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

Good morning, everybody. The highlights today, I will do a -- first say a few words, then quite an important part, Kelly is going to give her first impressions as CFO. Kelly will then go through the financial and operational review, and I will then talk about markets and outlook and then we'll move into Q&A. So as you can see from the figures on the right, we've had a very good first half, which again is another record performance. Standing here this time last year, I would have said inflation was a real major headwind for us, but I'm pleased to say that is now manageable. It's not gone away completely as a problem, but it's manageable. Balance sheet strength and significant daily cash remains fundamental. And over the last year, it's been -- fundamentally in Fit Out as well, so it's now fundamental across all our businesses. With the strong first half and visibility in the second half, we now expect our full year performance to be slightly ahead of our previous expectations. We've called ourselves for many, many years the Construction and Regeneration group. Now as the business has matured and as the specialisms have increased, we don't think that is actually specific enough for what we actually do. So we're now calling ourselves the Partnership, Fit Out and Construction Services Group. Now the 3 baskets of businesses all have different dynamics, and all have different strategic priorities. Now Fit Out, a business that generates cash is our most mature business. And here, we are the market leader, and we have been for some time. And the real challenge in our Fit Out business is maintaining that market-leading position because that's just as hard as getting there in the first place. Our construction services businesses, which are Morgan Sindall Infrastructure, Morgan Sindall Construction, Morgan Sindall Property Services and also BakerHicks, our growing design business, which is reported under Infrastructure services. All businesses, which are growing and will grow quite dramatically in the medium term. But here, it's about growing the businesses carefully. It's about we're -- looking at the margin rather than turnover. And if the markets get tight, very happy to let turn over fall in order to maintain the margin. Again, another business that generates cash. Partnerships is Lovell Partnerships, our Housing business -- our Partnership Housing business and Muse, our Mixed Use Partnership business. Now we used to call that our Urban Regeneration division, and of course, it is an urban regeneration specialist, but actually everything we do is in partnership, usually with government of one sort or another. Both our partnership businesses have very strong brands, need cash to grow and will be the drivers of the group profit, not only in the medium term, but especially in the long term. Now we see these 3 baskets of businesses as everything that we're going to be in for the foreseeable future. And that gives us a lot to go for. I'll now hand you over to Kelly.

