Mobico Group Plc (MCG) Earnings Call Transcript & Summary

Hello, everyone, and welcome to today's Mobico Group Call. My name is Seb, and I'll be the operator for your call today. [Operator Instructions] I will now hand the floor over to Ignacio Garat to begin the call. Please go ahead, when you're ready.

Good morning, and thank you for taking the time to speak to us today. I'm sorry to be coming to you with further unwelcomed news, but hopefully, we can reassure you about its context and likely impact. Again, this is all about German Rail only, and no other part of the group is affected. The good news is that we have made good progress in completing our review of accounting judgments in the German Rail business and the associated audit of those judgments. Although it may have been tight and there were a small number of items relating to Germany outstanding, we believe we could make our deadline to report our 2023 results by the end of March. All of the substantive work required in relation to the audit of the remainder of the group's businesses have been completed. However, as we have set out in today's RNS, there has been a recent announcement relating to the indices used in modeling the German Rail business, which now makes this impossible. Let me talk about the context. As you'll be aware, the German Rail contracts that we operate offer some protection from volatile energy prices, and the calculation of the cost recovery based upon indices produced by Destatis, the German statistical office. Towards the end of last week, we became aware that Destatis has published restated and rebased versions of those indices, changing the basis of those cost recovery calculations in the process. These indices are revised in this way infrequently. The last revision we are aware of was in [ 2016 ]. So a revision at this point was a surprise to us and also to the rest of the industry. This is clearly an industry-wide issue. It will affect all operators whose contract rely upon the same 625 and 626 indices. So following the revision, we are undertaking 2 streams of work: the first one, confirming the potential specific impact on the different contracts that we operate and the second, discussing with the PTAs around the extent to which these changes will or will not be used by them to determine payments of any cost compensation. And now James will take you through what we believe the impact may be and where we stand in relation to guidance.

Yes. Thanks, Ignacio. So as we said in our statement, we are discussing this issue with the PTAs. And it's important to note that our relationships with the PTAs are strong. Also, they are motivated -- as motivated than anyone to find an equitable solution to the problems these changes may cause the industry. They want a healthy competitive market. So whilst we expect that the models and the accounting judgment used to calculate the profitability of our German Rail business remain valid, further work is now required to determine the full effect of the revised indices. At this stage, we currently estimate that the maximum effect of the revised indices is a reduction in total cost recovery over the terms of the contracts to 2032 of around about GBP 15 million. Moving on to the wider audit. The wider audit process have been going well, time-consuming as these things always are, but we were pushing hard to announce our results at the end of March. All of the substantive work required in relation to the audit of the remainder of the group's businesses have been completed. And as is usual at this point in the process, a number of items relating to the German Rail business remains to be finalized between the group and our auditors. Those items are quite judgmental, and they impact both on the onerous contract provision as well potentially as in in-year adjusted EBIT. So where does that leave us? At this late stage of the audit process, a number of judgmental items remain to be agreed with the auditors, which could affect the final outcomes for FY 2023. In particular, we now need to fully assess and understand the impact of the revised indices on the financial results. As a result, we're updating our previous guidance to reflect the situation and currently expect the FY 2023 results to include adjusted EBIT to be in the range of GBP 160 million to GBP 175 million, although the group's expectations are that we will be at the upper end of that range; and a prior year adjustment in relation to the onerous contract provision in FY 2022 of somewhere in the region of GBP 25 million. In addition, an increase to the onerous contract provision as at 31st of December of a further GBP 70 million above that. I will hand back to Ignacio.

Thank you, James. And with that, I open for a few questions.

[Operator Instructions] We have a question from Gerald Khoo from Liberum.

Three from me, if I can. I was trying to get my head around why there's an impact on the 2023 results in terms of what doesn't fall into the [ OCP ] or why the accounting works that way. Secondly, you talked about that GBP 15 million reduction in energy cost recovery. Why has the onerous contract provision moved by more than that GBP 15 million? And finally, I'd like to say that with the change in indexation, the way that this works, you got Mobico's losses, the PTAs' gain, and therefore, what you're suggesting that's the scope to negotiate because that's not -- that wasn't the intent. I'll leave it there.

Thank you, Gerald. There are 2 questions and the third one on the full year '23. James?

