Morgan Sindall Group plc (MGNS) Earnings Call Transcript & Summary

Well, good morning, and a big welcome to our half year results. I must say it's great to see so many of you physically in the room. And I think we've got a few people watching virtually as well. So the agenda today is I'm going to do a very brief introduction. Steve is going to go through the financial and operational review, and then I'm going to talk about capital allocation at the end. So we started the year -- we've got an excellent start to the year. We've had 3 profit upgrades in the first 6 months. We're trading well ahead of our record year of '19. Very strong cash performance, up hugely our average daily cash. As you know, the dividend has also gone up dramatically. Now the market is an interesting market. Demand across all of our businesses is very strong, but we do have some headwinds with inflation and getting materials. I think over the last few weeks, material shortages have eased a little bit, but we still have a bit of inflation. But overall, the markets we're in are good. So real positive tailwinds. We normally talk about ESG because it's a real key thing for us. But because we did quite a lot at the full year, we'll wait until the full year results in January before we talk about or before Steve talks about it again. But in the meantime, I'll hand over to Steve.

Thanks, John, and morning, all. As usual, I'm going to do the financial and operational review. And if I might add as well, it's great to be back in person. So now the slides are slightly busy this time around because as well as showing last year's comparatives, we think 2019's numbers, pre-pandemic, give you a better reference against which to measure progress. And so on this income statement here, we've got 5 columns, but I'm just going to focus on the first column in green and then the last column in purple, which is the movement against the 2019 half year. So as John said, it's been a very good first half for us. Revenue is up 10%, operating margin up to 3.5% and profit before tax of GBP 53.1 million, up 46%, all going strongly in the right direction and a record first half for us as a group. EPS was up 45%, and we today declared an interim dividend of 30p per share, which is up 43%, both on 2020 and 2019 interim. Now this slide gives the divisional split of results. And again, I'm just going to focus on the comparison to 2019's numbers. I've got more on the operations later, but there's just a few immediate standout points on this slide. Firstly, a very strong performance from Construction & Infrastructure, profit up 63% on 2019 and a margin of 2.9%. Fit Out once again demonstrated what a high-quality business it is, with profit of GBP 19.3 million and a margin of 5.1%. And then it's also worth noting here Partnership Housing really starting to deliver. And as we've said before, this division is probably the biggest growth opportunity that we have as a group. On to cash, and you can see here the operating cash flow for the 6-month period showing an operating cash inflow of GBP 44.1 million. Now within this, there's a working capital outflow of only GBP 13.2 million, which is actually a much smaller outflow than we'd normally expect in the first half as the year-end position unwinds. Now there's obviously lots of moving parts in this, but the main driver here is a big increase in our VAT payable, VAT payable, as a result of the introduction of the reverse VAT mechanism on the 1st of March this year. Notwithstanding that, though, it's still a good cash performance. And you can see that particularly on this slide, it's always our favorite slide. It's our daily bank balance for every day of the first half, and that's the big thick green line on here. Our average daily net cash for the half was GBP 294 million, which is an increase of GBP 141 million on last year. Now within this average daily, around GBP 20 million of it was as a result of this VAT reverse charge. So in a way, the comparable underlying average daily net cash was around GBP 20 million lower. Importantly, you can see there on the slide, the lowest level on any one day was GBP 245 million. Net cash at the period end was GBP 337 million, but again, this included some VAT reverse charge benefit to the tune of GBP 67 million at the 30th of June. And this amount has actually now been paid out as at the end of July. So cash-wise, in summary, we're in really good shape. And based upon where we are now, we expect that the average daily net cash for the full year will be broadly similar to that which we've just reported for the first half. So for the full year, expect around GBP 290-ish million for the full year, plus or minus. Just a quick note on our payment practices to the supply chain. No real changes in performance here. For our largest division by volume, Construction & Infrastructure, we've maintained our top quartile performance of paying on average in 27 days, with 98% paid within 60 days, whilst Fit Out remains at around 21, 22 days on average and has been there for a few years. And there's also a few areas where we slipped a bit, too. So it just says we need to keep up the focus here. And I've said it before, but it's just worth reiterating again, our supply chain relationships are of strategic importance to us, and maintaining the best supply chain helps us give a real competitive advantage. Just briefly on the balance sheet, I've talked about the cash, no pension issues and tangible net assets of over GBP 220 million. So a really good platform to support us going forward. On to workload. And at a group level, the total order book remains at a very healthy GBP 8.3 billion, level with the year-end position. Within this, the construction order book is up 5%, while the regeneration order book is down 3%, both measured against the year-end position. More important though than just the headline number is that we've kept our discipline. We've not compromised on quality nor compromised on our expected returns hurdles. We've maintained the right risk profile for us. And with this high-quality order book, we feel really well set up for the future. So those are the group headlines then. Strong profit growth, strong cash, strong balance sheet and a high-quality workload. Just focusing a bit on the divisional performances. And firstly, then just to touch on an area which John mentioned, which has been well-publicized over the last few months, and that's the issue with materials inflation and shortages. You've no doubt all read about the price increases in recent months for the likes of, for example, steel, timber, shortages of cement, et cetera, et cetera. Well, we're no different to everyone else and we've had to manage the same challenges. The key takeaway for here, though, is that this has all been manageable. We've been able