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

Well, good morning, and welcome to our half year results presentation. Steve Crummett and I are joined by Chris Booth, MD of our Fit Out division. Chris runs our biggest and most profitable division, which has significantly upgraded its medium-term targets this morning. I will hand over to Steve shortly, who will go through the financial and operational review. Chris will then talk about Fit Out and all things Fit Out, and I will return to cover markets and outlook. I'm pleased to report a record performance for the first half. This would not have been possible without the tremendous work of all of our teams across the whole group and the full support of our clients and our supply chain. And I would like to thank them all very much indeed. Despite broader market challenges, we're now experiencing a more stable market with reduced inflation, a much better availability of labor and materials. Our strong balance sheet and cash are as important as ever with a high level of insolvencies in the industry as a whole. Our order book continues to grow, and our expectations for another record year remain unchanged since our upgrade in June. I would now like to hand over to Steve.

Thanks, John, and morning, all. As usual, I'm going to cover the financial and operational review. So looking first at the income statement then. You can see here, revenue was up 14% and operating profit was up 4%, with the lower margin just as a result of the divisional mix in the profit -- in the period. Higher interest rates on our cash helped generate a net finance income, giving profit before tax up 10% to GBP 59.8 million. EPS growth, however, was held back to a 3% increase, mainly due to a higher statutory tax rate in the period. And then taken all together, we've then declared an interim dividend of 36p per share, an increase of 9% on last year. So in all, a strong set of results. So looking at the high-level split by division, the standout here is clearly Fit Out, driving the group performance with profit up 43%. We've then got good performances from both Construction and Infrastructure, a relatively resilient one from Partnership Housing and a disappointing one from Property Services where we've struggled. Urban Regeneration did what we expected, which all then added up to an operating profit of GBP 59.1 million and an operating margin of 3.1%. On to cash. And although the 6 months cash flow is not really very representative of too much, you can see here that the operating cash flow for the period was an outflow of GBP 31.2 million. Now the main driver of this is a working capital outflow of GBP 91.7 million. A big number on the face of it. However, within this, is GBP 52.5 million of investment in the Regeneration activities of Partnership Housing and Urban Regeneration, which I've shown separately. And of this, it's mainly Partnership Housing inventory, investment in developing its new sites and partnerships. Of the rest of it, there's nothing else of any major significance really to draw out. But this is the important slide. The usual slide, which shows our daily bank balance for every day of the year so far, and that's the blue line here, the gray ones last year. Our average daily net cash for the period was GBP 268 million, with the lowest level of cash on any 1 day of GBP 195 million. So plenty of headroom and comfortable. And this allows us to continue making the right long-term decisions for the business to best position ourselves for the future, whatever the macro climate is. The highest day was GBP 371 million, and net cash at the period end was GBP 263 million. So cash wise, we're in good shape, too. And based upon where we are now, there's no change to our forecast for the year and that we expect the average daily net cash for 2023 to end up at around the GBP 250 million mark. And in terms of future workload at a group level, the total secured order book was a very healthy GBP 9.1 billion, up 7% on the year-end position. In itself, that's good growth. However, as always, more important than just the headline number is the quality of the order book in terms of margin and risk. And then growing the order book, we've not been compromising on quality or compromising on our expected returns. We've maintained the right risk profile for us and, therefore, with a 7% increase, we feel really well set up for the future. So those are the group headlines. Good profit growth, strong cash position and a high quality and growing workload. So just looking closer at the divisions now, and I'm just going to focus on the numbers here and leave the markets and the outlook for John to cover later. So firstly, we're now formally reporting Construction and Infrastructure separately, a separate business segment to properly reflect how we run the business on a day-to-day basis. There's no new information here as we're effectively reporting them separately before in any case. So just looking at Construction, good revenue growth, up 20% with the margin banging in the range we expect. As we've said before, this division is all about consistent delivery, disciplined contract selection and focused risk management. And we've got a business where the vast majority of its projects are only delivered either through frameworks, 2-stage processes or are directly negotiated with the client. 