew in Rental, Pit N Portal and Force. So how should we think about the overall skew of group earnings for FY '24? And sorry if that's been asked already, I dropped out just before.

Yes. We'll see growth half-on-half in our business, but we will see a slight drop-off in Pit N Portal as the derisking come through the business. And there's a bit of seasonality in Force typically the first half is a bit softer [indiscernible] the first half relatively flat half-on-half and some growth into the second half.

Yes. So first half relatively flat on the second half '23. Okay. Yes. And, yes -- sorry, again, this has already been asked, but obviously, you haven't given any sort of quantitative guidance, but I remember last result, you sort of gave us an indication that you were happy with consensus EBITDA expectations? Are you willing to say the same this time around?

Yes. I'm -- yes, I'm comfortable.

Okay. Great. That's it -- and maybe just the last one, actually, that top 10 customers as a percentage of revenue on Slide 21. That's for the whole group.

Correct.

Your next question comes from the line of Cameron Bell from Canaccord.

The 793Ds, did you have an opportunity to buy more of them?

[indiscernible] market 18 trucks of 793Ds. We secured them from South Africa actually. Actually, Cameron, it would be pretty tough to get at the moment. So I think it shows another core capability about being able to acquire these cores for our connections around the world. So look, if we could have got more of them, we would. I think our connections in Africa are pretty strong. I think that this business model of ours is being able to buy these cores, bring them into the country, cost-effectively rebuild them like we're caterpillar, do it ourself and put them out to meet customer demand really differentiates us. So it's, as I mentioned before, some of that really excites me. And we've got -- we've spoken to our customers. We have those relationships with our customers where we can work on them with the timing when rebuilding. So it's something that absolutely core business and we generate strong returns and growth for us moving forward.

Yes. I agree. How many of the rebuilds do you think will happen in FY '24?

Yes. I mentioned that we'll do those [indiscernible] we'll do them as a priority. So we'll try and knock over some cross-hired fleet that we're renting from others. And then if we bring in the [indiscernible] we roughly bank on about [indiscernible]. That's what I'm kind of thinking. So -- and that will be in the second half, and then that will project through into FY '24. But I can update the market on how we're going at the AGM, but that's a bit of a rough guide at the moment. But it's more about timing given through Force spanning in the country and that sort of thing. Demand [indiscernible] and put them through, we'll play some more. But I think the absolute strength of the business with this model is that we can time cash flows and our rebuild cost and our investment according to market demand and not hold hell of a lot of capital in these calls as we're running through that process.

Yes. Okay. And then kind of just fleshing out the answer you gave earlier and what you're saying then, can you maybe flesh out the potential cost savings from replacing your higher expenses with [ rebuild ]?

You mean that cross-hired?

Yes, yes.

Yes, I don't have that number on me right now. But I ran if I was going to say what is this total investment in growth CapEx and I guess was, right? If you look at the total amount, 793s and 789s, you're still about [ $44 million ]. That will give us about on an ongoing annualized basis [indiscernible]. I reckon we'll probably get maybe part of that in FY '24 towards the back end as we replace that gear and the timing goes in. So that's kind of how I see it at a bit of back of the envelope type analysis.

We have no further questions in the queue at this time. I'll turn the call back over to the presenters.

Thank you very much for your interest for the employees dialing in. I appreciate you guys. I really appreciate your work, and thank you very much.

Thank you.

This concludes today's conference call. Thank you for your participation, and you may now disconnect.