to minimize the operational disruption and mitigate the financial impact through a number of routes. And this is an area where strong and preferred supply chain relationships have really counted in our favor, further evidence as to why our payment practices and supply chain are so important to us. Looking ahead at a general level, again, as John seen -- has said, we've seen pricing and availability pressures start to alleviate and flatten in recent weeks, and we don't expect this to be a long-term issue. So let's have a look at the divisions. Construction & Infrastructure, a really positive performance. On the construction side, in the green boxes, we're doing well, reflecting the benefit of us keeping focused on operational delivery and disciplined contract selection. With revenue up 17%, its operating margin was 2.4% for the period giving profit of GBP 8.1 million, both well ahead of pre-COVID levels. Construction's order book is up 27% from the year-end to GBP 648 million. This is a really strong performance for us and it's all good, high-quality work. Now much of the growth has been the conversion into final contract of work where we were preferred bidder at the year-end. But that said, we've also replenished the preferred bidder coffers with just shy of another GBP 650 million worth of additional projects, which are now at a precontract stage. Now previously stated that the medium-term target for construction is for its margin to be in the range of 2.5% to 3% per annum. For this year, 2021, we expect to be around the top end of this range. That is up towards 3%. On the infrastructure side then, the blue boxes, it's been a really strong half also for operational delivery and contract performance. Although revenue was down 13% on last year, really just as a result of project timing and mix, the margin grew to 3.3%, and profit was GBP 14.5 million, nearly double that of 2019. Now based upon where we are now and the visibility we have for the rest of the year in infrastructure, we expect the full year margin will be in excess of its 3.5% medium-term target. Infrastructure will have a good year. On the order book front, infrastructure's order book is long-term and tends to land in big chunks, mainly through frameworks. So there's no concerns about a 6% reduction over a 6-month period. That's around GBP 1.9 billion. It's still a very sizable workload. For Fit Out, excellent result, a profit of GBP 19.3 million, margin of 5.1%. Now in the blue boxes on the right-hand side, you can see the analysis of revenue by type of work, sector and geography. The only material change to note here is the middle box, which shows that revenue -- shows that the revenue from the regions, that is outside of London, increased its share to 46%, up from 20% last year. In itself, this is quite a significant movement and shows the strength of Fit Out's regional presence and capabilities. However, that said, based upon workload in the second half, we do expect this balance to normalize back more towards London again in the second half and beyond. The big news from Fit Out though is the size of its order book, which at GBP 581 million was another record for the division. This was up 42% on the year-end position and up 25% on last year, and this gives us real confidence going forward. And in addition to this, we also have another around GBP 370 million of work at preferred bidder stage, so lots in the pipeline too. Of the secured order book, GBP 321 million of it is for the second half of this year, and it's on this basis that we expect the full year result will be materially ahead of its GBP 35 million medium-term profit target. The market for fit-out remains very active indeed. Property Services was probably the division which was most impacted by COVID last year, but its contracts have now remobilized with the division back up to full speed, other than just some delays on planned maintenance programs. Volumes were therefore well up on last year, but also up 25% on 2019. And this additional volume helped the margin to increase to 3.5%, with profit of GBP 2.4 million, up 50% on 2019. The division's order book is long term, with contracts tending to be up to 10 years, 15 years or so in length. And at GBP 973 million level with the year-end and with 80% of it for 2023 and beyond, we've got good long-term visibility of work streams here. Now the medium-term target for Property Services is to deliver a profit of GBP 10 million per annum, and we expect to make good progress towards that target in 2021. On Partnership Housing, along with the rest of the industry, the housing industry, we've also seen a good level of demand across the period. Revenue was up to GBP 270 million driven by the mixed tenure side of the business. And importantly, the margin was up to 4.5%, still not where it needs to be but evidence of real progress being made here now. Similarly, for ROCE, return on capital, at 17% over the last 12 months, a significant improvement and signs of real progress. And we're also making some good strategic advances in developing and formalizing our partnerships with local authorities and housing associations, all of which will form the basis of our growth going forward. The order book at nearly GBP 1.5 billion, up 2% on the year-end gives us confidence that we're moving quickly in the right direction with momentum. For the second half, we therefore expect further progress towards achieving its medium-term targets of a 20% ROCE and a 6% margin. And we've had a much better time in Urban Regeneration, too, where progress with its schemes has normalized again and are now tracking back to plan. Profit was up to GBP 8.7 million and is indicative of the high level of activity across its development portfolio. The profit was generated across all sectors and geographies. And the order book, which stands at nearly GBP 2.8 billion, is long term, with over 75% of it for 2023 and beyond, and this also reflects the diverse spread. The return on capital here for Urban Regeneration over the last 12 months was 14%, with the average ROCE over the last 3 years of 15%. For the second half, we expect continued progress and a broadly similar level of performance to that seen in the first with a mid-teens ROCE for the year of average capital employed expected to be around GBP 110 million. So in summary then, these are a really strong set of results for the first half, with trading substantially ahead of pre-pandemic 2019 levels. All our divisions are going well, and we've got a high quality, visible workload. Balance sheet remains strong with average daily net cash expected to be broadly around the GBP 290 million mark for the full year, give or take a bit. And all this plus an increase in the interim dividend of 43% to 30p per share. Thanks, and let me pass you over to John.