85% of it is public sector and around half of it is in the wider education sector. And the pipeline for new work is also very strong, with its order book up 17%. And in addition to this, projects worth over GBP 1 billion are at the preferred bidder stage. So there's plenty going on in Construction and no shortage of quality work to bet and win. And it's a pretty similar story for Infrastructure, consistent operational delivery and disciplined job selection, and this delivered good revenue growth of 15% at a margin in the middle of its targeted range. Rail and nuclear have driven this growth, with highways being a bit of a laggard. Projects here just seem to be taking a little bit longer at the moment to procure and to ultimately get on site. But that said, there's still lots to be bid for in Infrastructure, and we've got a sizable order book to get stuck into. Now for Fit Out, as I mentioned, this is the standout performance with another excellent result, profit of GBP 30.4 million, up 43% on last year and a margin of 6.1%. I'll leave it to Chris to talk through the business in detail and its prospects. But suffice to say, it's a business that's in really good shape. Not in so greater shape, however, is Property Services, where we've had a difficult period, making a loss of GBP 4.1 million. Now we've previously mentioned the cost pressures in this division, the complications with the pricing mechanisms in the contracts. Well, these issues are still hurting us. But laid on top of these is that we're also having some significant cost overruns on supporting the early stages, early phases of newer contracts, which in turn has also placed strain and inefficiency across other parts of the operations. And generally, we're also experiencing much higher volumes than we've geared up to service. To address this, we've changed a number of key management and operational roles and are implementing a remediation program, which is centered on stabilizing the operational platform to properly digest the recent growth in mobilizations and to ensure the future order book is delivered profitably. But this will take a bit of time, and there will also be additional cost associated with this in the second half, but we know what we've got to do. We're on with it. And just to be clear, everything here will be taken through normal trading results. In Partnership Housing, our model focusing on partnerships with the public sector provided some level of relative resilience against the softer housing market, with demand for contracting remaining strong. This was reflected in the revenue growth, which was up 31% to GBP 373 million, driven by the contracting side, which was up 49% and accounted for 57% of the business, a strategic and deliberate shift towards contracting when in a more uncertain housing market. Inevitably, though, profit was down, 27% to GBP 10.1 million. Now I say inevitably, this mainly is a result of lower open market sales in the mixed-tenure business and at a lower overall average selling price and margin. But as I mentioned, the partnership model enabled us to partially cushion the full force of the market downturn. This is a long-term game to us, long-term partnerships, and we've continued to be true to our strategy, take a long-term view and keep investing in the business. And that's why we're looking at average capital for the year of around GBP 240 million. And in Urban Regeneration, much as expected, really, with profit of GBP 6 million. And importantly, the return on capital employed moving in the right direction again at 17% over the last 12 months. And as I mentioned in February, there's a lot of activity and interest in this space, and we've got a number of preferred bidder awards looking to move into formal contracts in the second half. Therefore, supplementing the already sizable and long-term order book. Looking more short term, we've got a number of schemes coming towards the end in the second half, which will drive a lower average capital for the year, which we estimate will be at around the GBP 95 million mark. So just in summary then, we've had a strong first half with PBT up 10%; Fit Out is the standout and Property Services needs fixing; the other divisions are performing well, and the overall group result demonstrates the benefit of us having a diverse business across a wide range of sectors. Our continued balance sheet strength gives us confidence and we've got a high-quality workload growing secured workload. And not forgetting the base on all this, we've also increased the interim dividend by 9% to 36p per share. And on that, let me now hand you over to Chris, who's going to talk you through Fit Out in a lot more detail. Thanks.