Yes. So Gerald. So there's 2, really, impacts. One is that because these indices have changed in respect of prior years, so from 2021 to 2023, it's possible that the PTAs may require an adjustment to previously agreed cost recovery. And now I'll come back to the -- part 3 of your question was around the contracts and expectations. So there is a possibility that if that has to be repaid, then that would impact on the 2023 results. But the main impact, Gerald, is it could be because of the judgmental nature of the German Rail contracts, particularly the RME contract, where we are making judgments about long-term revenue and cost assumptions out to 2030. If the future expectations for revenue and cost change, [ so ] effectively it can be a catch-up -- there will be a noncash catch-up purely accounting the phasing that could impact on 2023. And because of the changes in the indices, we need to run back through those models and make sure that -- and obviously, our auditors are comfortable with those judgments.

And you have a last one on the Mobico losses [ to ] the PTA. Let me be very clear. I think the PTAs are motivated to make the industry work and make it sustainable. And again, these [ revisions ] took us all by surprise. We have had an initial contact with the PTA and have spoken to other [indiscernible], and they have been [indiscernible] as surprised as we were about the changes. I have to say that we do have a strong relationship with the -- these PTAs, and we expect to be able to have a constructive discussion with them about the impact of these changes. But they will also need some time to process the implications of the revised [indiscernible]. And again, we have taken a prudent view on this, and our estimations [ then ] include any benefit from any implication.

Okay. Just to understand on the GBP 15 million that you said reduced cost recovery and the [ OCP ] moving by more. Is that -- is the difference [ the ] other assumptions for revenue and other costs?

There's a bit of that, Gerald. We're also looking at the discount rates and change in the risk -- discount rates or risk-free rate has had a bit of an impact. So change in outlook doesn't impact the cash flow, but it does impact on the size of the provision if we move the discount rate to a risk-free rate.

[Operator Instructions] We just have another follow-up from Gerald Khoo at Liberum.

Yes. If no one wants to ask, I'll go again. Is there any mechanism that caps the losses on any of the contracts? Or alternatively, is there any way to exit the contract if, for example, if the PTAs don't renegotiate or they can't really renegotiate? Or if there was some other shock or unexpected events, whether it's indexation or something else, is there any way where the losses would -- could grow again? Is there any way for you to have a cap in losses or to exit, please?

Yes. Again, let me say that the PTAs are motivated to make the industry work and sustainable. And the contract has some languages that is if there's impacts in the environment, that impact will be in the cost modeling. The parties immediately will simply need to agree new suitable bases that most closely correspond to the original, in this case, the indices and the time of the offer calculation and does not result in any disadvantage for any of the parties under the term of the contract. So that is there. And again, these [indiscernible] are under very early stage. So that is included. But let me be very clear, that does not include the billing error that you all know that the RRX 2 and 3 has. So there is that level of protection. Now in terms of what can you do, to the other question, is there could be significant financial as a potential consequences if Mobico decided to walk away. So -- but also, let me tell you that even assuming no motivation, as I said before, RRX 1 and RME will remain profitable. And it is the RRX 2, 3 which will be loss-making as you know because of the billing errors in the past.

Okay. At this stage, it looks like there are no further questions on the call.

[indiscernible]

I'm here, yes.

Yes. So we do have somebody else trying to ask a question. So we're just trying to make sure he's using the right call. If you could just give us a minute, please.

Okay. Of course. If everyone could just stand by. Hello, everyone. Thank you for your patience. We have just now registered a few additional questions on the call. First one here comes from [ Farhaad Mallu ] from Jefferies.

Can you hear me?

Can you confirm you can hear us? I can hear you. Can you hear me? So we're not hearing anything from the line. We'll have to move to the last question. Just bear with me. We'll just double check on them. Sorry, [ Farhaad ], can you just try and speaking once more?

Can you hear me now?

Yes, we can.

Okay. Perfect. Yes -- no, so I just wanted to confirm, right, so the reason for the delay is the changes in Indices 65 and 66 (sic) [ 625 and 626 ], right? So before this, like there was -- like this wasn't an issue before when the results were delayed, one. And two, was this just kind of the main driver for the delay?

Yes, the republishing of the indices is the main driver for the delay.

Okay. And just -- I'm sorry, I think you mentioned it earlier, but I couldn't hear properly. But why is there revision in the EBIT guidance? Could you just clarify that as well?