Thank you, Steve. I'll do the really difficult bit that the Financial Director normally does, capital allocation. So for us, the fundamental principle is our commitment to maintaining a strong balance sheet and holding significant cash balances at all times. Now the main -- the most important figure for me that Steve has talked about this morning is what was our cash on the worst day, obviously, the GBP 245 million. So on the worst day, we want to have significant cash balances. We then have below that the capital allocation framework, which are the parameters with which we want to operate in, and that is maintaining balance sheet to enhance our competitive advantage, ensuring downside protection, maximizing investment to drive growth and maintaining the attractive dividend policy. And I'll now go through those one by one. It's really, really important for winning long-term work and our -- one of our strategies is to have longer-term work streams in all of our businesses. So clearly, Urban Regeneration often has work stream where individual jobs have gone for 25, 30 years. But Partnership Housing has the same. Property Services, a lot of their contracts are over 10 years. And even Fit Out now is winning longer-term work. Very, very important for those clients to see that we have really strong balance sheet and cash to deliver what they expect from us. The good people in the supply chain, clearly, only really want to work with people who've got a good balance sheet and why wouldn't they? So that is really fundamental. And we can't do a great job for our clients without that supply chain right behind us. But it's also really important for recruiting and retaining talented individuals who want to know that we've got the cash to invest in them and the business, and that they're working for a business that's going to do all the right things, such as paying back furlough money, having good ESG credentials. People want more than just cash. So a good balance sheet is really important. But also, it enables us to make all the right long-term decisions rather than a whole lot of short-term decisions. Long-term decisions that could have -- could mean reduced profit in 1 year and reduced cash in 1 year. If we got the balance sheet, we can make those right decisions. We're also going to make -- won't we forget, the sun is shining out there, the markets are good. But that's not always the case. And we need a balance sheet that's going to be really there for us in the downturn. And if revenue falls, cash goes out the door very, very quickly in our businesses, as everybody sort of experienced with the secondary banking crisis or a few years after that. Obviously, the construction business does have negative working capital, it's quite easy to see how the money goes out of the door. But obviously, in our regeneration businesses as well, things would slow down and we'd be turning over our stock more slowly, and that would have a hit on cash. So that's really important. The other thing we've got to remember is that every now and again in our industry, you get a bad job and a bad job ties up cash in work in progress, so we need to allow for that. But I think it's really important in a downturn or a recession to keep making the right decisions. And certainly, 10 years ago, we weren't doing that. Our balance sheet wasn't as strong as it should have been. And indeed, like the rest of the industry, it wasn't as strong as it should have been. And we were perhaps taking on jobs that terms and conditions weren't quite as good, but also we weren't taking advantage of all the opportunities that were there to actually really expand our businesses. So we think it's even more important in a downturn to have a strong balance sheet. It's also fundamental in a downturn to really, really be disciplined and allowing that turnover to fall, so you're only taking on the right jobs. Now we also need a balance sheet, which allows us to grow our businesses. So we operate in sectors where we expect real growth and opportunities to invest. Now those opportunities could be investing in new people, new regional offices, new geographical areas or a whole lot of other things. But any investment we need is there to accelerate our organic growth, our organic growth. Now clearly, our regeneration businesses, Urban Regeneration and Partnership Housing, is an area where we are looking to invest more money. And that is a priority over other areas to invest. And we would consider acquiring existing schemes from third parties to accelerate that growth. But any investment we make would need to fit within the existing group structure. But those businesses are now all in good shape and they can take more turnover through them. The other thing that's fundamental is maintaining an attractive dividend policy, a sustainable, attractive dividend policy. We realize the dividend is really important for shareholders. We have had previously an informal policy of 2.5 to 3x cover. We're now formally adopting a dividend policy of 2 to 2.5x cover. And we would actually prioritize investment opportunities and support for the ordinary dividend over other things. But we will continually assess the balance sheet in relation to the principles and the framework I've just described. And any surplus cash may be returned to shareholders. So if I could just sort of summarize where we are, we're going into the second half with real pace. All of our businesses have plenty of organic growth. And it's that organic growth that is going to drive turnover and profits over the next few years. We are really committed to maintaining a sustainable, attractive dividend policy. But perhaps even -- if there is one big message, it is the strength of the balance sheet at all times with substantial cash is fundamental to us. Thank you. We can now take questions.

