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

Two, I'm going to do a very brief introduction. Steve will go through the financial and operational review, and then I'm going to spend some time looking at the outlook after that. So very pleased. Record first half results despite really significant inflation and market headwinds. And I would actually like to really thank our teams of people up and down the country who've had to deal with this inflation, which has not been easy, and a big thank you to everybody. Our balance sheet is really, really important, and we continue to be completely committed to having significant daily cash. In these times of inflation and other market headwinds, our operational rigor, contract discipline and risk management could not be more important. And we're really, really homing in on that. We've got a high-quality order book, and actually, it's the quality of that order book, how much embedded margin is in that order book and how much risk is much more important than the size of the order book. So we're very, very pleased with where our order book is. Very pleased to increase the dividend 10%. And clearly, we feel pretty good about life because we now expect to deliver a result for the full year 2022, which is slightly ahead of our previous expectations. Over to you, Steve.

Thanks, John. Good morning, everyone. As usual, I'm going to do the financial and operational review. So in summary then, as John said, it's been a record first half for us, and this is despite the significant market headwinds we're all facing. Revenue is up 9%, operating profit up 4%, profit before tax up 3%, all going in the right direction. Now the operating margin was down slightly to 3.4%. No one particular driver behind this, more just simply the result of divisional and project mix. EPS was up 3%, and our interim dividend of 33p per share represents a 10% increase on last year, reflecting how positively we feel about the business and the future prospects. So this slide just gives a high-level split of the results by division. Just a few immediate standout points to note. Continued margin growth in Construction & Infrastructure, margin up to 3.2%, giving profit up 7% to GBP 24.1 million. Fit Out has, once again, demonstrated what a high-quality business it is with profit up 10% to GBP 21.2 million, and then continued progress also at Partnership Housing, profit up 15% and a return on capital of 20%, all against the backdrop of significant market headwinds, which John is going to cover in a bit more detail in his section. So I'm going to try not to mention inflation too much in this bit. Now on to cash. Now the 6-month cash flow is never really very representative of too much. But you can see here that the operating cash flow for the period is an outflow of GBP 40.4 million. Now within this, the main driver is a working capital outflow of GBP 84.7 million. A big number on the face of it. However, within this, GBP 57.4 million of it is investment in the regeneration activities of Partnership Housing and Urban Regeneration. And of this, its real assets, mainly bricks-and-mortar type inventory. The key takeaway overall is that there's been no significant change to the underlying profile in debtors and creditor payments. And on this, I've included a slide in the appendix, which shows our latest reported payment practices to the supply chain, which remains a key strategic competitive advantage for us. Now this is our usual slide, which shows our daily bank balance for every day of the period. That's the blue line this time around. Look, it's the ultimate disclosure on cash flow. Our average daily net cash for the half year was GBP 264 million, slightly lower than last year's really strong performance. Now nothing to get too concerned about other than just the usual ebb and flow of working capital movements and the significant investment we've had in regeneration in the period. And based upon where we are now, and the profile of cash movements in the second half, we expect the average daily cash for the full year will be slightly lower than the GBP 264 million we've just reported. Now importantly, the lowest level of cash on any one day was just over GBP 200 million. So plenty of headroom and comfortable. And therefore, it allows us to continue making the right long-term decisions for the business to best position ourselves for the future. Net cash at the period end was GBP 274 million, and so cash-wise, we're in really good shape. Now briefly on the balance sheet, I've talked about the cash, no pension issues, so a really good platform to support us as we move forward. On the workload and at the group level, the total order book was up 2% on the same time last year to a very healthy GBP 8.5 billion, albeit 1% lower than it was at the year-end. Now within this, on the left-hand side, the construction order book was up 14%, whilst the regeneration order book on the right was down 9%, both measured against the same time last year. But as John said, more important than just a headline number is that we've not compromised on the quality nor compromise on our expected returns. 