Thanks, Steve. Good morning to you all. I'm going to cover a bit of color about the business before I go on to talk about our market outlook. So I'm Chris Booth, the Managing Director of the Fit Out division. I've specialized in Fit Out since 1987, some 36 years ago. I joined the Morgan Sindall Group in 1994 and have been the MD of the Fit Out division for the past 10 years. So what does Fit Out do? Well, the business was established in 1977, 46 years ago, and our market is fitting out both -- and refurbishing both private and public sector offices, together with teaching spaces for the higher education sector. 87% of Fit Out revenue is delivered by Overbury, which operates in the traditional Fit Out market, delivering projects through clients' professional consultant teams and ultimately, it's responsible for construction delivery. Morgan Lovell makes up for 13% of Fit Out's revenue, and it operates in the design and build market. It provides a one-stop shop for both design and construction and it works directly with the end user client. So turning to our operational structure. Obviously, we have the 2 brands providing national coverage through 8 offices, each with a dedicated management resource and a localized proven supply chain. Resilience of that supply chain capability is managed in so far that there is very little overlap between these offices. And the supply chain has evolved with our growth. All of the management team have extensive experience in Fit Out. Recent team MD promotions in both 2022 and 2023 have been filled by internally grown talent that joined the business as school levers 20 years ago, ensuring both values, service culture, business strategy. And we have an academy that supports future succession of the team leadership roles. And we've focused for the last 10 years in developing homegrown diverse talent to our foundation program. So who do we work for? Well, we predominantly operate in the private commercial office sector, accounting for 73% of our revenue. Public sector work has grown twofold in the last 6 years, and now accounts for 12% of our revenue. And higher education makes up 11% of our revenue, and it provides a continuous flow of opportunities. We have extensive experience in refurbishments. 83% of Fit Out revenue is actually in existing building stock during 2022, of which 40% of that was carried out whilst the tenants remained in occupation. Turning to our financial track record. The management team have a strong track record through a full economic cycle that includes the impact of Brexit, COVID, the Ukraine war and latterly, the cost of living crisis. We have delivered a consistent compound annual growth rate in revenue of 9.5% and also a strengthening margin. So revenue has grown from GBP 427 million in 2013 to GBP 968 million in 2022, with margins growing from 2.6% to 5.4% in 2022. Now this growth has been driven incrementally over the years with business improvements, investments in our people, investments in our supply chain, and investments in our regional offices over a number of decades. And as Steve has just said earlier, we have delivered 6.1% margin in the first half of this year. All profits have been cash backed with consistent operating cash flow conversion over the 10-year period. So looking at our market, our clients seek technical experts with proven delivery track records. Attributes required to be demonstrated include certainty of delivery, relevant experience, and engaged and competent supply chain and a strong financial strength. There are some high hurdles to jump for projects valued in excess of GBP 20 million. These being proven relevant project experience, expert site management teams, the experience to deliver complex technology-enabled environment and high ESG capability credentials. And clients select us because of our unparalleled track record and experience, our expert project management teams and systems, our collaborative and expert supply chain and, of course, our strong financial strength which actually underpins the long-term obligations of the contracts that we operate under. So turning to the proposition to the market. Our success is founded upon the disciplined selection of work. We operate within our core competencies and risk profiles that we know we can deliver upon. We build long-term relationships through delivery with a view to developing both negotiated work, repeat business and frameworks. And this is all supported by a service culture, extensive training development of personnel, incentivized preferred supply chains and investments in software and our regional offices over many decades. So to demonstrate our credentials, I'd like to highlight 3 case studies, which reflect our market and also our delivery capabilities. First up is the large 370,000 square foot Fit Out for the European Bank for reconstruction and development, and this reflects the high barriers to entry to that sector of the market. This was a complex project in the heart of Canary Wharf with multiple stakeholders, BREEAM Outstanding and WELL Platinum rating requirements and a focus on social value and social enterprise. The project hit all of its environmental targets and has been awarded the British Council of Office's First ESG Award and also the CCS Leading Lights Award for its work with the Period Poverty Charity. Next up is the University of Portsmouth. And this represents a snapshot of our higher education client portfolio. It was delivered through our Southern regional hub. The project required creating studios to house different digital technologies, immersive virtual reality and augmented reality production facilities. And finally, the Hickman building was delivered through our Design and Build business, Morgan Lovell, and it represents a framework relationship with Great Portland Estates, which spans over 4 years and 40 projects. Now this project reflects the repurposing of their office stock with great flexibility and services for the incoming tenants. It's an award-winning building that is both smart and has sustainability at its very core. So looking ahead, our markets are being driven by significant lease events in London. Recent energy performance targets driving planned upgrade works to 77% of London office stock, which is also true for the regions as well. Occupiers are repurposing their offices to attract staff back to the office, retain staff and provide destination facilities and environments that enhance flexible working. Universities have not experienced any drop off in their enrollments and are committed to upgrading their buildings for future intakes. The financial sector recovery is actually spurring on Fit Out of their existing building stock and both private sector and government departments continue to relocate to the regions. So moving on to the order book and pipeline. We have a record order book of GBP 1.2 billion at the half year '23. This is up 40% on this time last year. We have visibility of work going into 2025 and beyond. There is a strong pipeline of opportunities. We have GBP 50 million worth of preferred bidder status work, ready to go. We have GBP 553 million worth of tender opportunities currently that are awaiting decisions upon, and that's 1% up on this time last year. And we have a further GBP 336 million worth of tender opportunities over the next 3 months, and this is 10% higher than the half year 2022. And importantly, there's been no compromise to the quality and the disciplined selectivity of the work in growing this order book. So growth opportunities. We believe the growth opportunities are positive, supported by the highest volume of London refurbishments since records began in 2005, covering 3.2 million square feet in London alone this year. The energy efficiency standards, together with developers seeking wider ESG standards, will provide sustained workload going forward. Tenants are repurposing and will continue to repurpose their offices with a view to support staff retention and attraction to provide those destination workplaces that are flexible. And we also know that there will be significant change forecasted to multinationals office stock in London. So finally, based on all of the factors that I've just spoken about, our order book, our market position, our prospects, the medium-term target for Fit Out has again been raised. The revised expectation is that Fit Out will deliver annual operating profit in the range of between GBP 50 million and GBP 70 million. And for 2023, specifically, we anticipate that the current trading patterns will continue through the second half of the year and that the full year results will be at or around the top end of this upgraded forecast. Thank you very much. I'm going to pass it over to John.