I think the way we have to do this under these circumstances is we've got a huge, great pole with a microphone on it, and the pole stretches over to this side first. I think it is, right, or was it the near side? Oh, I hope. So we'll give that a go. I don't know if people can pick that up on the camera, it's quite comical.

Three questions, please, from me. The first one would be on Fit Out. And clearly, it seems like within the order book, there's better visibility into next year than there would be at this stage of the year. And so just wondering whether that's from the pipeline of new offices that are coming through or whether it's maybe a bit more planning from customers in terms of replanning existing offices and what the moving parts are there. The second one would be on Partnership Housing. It looks like the ASP increased about 7% within mixed tenure in the first half. Just wondering how much of that is house price inflation and what's mix within that. And then the third one, again on Partnership Housing on the contracting side, just wondering what you're seeing from registered providers there and whether their appetite has changed given the market dynamics that we're seeing at the moment.

I'll deal with the first one and let Steve deal with the second, if that's okay. So with Fit Out, it's a bit of everything. At the moment, there's quite a lot of big new buildings which are being completed, where there's Fit Out work. There's also a lot of people who are just changing their space. Long term, all we need is change. But then again, our average job is still only about GBP 2 million. So we still have to win a job every day.

Very high level, I'd say about half and half on sales mix and price inflation. And obviously, there is a mix issue, geographical mix issue, et cetera. But I'd say broadly half and half. And then on the contracting side, not a huge amount in the last 6 months in terms of change of behaviors. At it may well, in due course, but as of the last 6 months we've not really experienced anything.

And on your third question, we're not really seeing any dramatic change.

Right. I did both of those. I'm pleased it was the same answer as well. Have we exhausted this side? Anand? Oh, just go for it.

So one for you, Steve, I suspect on the reverse VAT mechanism. Can you just talk us through how that works? And are we right in thinking there's a full year benefit to cash but an average hit to cash? If you could just talk to how that works. And then maybe one for you, John. In terms of regeneration, you've given some really useful targets on the margins and the ROCE. Can you also give us some indication of where the capital employed can go, because obviously that has been shrinking slightly?

If I start with the VAT, the way it works quite simply is that we -- as a general rule, other than for the housing side, the Partnership Housing and the Urban Regeneration, which are sort of, for these purposes, are VAT exempt. So just -- so this is Construction & Infrastructure and the like, it's only applicable. So effectively, we hold on to the VAT that we ordinarily -- or the 0 regime would have paid down to the supply chain and pay it on their behalf. So you see this buildup. So from the 1st of March, you'd have seen a buildup. We started off with 0. Up to the 30th of June, we were holding about GBP 67 million worth of incremental VAT, which we wouldn't have had without the reverse VAT mechanism. Kept building out throughout July and then it all got paid over in July. So we wrote a check out to the VAT man, for the best part, GBP 70 million on the 31st of July. And then it goes back to 0 and then it builds up and builds up and builds up. So you are going to get a benefit on your average daily position. Hence, in this first half, it was GBP 20 million, but that was only for 4 months' worth. And on the spot cash, it was inflated, if I can use that word, to the tune of GBP 67 million, which we wouldn't have had without the reverse VAT mechanism. And you're going to see this in all contractors. And if you don't have the sort of the housing side, the numbers will be that much bigger as well. So it is a benefit. It's the way it works.