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 just looking at the specific divisional performances now. I'm just going to focus on the past -- the last 6 months and leave the outlook to John. In Construction & Infrastructure, firstly, a really positive performance. Its margin up to 3.2%, giving profit of GBP 24.1 million. On the Construction side in the green boxes, we're doing well, reflecting the benefit of keeping focused on operational delivery and disciplined contract selection. With revenue up a strong 16%, its operating margin was 2.9% for the period, giving a profit of GBP 11.3 million, which is up 40%. Construction's order book was up 17% from the same time last year, 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 previously preferred bidder. But at the same time, we've also replenished the preferred bidder pot with another GBP 701 million worth of additional projects, which are also now at the precontract stage. On the infrastructure side, the blue boxes, revenue was down as expected on last year due to project timings and the nature and type of the work. So although revenue was down 14%, the margin grew to 3.4%, but notwithstanding this, the lower revenue led to lower profit down 12% to GBP 12.8 million. On the order book front, Infrastructure's order book is long term and tends to come in big chunks, mainly through frameworks and the likes. So there's no concerns about a 6% reduction since last year. It's around GBP 1.8 billion. It's still a very sizable workload. For Fit Out, as I mentioned, another excellent result, a profit of GBP 21.2 million, up 10% on last year. In the blue boxes on the right-hand side, you can see the analysis of revenue by type of work, sector and geography. In short, the London commercial office sector remains the most important for Fit Out. Now I'm not going to dwell on the order book too much, again, I leave that to John. However, it suffices to say that demand here remains very strong. And with an order book of GBP 869 million, up 50% on the same time last year, we have better forward visibility in this division than we've ever had before. Property Services here, revenue was up 10%, even though some planned maintenance programs still remain slow in getting started. This gave operating profit of GBP 2.5 million, up 4% and was adversely impacted by inflation in the time taken to administer the adjustment mechanisms in the client contracts. Now the division's order book is long term here with contracts tending to be up to 10 years or so in length. And so GBP 1.3 billion, and with over 80% of it for 2024 and beyond, we've got really good long-term visibility of work streams here. And the 3 more recent contract wins, which are noted here in the green box will all have mobilized by the end of the year, increasing the run rate further going into next year. Partnership Housing, revenue was up 5% to GBP 284 million; profit up 15% to GBP 13.9 million; and margin, up to 4.9%, all evidence of real progress being made and similarly, for return on capital at 20% for the last 12 months. Again, I'll leave build cost inflation and sales pricing to John. However, strategically, we're making progress. With the size of our mixed-tenure sites increasing now at 169 open market units per site, up from 122 units per site at this time last year. And the order book at GBP 1.6 billion, up 10% on the same time last year gives us confidence here that we're really moving in the right direction with momentum. Now as I mentioned earlier, we've had a period of significant investment in Partnership Housing, with capital employed at the period end of GBP 191 million. And we expect the average for the full year for Partnership Housing to remain at around this level in the range of around GBP 190 million to GBP 200 million. For Urban Regeneration, there's lots of activity going on here. On top of the GBP 2.2 billion order book, there's also many sizable schemes currently being bid. And these schemes are long term and take time. So on that basis, we're not concerned at all with the order book being down year-on-year. Now the headline profit of GBP 7.3 million and a return on capital of 12%. However, that result does include a GBP 7 million provision in relation to building safety. If we were to add this back, the return on capital for the last 12 months would be 20% and this is a much better indicator of the real underlying performance of the business. Now just on building safety. As I'm sure most of you already know, the new Building Safety Act came into force during the first half. And in addition, as we announced earlier on in the year, Partnership Housing signed up to the Developers Pledge along with most of the U.K. -- major U.K. house building industry back in April. Now as a result, this has cost us something in the first half, not material in Partnership Housing and the GBP 7 million I've just referred to in Urban Regeneration. Now what's happened since though, is in the last few weeks, it's become clear that a wider population of industry beyond the first wave of house builders and developers will now also be approached and asked to sign up to similar pledge-type obligations. And this will now include our Urban Regeneration division. Now amongst other things, the additional pledge obligations include the upfront reimbursement of amounts already drawn under the Building Safety fund on developments which have been or are being rectified, plus the requirement to actively fund upfront any works as quickly as possible and ahead of any contractual claims to recover being made. So a consequence of this is, therefore, a timing difference on the accounting between the expense which will need to be recognized immediately versus the recognition of income from recoveries through contractual remedies, which would come later. So to reflect this position, we've disclosed a contingent liability in the half year accounts, flagging that should Urban Regeneration also sign up to pledge-type obligations in the second half, then the likely result would be for us to recognize an accounting provision. This year, which we would estimate at this stage could be in the range of GBP 40 million to GBP 50 million, and which, if so, we'd need to show separately as an exceptional item due to its size and nature. As and when we get recoveries against these amounts, they will then be shown as exceptional profits, but will be spread over a number of years. So just going back to the half year, in summary, a record performance and this against a difficult market backdrop. All divisions are on good form, and we've got a high-quality visible workload. The balance sheet remains strong, and we've increased the interim dividend by 10% to 33p per share. Thanks. And on that, let me pass you back to John.