Thank you, John, and good morning to you all, everyone. So a slight departure from the financial and the operating review. Having now been with the group for 3 months, I thought it would be a really opportune moment to share with you my initial reflections but also my priorities as CFO for the group. Now, to set some context, since joining, I've visited over 20 of our regional businesses and a number of our major projects. To set some context to all of this, I've understood that the group's scale and complexity is quite phenomenal and gained a real insight into the strength and the depth of our local management teams. Now, all of this has been underpinned by a really good handover from my predecessor, Steve Crummett. And I'm really pleased to say that the group's balance sheet is not only robust, but it's in good shape. So perhaps let me start with my initial reflections. The strong culture, the values, the right behaviors, which include doing the right thing, being open and transparent and deeply embedded throughout this organization, and they don't just sit at group or divisional level. It was really visible to me when I was meeting a number of people along my journey ranging from bid managers, trainee quantity surveyors, project managers to regional MDs that this was deeply inherent in how they worked from day to day. There's real clarity over the group's strategy and what will move the needle in the long term. Now, I was really encouraged that this is a subject of our discussions with the divisions when we meet with them. And it's at the heart of their decision-making which neatly goes hand in hand with our capital allocation strategy, which I'm totally supportive of, but in turn, really encouraged by how it supports our long-term growth plans for partnerships. And finally, having reviewed most of our major projects and visited a fair view, there's been a real emerging theme for me here, and that's been about our conservative approach to judgments and estimates and the robust risk management framework, and I'm committed to ensuring that's maintained going forward. So with regards to my priorities, there's nothing new here, but there are a few areas that I want to place my focus on. Now, the first one to some degree, I've already covered. It's about maintaining the conservative approach around our judgments and our estimates and continuing with our robust risk approach. Nothing is changing there. The second area is very much around the remediation plan for Property Services. Now, you'll have all read this morning, that's been progressing really well, but it's a key priority of mine to ensure that concludes in a good, orderly fashion by the end of this year such that we set this business up for success for future years. In the medium term, the remaining 2 priorities do very much go hand in hand. It's working with our capital allocation strategy and optimizing growth in partnerships. And secondly, delivering on our medium-term targets. So moving on to the financial and operational review and the key headlines to the income statement. So revenues were up 14% to GBP 2.2 billion. Our operating profit grew by 11% to GBP 65.5 million, and that was accompanied by an operating margin of 3% in the period, slightly down on this time last year but entirely due to the divisional mix profile. Now, elevated interest rates on our strong cash balances helped deliver an interest -- net interest income of GBP 4.6 million, which in turn has allowed our profit before tax to grow by 17% to GBP 70.1 million, with an equivalent PBTA margin of 3.2%. Now, EPS growth has been held back a few points to 14%, but that's largely due to the slightly higher statutory tax rate in the period. Overall, our interim dividend has gone up 15% and to 41.5p share. So in summary, a strong set of results with strong double-digit growth across revenue, profit before tax and our interim dividend. So moving on to the performance split by division. And once again, Fit Out has delivered a significant contribution in the period towards the group's performance with profits up 36% compared to the prior year. Now, that's also been followed by strong contributions and good growth from Construction and Infrastructure, together with Partnership Housing despite only a modest recovery in the housing market. In Property Services, the remediation program has progressed really well, but it has meant that in the period, we've recorded operating losses of GBP 11 million. And in Mixed Use Partnerships, profits were lower in the first half, but that's really a function of the lower level of scheme completions in the year-to-date. So overall, operating profit at GBP 65.5 million with an operating margin of 3%. Now, this chart presents an operating cash flow of just over GBP 36 million. And if you cast your minds back to this time last year, we had a similar profile of around GBP 31 million of an operating cash outflow. Now in truth, this doesn't represent how we run our business on a day-to-day basis. But there are probably 1 or 2 areas I bring your attention to, the working capital outflow of GBP 104.9 million is predominantly led by our investment of GBP 97.3 million in partnership activities, which is largely our investment in Partnership Housing in new sites, but also our partnerships. Now, this slide is something personally I have found a real differentiator for this group, and I am absolutely committed to continuing with this going forward. It records some of the most important information we see on a day-to-day basis, our daily net cash balances. Now, the blue line represents that position for the last 6 months. The gray line does exactly the same but for the full year 2023. Our average net daily cash for the last 6 months, GBP 372 million. That's GBP 104 million higher than this time last year. But it should be noted that our lowest point during this period was GBP 295 million. So it gives you a good indication of how significant our cash swings can be, particularly for a business that delivers over GBP 4 billion of revenue a year. Importantly, it also allows us to focus on making the right decisions to drive long-term sustainable growth. Cash at the end of the period was GBP 351 million. So I'd say overall, we're in really good shape when it comes to