That was an easy question. On Urban Regeneration, yes, we expect to be investing more money, but a lot of the schemes are presold and therefore prefunded. And that obviously helps ROCE. We would expect Partnership Housing to use more capital than Urban Regeneration going forward.

So as far as the [ housing unit expansion, please, in Urban Regeneration ]...

Yes. To increase, but by less.

I've got a couple as well, please. The first one is on people. So you've talked a bit about materials. Are you seeing any issue with your own sort of managers on-site or in the subcontracting chain? Second one is that classic one on cash. Are you actually seeing -- or how do you see that manifest itself when you are bidding? Is it a prerequisite for a prequalification? Or is it a sort of qualitative or a quantitative measure that sort of clients are now asking for? And then the final one, I thought it's quite interesting you're thinking about acquiring schemes, which I think is quite new. Are there distressed players out there? Or why would someone sell the scheme? Just curious.

Okay. So as far as the people front is concerned, we're not seeing a dramatic change. And as far as the acquisitions are potentially concerned, we're not saying we will. We're saying we might, and that is a marginal change. But we have the cash and we want to grow these businesses faster. And yes, there may be some people out there who perhaps have too many schemes for their balance sheet and we may have a chat to some of those people. And the second question...

Is about the cash and whether it creates a competitive advantage in winning business.

Yes. It's a very, very good question. Sometimes, it gives us no advantage whatsoever. And then other times, it's absolutely fundamental to the client. So there is no one size fit all. But on the whole, the longer the job is and the more they are looking for us to put cash into something, the more they're interested in our balance sheet. So if we're talking perhaps a long-term 25-year partnership with a local authority where we're having to put several millions into the scheme, they want to know that we've got that money to put in, we're prepared to put it in and that we will be able to continually put it in for many, many years, and then it's fundamental.

There is sort of an irony in a sense to some of the tender documents would look at the old-fashioned balance sheet ratios. And if you've turned a lot of your debtors, for example, into cash, you get penalized because your debts are lower. So they only say the working capital aspect and exclude the cash. So the people do it in all sorts of ways. But I think that's absolutely right. In some cases, yes. In some cases, no. And then, John, on the acquisitions. Did you do that one yet?

It's coming to you, right? It's coming to you.

Extra difficult.

Can we just go back a bit, if you don't mind, to Fit Out and just give us a sense of whether -- 2 things really. One is are you gaining share, is that the sense of what you get? Or is it that the market got bigger? And the second element of that is in and around the manpower in that area. I mean it's quite specialist labor. It's not just -- you can't just get an ordinary bloke off the street to do that because it's quite serious quality issues, quite serious issues with regard to time. So could you just sort of explore that a little bit? So it's about share and about delivery. The second one I wanted to ask was about Property Services, where you talk about GBP 10 million per annum operating profit. So that means GBP 69 million of the first half revenue -- I know there's a big order book. We're looking there probably, given typical margins, of GBP 200 million, GBP 220 million of annual revenues in that space, I would think, unless you're getting unusually better margins than everybody else. Can you talk us through that a little bit? And finally, in the text you've mentioned BakerHicks. Now typically, this has been sort of a skunkworks, somewhere at the back of the room and you haven't talked much about it. What's -- is there something behind that I should've understand a little better with regard either to the nature of the work, the nature of the market or the nature of your margins? Is that -- so I'm sorry to give you a loaded questions, but she's done such an effort to get this boom to me.

So with Fit Out, no, we're not having a problem with labor in Fit Out. As far as the market share, we're definitely winning our fair share of the market maybe a tad more, but it's a good market in Fit Out. That's a very good market. And there are -- we actually -- our visibility is just a bit longer than normal, which is nice as well.

But is the nature of the market obviously then, John -- I mean you typically work on a sort of 6-month order book in this space. I mean looking at where you are now with orders and preferred bidders, you're looking at possibly over a year, I guess. So...

I think it's probably fair to say we've got a few jobs at the moment which are going to last for 3 or 4 years. But -- so it's looking a little -- it's looking good. Looking very good.

And Property Services?

I think Property Services, we sort of, in our own minds, have got GBP 200 million at 5% net is the way you get to your GBP 10 million. And yes, GBP 70 million in the first half times 2, add a bit, you're GBP 150 million. As I say, planned maintenance, we expect to start coming -- normalizing. We expect more business to be won in due course. So we do have to get to the 200, we still do have to win the business. But it's got to be the right business. There's a lot of stuff you could bid in this, but it has to be the right business with the right clients who can see the value in our proposition. So we're on that journey.