Thank you, Steve. I would like to spend a bit of time talking about inflation because it is a considerable headwind for us. Now we think prices on materials have gone up about 23% over the last year and the labor element about 10%. Now clearly, it's not as simple as prices going up on a gradual basis. It comes in big lumps and not always when you expect it. So it takes quite a lot of managing. And it affects our different divisions in different ways, and I'll talk about it when I go through each division. But there are some things that we can mitigate across the group. And a few of those are things like a lot of our jobs are reimbursable cost, where inflation isn't a problem for us or we have contracts with inflation clauses, which again helps significantly. We're also buying a lot of our materials on a 12-month rolling basis. And because we have lots and lots of small jobs relative to our size, we've got a pretty good idea of jobs that we're going to win even if we haven't already won them, and we're buying materials for those as well. Now that doesn't get rid of the problem completely, but it helps to mitigate. We've also got a supply chain family, which we established about 20 years ago. This is where we work really closely with our supply chain, allowing them access to our preordered materials and indeed access to our group discounts. And that really does make a big difference, working with the supply chain, having a really good supply chain who we look after, tend to look after us in the bad times as well, particularly as we're able to give them consistent long-term work. But we think inflation isn't going to go away anytime soon, and we've got to learn to live with it. So I'll go through each of the businesses, Construction. Just to remind you, the medium-term target is an operating margin between 2.5% and 3% and a revenue of GBP 1 billion. Now it's the margin that is our primary target, and the revenue is a secondary target. So if the market gets tougher and the work isn't available at the right margin, we will not go for the turnover. We will go for the margin. Now here, inflation is a headwind, particularly in slowing down contract awards. As you know, for us, it's not a contract until we have a signed fixed contract to go ahead, whereas a lot of our work is won on 2-stage tendering. And often, it's a year between winning it as preferred bidder to actually getting the order, and inflation in that time can actually really cause a problem. And clients may have to reduce their spec, find some extra money from somewhere. But it is actually slowing down order intake, so that is quite a considerable headwind. Having said that, in Construction, demand is very strong, very strong indeed. As you can see -- because our order book is up 17% on this time last year, as indeed, our preferred bidder is up 8% as well. And all the work is good quality work delivered through negotiation, framework or 2-stage tendering process. So I think we can actually expect this year the margin to be around the top end of the range and real progress towards a revenue target for the full year. And with the order book we have, the preferred bidder situation we have, we can be pretty confident for 2023 and beyond. Infrastructure, again, an operating margin and the revenue target, a margin of between 3.5% and 4% and a revenue of GBP 1 billion. Again, the revenue is the secondary target to the margin target. Inflation headwinds here are also a real problem when it comes to order intake. And indeed, some jobs, a couple of jobs are not -- are unlikely to go ahead as a result. A lot of our jobs in infrastructure, though, are cost reimbursable. So actually, the inflation once we win the job, is less of an issue than it is for other parts of the group. As Steve said, the order book is down 6% on the prior year, but we shouldn't worry too much about that because the order book tends to be lumpy and they come in big chunks. But around 95% are on frameworks. So this is good quality order book, and 78% of it is for 2023 and beyond. So we've got pretty good visibility. Now we expect here revenue to be lower this year than last year as expected, but for the margin to be towards the top of the range. The margin we made last year of 4.3% was actually above the range, and we said that at the time when we issued the new medium-term targets. Now with Fit Out. The medium-term target is an operating profit of GBP 40 million to GBP 45 million and that is an average through the cycle. Now we have a strong market in Fit Out at the moment, and it's not necessarily the market we might expect because the market is based on lease renewals, new builds where pre-lets were done a few years ago, and indeed, making buildings more energy efficient, which is also a big driver in Fit Out. It is not so much repurposing after COVID. And I think that will be quite a surprise to quite a few people. We think COVID is really going to just accelerate trends that were happening anyway. And we think we're going to end up with less square footage used as offices and poorer offices' space will either have to be rebuilt or repurposed, which could be good for other parts of the group. Having said that, we believe that this price that people will spend per square foot on Fit Out will increase considerably. As you can imagine, a Fit Out, which has loads and loads of desks is a cheaper Fit Out than with a lot of collaboration space, leisure space and what have you. So we see the demand strong at the moment, but the repurposing will be coming through later. A lot of our bigger clients are still coming to grips with what it's going to look like and what their office accommodation is going to be. Order book up 50% on this time last year is obviously very, very significant. And GBP 394 million relates to the second half, which is 23% higher than last year. GBP 475 million, i.e., 55% of the order book is for 2023 and beyond. The equivalent figure last year was GBP 260 million. So we expect the profit to be materially ahead of the top end of the target range for the full year. And the larger and longer order book gives us real confidence for 2023. Now Property Services, we have an operating profit target of GBP 15 million. Now this is a very stable market. It's not the most dynamic market, but it's very stable. We have some very strong inquiries for the longer-term contracts, and it's the longer-term contracts that we'd like to win, contracts which are 10 years but perhaps extensions to be longer. These are jobs which take quite a lot of mobilizing to get efficient. And actually, to have short-term durations are not really the ones that we are going for. Inflation and indeed, labor shortages are real headwinds in this business, but the jobs are index-linked, and that usually is once a year, the index for inflation and that once a year. So there's usually a bit of a lag and then some catch up, which gives us some mitigation. Clearly, the order book is going up 31% on last year. 80% is for 2024 and beyond. And the order book is about 8x current revenue. So we expect here the order book to grow faster than the revenue. And we are looking to make this as close to an annuity income as possible and we expect steady progress. And in the second half of the year, we expect slightly higher revenue and progress towards medium-term targets. Partnership Housing, again, 2 targets: an operating margin of 8% and return on capital towards 25%. Now here, the scale and the number of schemes that are visible to us are at record levels. We're looking to continue to increase the average job size and cost inflation is currently mitigated by house price inflation. We're doing more contracting than normal as a lot of clients are looking for contractors to do the bigger contracted schemes that have a really good balance sheet. And those jobs tend to be index-linked for inflation. So the order book is up, mixed-tenure up not quite as much as contracting. Contracting is very strong at the moment. But we see the capital employed and scale of this business continuing to grow, such as it is a really major growth area for us. And we expect continued progress towards its target this year. Urban Regeneration, the medium-term target is a 3-year rolling average ROCE up towards 20%. Here at the moment, there are a large number of very significant schemes that we have some visibility of, schemes that hit our sweet spot. These are large, complicated mixed-tenure schemes in partnership. Inflation, though, is affecting the viability of quite a lot of schemes. So we'll win a job. And within that, there'll be lots of individual schemes. And some of those are hard to get across the line at the moment where build cost inflation is higher than the value of the inflation of the office building or whatever else we're doing. So that is affecting us to some extent, and the building safety issues are felt strongest in Urban Regeneration. So although the order book is down 19% on prior year, I wouldn't be too worried about that because the visibility we've got of some big schemes coming in the next year, 18 months, are very strong indeed. And the orders here are going to be lumpy because they're big. But the prospects for the medium term are very strong indeed, and the ROCE is expected to improve in the second half with progress towards its target for the full year. So if I could just sort of summarize. There's absolutely no change to our organic growth strategy. It's making -- we're in the spaces we want to be in, these are growth areas, and we just want to make those businesses better and better and better for all the stakeholders. We're committed to a strong balance sheet with significant daily cash every day. And it's just no change, we're just driving that forward. And our focus now is delivering those upgraded medium targets that we set back in February. We don't think inflation is going to go away for some time, and we've just got to live with it. But we -- but as I said earlier, we expect to deliver results for the full year, which is slightly ahead of our previous expectations. Thank you.