Well, thank you very much indeed for that, Chris. Now Chris and his team have spent the last 25 years making the business better and better and then better again for all the stakeholders and growing the business organically at the same time. Now this is the basic strategy we have for all of our businesses: always taking a long-term view, even if that may be a little expense of short-term profit or cash. I'm also pleased that Chris and his team have spent a huge amount of time bringing on younger talent, such we now have a situation where half of the turnover in Fit Out is run by the next generation. So on the general market themes, which I'll cover all of the markets we operate in. The market on the whole that we operate in are generally more stable with a good level of demand and a good availability of materials and labor with inflation greatly reduced. The public and regulatory sector, which is very important to us, is still very active. Financial weakness in our supply chain is, however, a real concern. To some extent, that is mitigated by different divisions using different supply chains, and we're not reliant on any one supplier. So if I go through the businesses one by one. So with Construction, the market -- most of our work is done through frameworks. And there's a big demand for schools, increasing demand for hospitals. This isn't new built hospitals, this is tending to be diagnostic centers or actually modernizing the estate. And as Steve said, we've got about GBP 1 billion worth of work in preferred bidder for Construction. So we have pretty good visibility. The markets that are a little bit weak are commercial and residential, but those are not markets that we rely on. In Infrastructure, we're seeing growth driven by government policy, in particular, Energy & Defense, which are very strong. We're also seeing significant growth opportunities in nuclear with some procurement activity underway, although typically, these jobs do take longer to procure, but they then last for a very long time. We're seeing a weaker market in highways and a relatively stable rail market. I won't go into detail on the Fit Out market, because I think Chris has covered that. But as you know, the market is very strong. With Property Services, there is no shortage of market opportunities for general repairs and maintenance work and clients from local authorities and housing associations are now extremely focused on their housing stock, which is very poor, and we see a big growth in the amount of money they're going to spend. There's also a significant transition phase ahead with decent homes agenda, dampened mold as well as decarbonization and refit, all providing growth opportunities beyond traditional repair contracting. In Partnership Housing, our partnership model, focusing on long-term partnerships with the public sector, has given us some resilience against the very soft housing market and demand for contracting has remained strong throughout the period. As expected, our sales rates for open market housing has reduced, and we're using incentives on many sites to get sales across the line. Interestingly, Wales is our strongest market, where we still have Help to Buy. Typically, 50% of our buyers would be first-time buyers, but we're now finding that is about 30% of our buyers. Our construction activity has increased with good quality work. Now this is because customers are looking for contractors with good balance sheets as several of the main contractors in this space have gone out of business. Urban Regeneration. Now this division obviously is affected by open market residential sales, but to a lesser extent in Partnership Housing as more is forward-funded. The increase in expected yields and build cost inflation have had some impact on getting new schemes across the line. There is, however, a significant increase in the type of regeneration that we do, and we have GBP 1 billion plus in preferred bidder. So if I look at the outlook and medium-term targets, Construction is an operating margin of 2.5% to 3% a year and revenue of GBP 1 billion. Now this year, we expect a margin around the middle of the range and good progress towards the GBP 1 billion revenue. Clearly, the GBP 1 billion we have in preferred bidder gives us great confidence. In Infrastructure, the medium-term target is an operating margin of 3.5% to 4%, and again, revenue of GBP 1 billion. This year, we expect the margin to be slightly above the top of the range and good progress towards the GBP 1 billion revenue. The Fit Out target, obviously, being upgraded to an annual operating profit within the range of GBP 50 million to GBP 70 million and as Chris has said, we expect to be around the top end of this upgraded range this year. Now with Property Services, we have downgraded the target to an operating profit of GBP 7.5 million a year. I wouldn't want you to think that it's a limit of our ambition or indeed any of these targets are the limit of our ambition. But this year, we expect a further loss in the second half in Property Services, which will be slightly higher than the first half. In Partnership Housing -- in Property Services, obviously, we have a lot to do. And Pat Boyle, who has turned around our construction company over the last 7 or 8 years, who made it a very good company, is actually now heading up Property Services. Partnership Housing, we have a medium-term operating margin of 8% and ROCE up towards 25%. Now although we're expecting an improved performance in the second half of 2023, we expect the margin in ROCE to be significantly lower than last year. Urban Regeneration has a minimum target 3-year rolling ROCE towards 20%. We're expecting a higher profit in the second half of this year, and, therefore, improving the 3-year rolling ROCE target. So if I could sort of just sort of summarize briefly where we are. The markets that we're operating in are actually fairly stable and very manageable with both inflation and the availability of raw materials and labor, not really too much of a problem. We think it's fundamental to keep our strong balance sheet. Although the major contractors have all increased and improved their balance sheets over the last few years, balance sheets in the supply chain of the whole are very weak, and we've seen lots of insolvencies, and I'm afraid we expect to see many more. This group is all about the long term, long-term work streams and long-term client relationships. We've increased the medium-term target for Fit Out and reduced the medium-term target in a much smaller business for us, Property Services, where we fully appreciate we have a lot of work to do. But we upgraded our expectations in June '23, and we're on target to meet them this year. Thank you very much.