cash. Looking ahead, we expect that the average daily net cash for the end of the year to be in excess of GBP 350 million, noting that our previous guidance stated well in excess of GBP 300 million. The secured order book at the end of the period stood at GBP 8.7 billion, but it does reflect the removal of those future revenues for those contracts in Property Services, where we've negotiated an early release from. Overall, our order book is underpinned by contracts that have good quality margins. And yes, they contain risks, but risks that we know how to manage well such that we don't compromise our ability to deliver on our target returns. In short, this sets us up with a really solid platform to deliver our revenues for future years. So in summary, good growth in profit before tax, a really strong cash position and a high-quality order book. So moving on to the divisional performances. And I'm going to cover, as usual, the trading performance is, and I'm going to leave John to cover the divisional outlook in a short while. So starting with Construction. Good revenue growth of 10%, followed by strong profit growth of 18% at GBP 14.1 million, accompanied by an operating margin of 2.7%. That's right in the middle of its target range. Now, the performance of this division is underpinned by our continuing strategy of careful contract selectivity with a strong focus on operational delivery and robust risk management. This risk profile is reduced even further as 98% of our work is procured on trough frameworks, through 2-stage bidding process and negotiated works. Now, with 85% of our work with the public sector, that risk profile is managed even more, whilst education still remains our strongest subsector in this division. Overall, this division closed with an order book of GBP 900 million at the end of the period, followed by a further GBP 1.2 billion of work at preferred bidder stage. In Infrastructure, it's a very similar strategy actually to Construction, where there's been strong focus on discipline and delivery. Both of these factors have enabled us to deliver strong revenue and profit growth of 24 percentage such that our profits rose in the period to GBP 19.7 million with an operating margin of 3.7%, again, right in the middle of its target range. Now, the slight downside is, and we've said this before, the procurement cycle in some places is taking a bit longer, which means for some of our projects, mobilization can be a bit delayed. But overall, the order book levels remained strong at GBP 1.7 billion, and we can see some good visible opportunities emerging further down the track. So moving on to Fit Out. Fit Out has delivered another quite exceptional result in the period with profits up 36% to GBP 41.3 million, supported by an operating margin of 6.6%. Now, that's not just off the back of significant revenue growth. That's also a really good operational leverage. What's been really key for this division is not to be complacent. It's been absolutely 100% focused on project delivery and on the customer experience. At the end of the period, Fit Out had a substantial order book of GBP 1.2 billion, and it's been followed by a pipeline of really good opportunities at various tender stages. The remediation program has continued to progress really well in Property Services under the leadership of its new management team. Now, in the first half, I've already said we've recorded operating losses of GBP 11 million. However, GBP 8 million of that related to an exit cost for a small handful of contracts that were underperforming and simply just were not commercially viable for us. The good news, as I've said, is that we've negotiated an early release from those contracts. Elsewhere, the division is well underway with its operational restructuring efforts for its remaining existing contract portfolio. As in previous periods, these operating losses continue to be reported in the group's normal trading results. So to sum up for this division, we remain confident of its turnaround by the end of this year and to return it back to profit in 2025. Our focus on long-term partnerships with the public sector has continued in contracting work, and it's continued to provide us with that short-term resilience in a challenging housing market. Revenues improved modestly by 2% to GBP 381 million in the period, supported by strong growth in contracting, which was up 21%. So it continued to provide that short-term shield effect as we saw a gradual but slow recovery in open market sales. Now, despite the revenue mix profile, the division did enjoy stronger margins in the period. And that's largely being led by contract type, but also the mix of schemes delivered in the period. Overall, profits were up 16% to GBP 11.7 million. Now, despite our short-term pivot towards contracting, our long-term strategy in partnerships still remains strong and present. And that's been evident by the investment we've made year-to-date in this division. By the end of this year, we expect our average capital employed to remain at GBP 330 million as per our previous guidance. With a strong order book of GBP 2 billion and visible opportunities of a further GBP 1 billion, we remain both excited and confident of our medium- and our long-term ambitions for Partnership Housing. And finally, in Mixed Use Partnerships, profits were lower at GBP 0.5 million compared to this time last year. But this business has been impacted by a longer hiatus. And that's been driven by the higher number of completions last year and very much the lower level of completions in the first half of this year. However, the volume of procurement activity in this space is increasing, and it continues to support our long-term aspirations for this division, which are further underpinned by the secured development order book of GBP 1.8 billion and also the sizable new schemes that we see at preferred bidder stage. So to summarize, we've had a great first half. The diversity of our operations has supported our excellent growth in our profit before tax of 17% in the period. We have a strong high-quality order book. Our balance sheet strength gives us confidence over decisions about our future, which overall supports our 15% growth in the interim dividend to 41.5p per share. John?