So I guess is there any questions.

Jonny Coubrough at Numis. A couple of questions, please. Firstly, on Fit Out, given the stronger market, are you able to do much on pricing there? Are you seeing pricing improve within Fit Out? And the second one would be on Partnership Housing. Just keen to hear what's driving the increase in average site size. Quite a big move. Is that new larger sites coming on? Or are you finding ways to expand existing sites?

So on Partnership Housing, this is where we're investing money, and we are driving the business to do bigger sites and to be a bigger business.

Fit Out pricing?

I think Fit Out pricing because the jobs tend to be relatively short term or even if they are a big job, they tend to be in phases. We tend to -- inflation isn't such an issue. But clearly, pricing is going up as costs are going up. And indeed, what I think is very interesting is how the average price of a Fit Out has grown substantially more than inflation over the last 20, 30 years, and we see that trend continuing. So Fit Out now ranges from about GBP 150 a foot to up to GBP 300 a foot, which isn't so much less than the cost of building the office in the first place.

Keep asking the questions to John.

Just sticking with Fit Out, clearly, there's a really good order book and underpinned by one very large contract. Could you give us some indication whether there is any inflation protection within that contract? And secondly, on the Developers Pledge. Clearly, it was signed only on behalf of partnership housing originally and not urban regeneration. Could you just give me a bit more of a detailed understanding as to why that was the case?

Yes. So the simple answer is to the large Fit Out contract. Yes, it's a whole series of small jobs, so -- or smaller jobs. So yes, there is an inflation. It's fine.