[ Johnny ] [indiscernible] And perhaps one for Chris, initially is on Fit Out. You spoke about how margins have improved over the decade. Are you able to give us a range of what margins look like within the portfolio in terms of how many might be loss-making if there are any that have exceptional margins within the mix?

No. I think, as John said, everything we do is for the long term. So selectivity of the contracts is absolutely key. So if we don't believe we can make the right margin that is sustainable from the outset, we decline the tender. So we're not driven by revenue and we don't have any projects that might fall into that category that you...

And it's probably fair to say, Chris, is that you don't have any really high-margin jobs or any low-margin jobs, we're in a very tight band.

And then a question on the wider supply chain. Are you seeing the way the supply chain is contracting and bidding changing because of inflation that has become an emerging area over the last 3 years, but maybe they weren't used to prior to that?

Yes. I think, it would be very, very easy to generalize about the supply chain as a whole. And of course, they're all in different situations. But generally, at the moment, the supply chain who are supplying the housing industry are sort of perhaps bidding on tighter margins.

Yes, I'd say in our markets, the markets have sort of stabilized, as John said. So I think the supply chain are much more confident about the resources and inflation. So yes, it's pretty stable.

And then last question for me is on partnerships. If you do see a recovery in private market sales rates, how long would it take to shift the mix back towards private? And also, should we expect that scenario revenue comes down and we see margin recovery? Or do you think you could hold the revenue and you just get the margin recovery?

I think, it's very important, because we've taken a very long-term view again in Partnership Housing, which means continuing to spend money, winning partnership schemes right the way through all the markets. So we can get back to increasing our volumes relatively quickly. And the percentage on open market sales would increase relatively quickly when the market changes.

Joe Spooner from HSBC. Just one more on the Fit Out division, if I can. The revenue growth that you've seen there and the build in the order book. Are you seeing substantially larger projects coming in because of all of the sustainability and other requirements? Or is that largely kind of a volume dynamic that you're seeing there?