Yes. So I said there were 2 aspects of the potential revision to EBIT. One is the fact that because these indices have been republished in respect of historic years 2021 to 2023, settlements that we previously agreed with the PTA could be reopened, and there is a possibility that we have [ the plan ] to repay some of that amount. The second aspect is the impact on the judgmental areas around RME. So the RME contract is the one that we account for on a long-term contract accounting basis. There are some significant judgments around -- particularly around the revenue growth rate that we go through every year. We need to go through those with our auditors. And those judgmental areas are typically closed out towards the end of the order. We just needed to now continue through that process. As I said, if there are adjustments to the judgmental areas, it means that we're changing the view on future revenue and future costs. There is no cash impact in FY '23, but there could be a catch-up adjustment into the 2023 results as I was mentioning.

Let me reemphasize to your further question. Again, we -- all the substantive work required in relation to the audit of the remainder of the group's businesses have been completed. And it was only a small number of items relating to the German Rail business that remain to be finalized with the auditors. So we were very close and would have announced either on Thursday of this week or even the next week. And clearly, the discovery of the news on the indices impacted the progress through the final stage of the audit at the end of last week. So now we need extra time to complete our work with our auditors and the discussion with the PTA to have the clarity.

Okay. No, that super helpful. And then I guess, I think the last time you mentioned as well that you're [ willing ] to have a sort of really impact the fiscal '23 results in terms of your guidance, and that's why guidance was kind of unchanged from previously. But is there like a -- like do you have any comments on that at this stage, like obviously, now that your guide is lower?

Yes, it's the same as I just described. We have to go through the judgmental areas relating to the future revenue and cost assumptions. Those are all the kind of things we go through with the auditors, and they typically close out towards the end of the process. Had it not been for the republication of the indices, we would have finalized that discussion with the auditors in time for the 28 March or close to that time. Now the -- when the indices were changed, it means there was a bit of a delay in getting that work done because obviously, we need to go back [indiscernible] on what this index change means. So at this stage, there are judgmental areas there that still remain to be closed out in respect of Germany. And therefore, we thought it was right to give at this stage because they're not closed out where the range of where that could potentially be, although I'd emphasize again that we -- the group's view is that we will be towards the top end of that range. But that's -- the range you've got reflects the remains of the range of judgment that is still being finalized.

Okay. And then I guess on the onerous contract provisions moving forward as well. I think my understanding was previously kind of about GBP 5 million to GBP 8 million of [ debt ] per year into future earnings. Do you still estimate something similar? Or...

I expect them to be -- the cash outflow unmitigated and assuming we can't recover anything back from the PTA, which we would expect to do. But from an unmitigated perspective, the average cash flow of the remaining -- the remainder of the contract life is about GBP 14 million per annum on average. It is about double that in 2024 but then reverts to more like the average of the remainder of the contract lives.

Okay. So that's a big change from the previous -- and then I guess...

Previously, we said it was in the region of GBP 8 million to GBP 10 million. It's now about GBP 14 million.

Okay, cool. And around [ GBP 20 million to GBP 24 million ], I'm guessing for 2024.

Yes. So [ GBP 20 million ] on average.

Yes. I think you said double for 2024, right? So...

Yes, yes, yes. Roughly double that in 2024, that's right, yes.

The next one is from Ruairi Cullinane, RBC Capital Markets.

Firstly, could you help us it with perhaps adjusted EBIT prospects going forward in German Rail? I suppose one part of that question, are the provisions [ at such ] a level with adjusted EBIT from 2 of the contracts [ is ] expected to be around 0? Secondly, is the [indiscernible] tool in asset-light contracts? And then this may be -- there may be some repetition there, but just what drove the sort of GBP 25 million adjustment in full year 2022?

James, do you like to take that one?

Yes. I'll take 1 of the 3. So the adjusted EBIT prospect, so the contracts that are onerous are the RRX 2 and 3. They're the only contracts that remain onerous, that is, to say, there's no impact on them on adjusted earnings, but there is clearly a cash flow impact associated with those and the onerous contract provision. The 2 other contracts, RRX 1 and RME, remain profitable. We expect them to generate approximately GBP 20 million of profit over the remainder of the contract lives. So it is a reduction from what we previously expected, again, unmitigated and assuming we can't get -- recover some of this from the PTA. But at the moment, that's what I would expect around about GBP 20 million of the remaining contract life. You asked about the GBP 25 million adjustment to prior year. We'll give more detail on that around year-end. But essentially, it relates to -- it doesn't change the 2023 position. It just relates to judgments that were made around that year-end time that in context of things that we've seen developed during the course of the year, we felt that it was right to make [ full ] efficiency, but it doesn't change the cash flow -- future cash flow profile, and it doesn't change the FY '23 year-end position. And then there was also a question there about [ upside ] asset-light contracts. Ignacio, do you want to take that one?