Thank you, Kelly. Thank you very much indeed. So I want to talk about our markets overall. The big picture is the markets are okay. They're not really up there and they're certainly knock down there. But probably on the whole, they're just improving a bit. But obviously, it's a little bit different from one market to another. Certainly, the public and regulated sectors are very active, and that's really important for us because outside of Fit Out, it's probably 70% of what we do. I mentioned inflation is manageable, which has made a big difference. But supply chain is the thing that keeps me awake at night. A lot of the supply chain are very weakened by COVID, by main contractors going bust and perhaps lower work in housing and contracting generally over the last couple of years. It's easy for us to look at our supply chain because we talk to them. We look at their balance sheets, we look at their management accounts. We want to know who else they're working for, but it's quite difficult to get below that to the supply chain's supply chain's supply chain and the whole industry is sort of interconnected. So that's the one thing that keeps us awake at night. If I go business by business, Construction, clearly, we do about GBP 1 billion worth of turnover, but people may find quite surprising is our average job is at least about GBP 16 million. And the market here at the moment looks pretty flat. It's not improving and it's not going down, just pretty consistent. Infrastructure, I think we perhaps had slightly less of a market over the last couple of years than we would have liked, but we actually see in the medium term that market actually improving. Now, Fit Out is the one that I'm always asked about because I've been accused of saying the market is getting worse, and it's getting worse, and we're going to be worse and worse. And you can laugh, Mr. Finance Director of Fit Out. But each time we come up with a little bit more money. But I can honestly say this is a very strong market. And I'm not saying the market is going to get weak, but it's got to reduce somewhat to more normal levels. And that's why our guidance -- medium-term guidance is no different. Property Services, obviously, a small business for us, but actually, the amount of work in that market is actually increasing. Now, Partnership Housing, the housing market, we see some modest improvement, but we're also seeing on the contracting side, a lot of the housing associations really wants a contractor with a really strong balance sheet. There's been a lot of relatively medium-sized companies who have gone out of business and caused huge embarrassment to our clients. So we see that market improving. Now, Mixed Use Partnerships where we have a very, very strong brand, and we are seeing many more opportunities and have many more preferred bidder opportunities than we've ever had before. So we see that again improving. So I'm actually saying all the markets are sort of going up a bit, not doing much, but I'm saying Fit Outs got to normalize at some stage. And you must also remember in Fit Out, our jobs are quite short on the whole. Our average job is still only about GBP 3 million. And when you're doing GBP 1 billion worth of turnover, that's a lot of GBP 3 million jobs. I put in here just for reference, our medium-term targets. I don't intend to go through them, but I think it's a useful thing to have as a reference in the pack. So if we look at the divisional sort of outlook, we expect to meet the revenue and margin targets for Construction this year. In Infrastructure, we will hit our margin target, and we will fall short of the GBP 1 billion turnover, but we are getting closer to it. Now, Fit Out, the operating profit is likely to be well in excess of our medium-term target this year. And that is really due to exceptional revenue going through. Property Services, we expect a further loss in the second half, which is likely to be about half the loss in the first half. And as you heard from Kelly, the main thing is to make certain that, that business is set up to make a profit next year. So with Partnership Housing, we expect an improved performance in the second half, but the ROCE still will be down on where it was last year. And with Mixed Use Partnerships, again, both the profit and the ROCE is expected to be lower, much lower in the second half of 2024 than it was in '23. So I think if I sort of summarize everything. I think we're in pretty good shape, quite frankly. And we expect to continue our strong organic growth. We mentioned in the capital allocation strategy that we might do bolt-on acquisitions, but any acquisition would only be a bolt-on in exactly the space we're in, in order to increase organic growth. We see our balance sheet being a real differentiator and maintaining strong cash at all times is the most fundamental thing for us. And I know we've said that before. Questions?