I think on the pledge, it's quite simple really. They're completely different sectors. Partnership Housing is part of the housebuilding sector that was approached initially by the government to sign the house builders, Developers Pledge, whatever you want to call it, it was the top 50 housebuilders. Urban Regeneration is a mixed-use urban regeneration business. So it's very different. And at the time it was just sort of unknown as to what the approach was going to be taking. We have continued obviously fulfilling our obligations and doing the right thing. And hence, you've seen the GBP 7 million that we took in the first half. So it sort of doesn't change behaviors as such. It, to an extent, just changes the accounting.

It's Anand from HSBC. Could you just run us through where suppliers or subcontractors do come to you and say, "Hey, guys, it's tough." Could you outline how you approach them? How you take the decision, okay, we're going to support you. We might not support you or whatever it is? Secondly, is it too early to think about you winning extra work? Because you're seen as one of the few partners that will be around in 3 to 5 years' time and presumably that number has shrunk. And then lastly, and I appreciate it's a bit sensitive. But to what extent are customers now not happy about, but incorporating higher prices. And therefore, if inflation was to fall -- as with our spreadsheets, we'd say, "Oh, that's good for margin." Would you try and pass that back to them? But I appreciate that's a bit sensitive.

I'll deal with your last question first. I think clearly, everybody reads the newspaper. They know inflation is an issue. So they're really happy to talk to us, and they may not be happy about it, but they understand. And I really look forward to a situation where we have deflation and that problem to deal with, and we don't see that anytime soon.

On the second question in relation to are we seeing people coming to us on the -- as a result of balance sheet. I think, yes, definitely.

Is it more than usual there?

I would say so, definitely, and particularly private sector. So certainly, that's where we see balance sheet a real competitive advantage for us, and in these times, even more so, certainly. I'm struggling to remember your first one, to be honest. I did write it down, but...

No. So if I come to you as a supplier of subcontractor and say, "Hey, guys, I'm really struggling here." Obviously, that's got to be managed very carefully. And there is a big risk to margin in the group -- I mean, not the group but margin. Could you almost give us an outline of how you would approach that? Or is it utterly ad hoc?

Actually, ad hoc. We don't have a policy because you can imagine some people perhaps trying it on and other people don't really need help.

It's horses for courses very much so. And as John said, because we have this sort of decentralized sort of structure and philosophy in the group, decisions are made at an absolute local level, project level by the empowered people. So it's not we have a sort of a group-wide policy. That would never work. It's right down case by case, situation by situation, and people make the decisions.

On the secured workload, you've always told us, and you've mentioned it again that it's only once where 100% confidence is going ahead. Have you had any instances where something has fallen out of secured workload because the budget doesn't work anymore?

If I answer it, the one that comes -- springs to mind that was in secured workload through a framework with smart motorways and we've reduced that amount obviously significantly, but that was done 6 months ago. On the whole, once we have a secured written contract, that means the job is going ahead because you've gone through the negotiation, you've taken the price, you built the price. So you've taken inflation into account, so it goes ahead. Where things do stall, what John said, is that sort of second stage where you put in a Stage 1 price, you're building it up and you come back with a figure which is higher than a client budget. That's when it can fall down. Once you sign a contract invariably, it's there.

Alastair Stewart from Shore Capital. A couple of questions. The first one follows on from one of the previous ones. Your supply chain family, are you now applying some of the same rigors and selection that it sounds like your clients are applying to you looking at the balance sheet strength reliability and so on? A bit of color on that. And the second question, in terms of infrastructure, you say that the inflation headwinds are slowing order intake. What sort of sense from your bigger infrastructure clients that you're getting? Is it they're putting it on hold for X number of months on average? Or could some of these actually fall out to the hopper?

Some of them might fall out of the hopper, and some of them being put on hold for a bit. And I think some might well go away, and I think everybody is sort of waiting to see what the new Prime Minister, the new regime will do and where they will spend their money. I think on your first question, it's a really good one because I would say the rigor and the way we look at our supply chain is probably even more than our clients look at us. So we really want to know who else they're working for, particularly where quite a lot of people in the sector have some weak balance sheets. And that's a really important aspect. What are their balance sheets like, where their at risk? So we've spent a lot -- that's a big thing for us, a big thing for us.

Could you give an example, say, compared to about 3 years ago pre-pandemic and so on in a normal market? How many were in your supply chain family then and how many now? Has it changed much?

No, it hasn't changed dramatically, and it may well be that we just don't want to give somebody too much work if we think they're working with too much risk elsewhere. So it's a bit of a measured thing really, but we have some very good, honest relationships with them where we can talk about these things.

And is there any churn in that? Are you just stick...

I would say there's probably a 10% churn every year.