I think there's definitely some larger projects forecast over the next 2 years. I think a lot of that's been driven by lease events. So that would be true. But I think the sort of upgrading of office stock to meet wider ESG requirements and the EPC ratings is actually driving probably the whole market rather than just one particular part of it.

I'm Andrew Nussey from Peel Hunt. Again, a couple of questions. First one is for Chris. And just to sort of further explore the point around margins, and particularly, when we look back historically, how much do you think of the improvement has been market versus your own model, following off from what I think Johnny's point was around were there some loss makers when you go back and time that you're now avoiding? And secondly, on Infrastructure, John, you've sort of suggested margins are going to be top end or slightly ahead of your range, because of various completions. What are your thoughts when you begin to look into next year and beyond in terms of margin and any particular pluses or minuses that might be in there?

I'll answer Infrastructure one first. And then, I mean -- okay, I've never tell looking forward, but I don't think we would be -- expect to be above the range next year. Otherwise, we would perhaps have different sort of guidance. So I'd expect to be back within the range next year.

Yes. And I guess if I talked about Fit Out. I mean, I've been in the business, as I said, 29 years. So I've been there from a point where it was, I think, GBP 50-odd million when I first joined to the size it is now. And we've gone through growing pains historically. So I think there's an awful lot of knowledge in the business, and I think that helps frame how we select our work going forward. So in the last 10 years, I think a lot of it has been down to that knowledge. The efforts that we put into people, the efforts that we put into the supply chain and the focus on quality. So I hope that answers your question.

I suppose the thrust is ultimately, this -- the right margin for this business is high 5s, sort of low 6% type margin.

We've been fairly consistent for quite a few years now.

Stephen Rawlinson from Applied Value. Just a couple from me. In the Infrastructure business, could you just talk a little bit about the contribution of the consultancy side in BakerHicks, it is still 3.7% margin? Because obviously, that's a differentiator for you, you'd expect that to be sort of as a Consultancy business doing margins around 10%. So obviously, it's making a contribution. But just give us a clue as to how -- what contribution is making currently? And secondly, in terms of Property Services, you've talked in the past about the investments that you've been making in the technology there and your IT systems. You haven't mentioned this morning and you can't mention everything all the time, so I get that. But could you just tell us where you're up to with that and the contribution? Has that spend now finished? And this is actually more or less -- the glitch this year is more or less a sort of, if you like, a contractual issue, the reasons for which you've explained. So are the IT systems up and running and able to make a full of contribution to the recovery of that part of the business?

I think these are 2 questions for Steve, who's been very quite so far today.

Yes. And I've been -- I was miles away on that one. In terms of the BakerHicks business, BakerHicks does about GBP 100 million revenue per year, which is part of the Infrastructure business. It's designed. It does a number of projects with the Infrastructure side of the business, so there's a bit of a little bit of intercompany training. It also has a strong position in pharmaceuticals, life sciences as well, pure design, trades under the name of BakerHicks. And I'd say, it does revenue of about GBP 100 million. I'd love it to be doing 10% margin, Stephen, but it's not, I'm afraid. But it does a decent margin, and it does. It is higher weight than a higher margin than the Infrastructure, sort of the roads, rail, nuclear business. Hopefully, that gives you some sort of indication. And then Property Services was the second one in terms of the IT. Look, we need to keep reengineering, keep working and developing on the IT systems, but I don't think IT systems is going to be a big barrier to us getting this business right. There's operational pieces that we just need to sort out, which are not wholly IT dependent. So I don't see IT being a big barrier to us getting this right.

Is the money being spent?

The money is being spent?

Yes.

We have to continue to invest, but not big numbers, not big numbers.

Well done, again. Alex O'Hanlon from Liberum. Just one question from me on Property Services. You mentioned the operational inefficiencies included the higher use of subcontract which is rather than direct labor. What's the availability of labor like for that division? And are you able to kind of shift it back towards direct labor?

Availability is tough. It's tough. It's been one of the issues we've had, and it's the turnover of staff as well of operatives we've had. So we've had very quick turnover, which has created its own issues.

And can you see that kind of getting easier over the next 6 months or a year or will that sustain?

And I think it's quite easy to get the labor, but can we get the right labor? And then, that's the harder part. Any other questions? Well, thank you very much for coming.

Thank you.

Thank you.