Jonny Coubrough from Deutsche Numis. I've got 3 questions, but perhaps I'll ask them one by one. Firstly, on Fit Out. I mean, clearly, the margin was very high once again. What do you think is a sustainable margin in the division now?

I think we've talked in the past about something around 5.5% and nothing has changed.

And then secondly, on Property Services. How much of the losses in the first half are one-offs and are the exit-of-contract costs now done?

So maybe I'll take that. So I think we've already noted that GBP 8 million were one-off costs in respect of the exits for the small number of contracts. Jonny, remind me of the...

Yes. And if those one-off costs are now done?

Yes, they are. Yes.

And then the third one, in partnerships, clearly, a pickup in contracting again. Are you seeing a change in the contracting margin? And if so, what's driving that?

No, we're seeing -- we're seeing it pretty consistent.

Rob Chantry, Berenberg. Thanks for the presentation, 3 questions as is traditional. So Partnership, so can you just talk about how the dynamics are changing at preferred bidder stage in the Mixed Use business? Is it more competitive? There's a lot of companies talking about this. How is that changing? Slightly one at a time or separately? Secondly, you mentioned capital allocation and partnerships quite a lot and kind of touched on M&A. What type of deals are you interested in? Obviously, you mentioned bolt-on? Is it geographic diversification, capability, access to relationships, what type of things might be of interest? And then thirdly, on the normalization of the Fit Out market. Clearly, I guess, there's some element of natural conservatism and experience in your comments. I guess could you just talk about what are the exact operational factors driving that real buoyancy at the moment? Is it volume? Is it price? And how do you expect that normalization to come through?

So I think with Fit Out, we're not expecting the market to go down dramatically, far from it. And there are a lot of structural changes, which were long-term structural changes, which means the market will remain strong. So we feel pretty good about Fit Out and I just don't want people to get too excited about it. Partnership Housing, I don't think the market has changed dramatically. I think it's pretty similar to what it was. And the third question?

So the third question really is about, I think you -- Rob, you talked about the Mixed Use Partnerships and the schemes converting from preferred bidder...

Yes, that was one that was around M&A.

Maybe if I take the M&A one. So I think, look, with M&A, very much our strategy is to pursue organic investment in Partnership activities. If by chance, we come across a particular target in that space that will help propel our overall strategy. We will take a look at it. We are seeing opportunities come by. But of course, we've got some fairly high requirements in terms of returns and managing those risks. We don't have any prescribed characteristics. We're being open-minded, but we are wanting to stick to partnerships at this stage.

And, of course, if you look at our capital allocation strategy, it was very -- a long way down, but we wanted to mention it publicly because we didn't want opportunities not to be put to us. But we haven't done anything, and we might not do anything at all, but we wouldn't want to rule it out or actually surprise somebody if we did something.

And John, I think the final question was around Mixed Use Partnerships and preferred bidder. Rob, just remind me, was your question about how we get to -- how do we convert or...

So I think kind of John touched on it, is more kind of how effectively -- how -- are there any dynamics changing in that preferred bidder stage?

I don't think the dynamics are fundamentally changed except I think there's going to be fewer larger players in the medium-to-long term, and it's harder for smaller players as more and more sites and partnerships are being amalgamated rather than being individual sites.

Joe Spooner from HSBC. Given the change of government and obviously the mood music around what they plan to do with housing and so forth. Are you thinking about the partnerships -- obviously, it's the area that you invest the cash in. Are you looking at potentially stepping up the investment in there to take advantage of opportunities? Or is that something still to think about ahead?

But it's really difficult for us at this stage to know exactly what it's all going to mean. But we do feel that the rhetoric would be the sort of spaces, which we can help in, and we will react very quickly when we know exactly what it means.

And you also spoke about the liquidity risks that you see in the supply chain. How do you go about managing that given the lack of visibility that you spoke about in terms of seeing where that lies?

Yes. And of course, when I'm talking about supply chain, I'm talking about subcontractors rather than the big material manufacturers. And each -- I think one of the things that's fundamental is each of our businesses use a different supply chain, which helps. And we look very closely at the people that we work with directly, but that doesn't mean we get the -- we do get the odd shock every now and again. I don't think there's a lot more we can do.

And just one final one. On the Fit Out division, obviously, you're kind of cautious about the level of activity kind of going forward. But are there other constraints in that business in terms of the capacity of it actually being able to do more? Or is it kind of trading at its full capacity now?

Well, one thing that's absolutely fundamental for us is every job we do has to be perfect because the brand is so fundamental. So we won't take on more work than we actually have the skilled people to deliver it properly. So that is a constraint in the short-to-medium term. But on the other hand, the turnover and the size of that market must normalize at some stage.