[indiscernible], yes, I mean, we are making good progress in that [indiscernible] asset-light. So you saw the -- I mean we have been reporting on that and provided more visibility in the pipeline on how much is asset-light and also on what is the conversion rate. So we do see and we will provide more details in our full year results. But I think it will be very helpful for you to understand.

Our next question on the line comes from Joe Thomas from HSBC.

I'd just like to come back to something you said earlier, Ignacio, about -- when asked about potential for exiting these contracts. You talked about the reputational -- potential reputational damage, which I think we can all understand. But you also talked about financial damage as well. And I was just wondering if you could elaborate on that a little bit. Are there any sort of trigger clauses in other contracts beyond Germany if you were to exit Germany? Or is it some sort of large performance bond lodged there?

Correct. That is right [indiscernible].

It's performance bonds related, Joe, that's exactly right. It is [indiscernible] contained to Germany. What we were saying about if we were to walk away, we cut the contract, and it could impact our ability to bid for future work elsewhere in the group. There is no impact on existing contracts in the [ group elsewhere ].

Okay. And then just thinking about the downgrade for the contracts that remain profitable. I'm just trying to sort of square that against the guidance that you've given today for the latest range that you've given. Is there some outperformance elsewhere in the group? Or is this cut just relating to that change in the outlook? If you could just go through the other moving parts or if there's anything change in expectations around other parts of the business, that would be quite helpful.

The rest of the group is in line with our expectations. Again, this is forward-looking [ forward ] constant revenue and the level of reimbursement in this general contract. And as we have said, we have taken a prudent view of the issue. So there is no mitigation, no benefits from mitigations, and this what we have exposed as the reason for having that impact reflected in our new values.

Okay. And then just...

[indiscernible] Yes, go ahead.

Yes. Just the final thing that I wanted to ask you about obviously there is some hope here that there might be compensation or renegotiation coming from elsewhere from the PTAs. Is there any precedent for that? Or is there anywhere else we can look in Germany, where we've seen PTA [indiscernible]?

We are convinced we are -- James, you can talk about that.

So as Ignacio said, there was a contractual clause that requires both partners to seek to rebalance the contract if there are changes to circumstances outside of the past control. We've never had to exercise that clause, but it is there. But in terms of precedent, absolutely the risk precedent [ and it's with ] us. We previously have moved an index that related to labor costs from a more generalistic labor inflation index to a rail-specific inflation index that was more favorable to us as an operator. That was agreed with the PTA and has been implemented. We didn't require us to enforce -- to try and enforce the contract. It was a good-faith negotiations. So there is absolutely a precedent for doing this. And I would point out that PTA actually approached us in respect of the energy...

That's what I was trying to mention. Let's not forget that ongoing discussions with them, which was proactive coming from the PTA as well because they believe that it reflects much better the actual cost of the energy.

Okay. That's good to hear. And just a final thing. On the performance bond, how large they are -- but I can't remember for them being quantified. Perhaps you could -- if you're able to disclose, it would be quite helpful.

We -- I think they are disclosed, Joe. But I'd have to get back to you on the exact details of that.

Just have another follow-up question from [ Farhaad Mallu ] at Jefferies.

Just one follow-up question. I have 2 actually. One was -- the first one was on sort of PTA, the kind of renegotiation. How much are you expecting to get back on that is the first question. And the second question is on the North America school bus business sale. At this time, do you have anything more that you could comment on that? And like how the progress on that sale is going or talks around that?

Thank you. So on the first one, the discussions are very early stage with the PTA. So nothing that we can say at this moment in time, apart from what we have said that we have a very strong relationship with them, and we are having very constructive discussions. On the second one, as we said, we are progressing well in terms of the process. And we will provide more visibility on the full year results on the North American school bus disposal.

Okay. And so I guess on the time lines of the kind of like the PTA kind of negotiations, when would we expect to hear something back? Would that be -- would that still be like a few months away? Like we wouldn't expect to hear anything for the next few weeks once the full year results have...

Again, it's too early stage, and this just came up last week. So we have spoken to them. And as I said before, they need to still work, what are the implications for them. So I cannot comment on any specific time for it.

Because the whole industry is considering its position at the moment. And when we noticed the issue, we were, I think, the first in the industry to notice it. So it's very early stage, but we will, of course, update you when there is any substantive progress.

Currently, we have no further questions registered on the call.

Well, thank you, everyone. And with that, we'll see you soon at the full year results.

Thank you. This concludes the Mobico Group call. You may now disconnect.