Stephen Rawlinson from Applied Value. You just touched upon brand there, John. Can I just ask one question with regard to that, first of all? I mean it used to be called the Construction Brands Group as well. Are you downplaying that in favor of Morgan Sindall as being the brand for -- as a coverall? Or is there something I don't know about there...

Not at all. Not at all.

Lovell is still...

Big time, big time. And they are big brands. And, of course, it's only a brand if you get business that you would not otherwise get. Otherwise, it's just a name.

Yes, the pack doesn't seem to have many of those it normally has. So just on that -- okay, on Fit Out, I mean the order book used to be 4, 5 months, it's now 12. So if we do see a decline in activity overall in that area, will we see it through that order book? And what's changed that it's now 12 months, not 4?

We got a few big jobs, which give us sort of real confidence for the second half of this year. And we don't normally have as many big jobs in the order book. So we could have a reducing order book, but we shouldn't be too worried when that happens.

Right. So we might start to see that fall and that would be an indicator. Okay. And in Property Services, you used to be -- talking about the supply chain. That's where I think you've had most difficulties. There isn't much mention of that. I've seen the taxed IT systems and those sorts of things which might encourage a better performance. Can you just help us out with a little bit more of the detail there about that operational restructure, the status of your IT development and whether actually you're going to go on a more direct employee route rather than the subcontractor route, which I think historically has been the case in that particular section.

Yes. So we are -- it is more direct contractor route. It is -- it's more smaller contracts rather than response maintenance. And the -- what was your -- the other point?

Is it around the whole area of how you're actually addressing your contracts now in a different way to give you more solidity? Because it was the supply chain failures that were really hampering you in that area, maybe because they built the wrong price, or you built the wrong price or something of that nature?

So I think the key thing is we're downsizing that business. We need to fix it, only when it's fixed, will we start to grow it. And while we're fixing it, we're using our own labor much more than subcontractors.

And in that order book of GBP 1 billion, I mean, I think it's probably the second largest part of the business revenue to order book. Are you confident about the margin with -- inherent margin within that one? That order book?

We've got -- we've taken out of the order book and exited where the margins are not satisfactory.

Okay. And last question, if I may. And forgive me, a bit cheeky one, but how long was the Board discussion about share buybacks, John?

That is a cheeky one, isn't it? I think it'd be wrong to say that, that isn't a discussion that happens on a regular basis. It isn't as if it was one discussion. And -- but it is interesting, there's a lot of potential uses for our cash, which we think are a lot better than share buybacks at the moment. But a nice question. Thank you.

Alastair Stewart from Progressive Equity Research. A couple of questions. Where are you on open market sales rate just now in housing? Since the election and the cut in interest rates, and I know it's very recent, but have you noticed any significant change there? And then build costs, you say it's manageable. Yesterday's PMI data really shot the lights out. And the RICS survey today showed buyer inquiries up for the first time in quite a while, labor planning, all this new housing, don't you think it could actually become significant build cost inflation in the months and years ahead?

I think that's a possibility. I'm really commenting on where we are now. I mean, as we know, a lot of the big companies have closed down some of their -- they need to open them up again, clearly. But we don't know, but we are alert to the fact that it could come back as a problem.

Let me take the open market sales question. So look, I think, Alastair, you would have noted that in the first half, our open market sales have shown some gradual recovery, which is encouraging. I think we have seen a little bit of movement since the election, but it's still too early to say. We've only just...

Positive movement?

Yes, yes, positive. But it's still too early to say. That's going to have to work its way through the system together with the rate cuts.

And obviously, what we look at on the early indicators, which are how many inquiries that we got, how many hits we got on the website because that actually gives us a better indicator than the orders in the -- that we take in the week because there's a lag of 3 or 4 weeks between the two.

How is that looking?

That has gone up.

That's positive. That's gone up.

Single digit percent? Double digits...

Double digits.

Double digits.

Low double digits?

Double digits.

Double digits, yes. And consistent with other housebuilders, yes. Any other questions? Well, thank you very much indeed, everybody. Thank you.

Thank you.