North American Construction Group Ltd. (NOA) Earnings Call Transcript & Summary

Good morning, ladies and gentlemen. Welcome to the North American Construction Group Earnings Call. [Operator Instructions] The company wishes to confirm that today's comments contain forward-looking information and that actual results could differ materially from a conclusion, forecast or projection contained in that forward-looking information. Certain material factors or assumptions were applied in drawing conclusions or in making forecasts or projections that are reflected in the forward-looking information. Additional information about those material factors is contained in the company's most recent management discussion and analysis, which is available on SEDAR and EDGAR as well as the company's website at nacg.ca. I will now turn the conference over to Joe Lambert, President and CEO.

Thanks, Joan. Good morning, everyone, and thanks for joining our call today. Today's call is clearly different than ones in the past, given the share purchase agreement we signed yesterday, and we fully expect the majority of the discussion to involve the transformational acquisition of the MacKellar Group. Therefore, we'll do things a bit different this morning. I've asked Jason to summarize our Q2 performance, and then I'll jump right into the commentary and context on MacKellar. At the end of the prepared remarks, we are happy to address Q&A on either Q2 or MacKellar. With that, I'll hand it over to Jason.

Thanks, Joe, and good morning, everyone. As mentioned, the focus on MacKellar, the quarterly comments this morning will be brief. On Slide 3, as a standard practice here, we start with safety and our everyone gets home safe commitment. Our trailing 12-month recordable rate is now at 0.27 and represents a significant improvement from last year, which ended above our company target. We are primarily focused on leading indicator initiatives with several outlined on the slide but are encouraged by the lagging indicator trend. On Slide 4, you will see 2 things. One, 61% was the highest utilization we've ever had in the second quarter, but 2, and probably more noticeable, the month of June was well below our expectation. April and May benefited from the strong momentum carried from Q1 and average 70%, which was very encouraging. However, the surprisingly wet weather in June and a required mobilization of equipment into Fort Hills drove utilization in that month to below 50%, a level we haven't seen since mid-2020. High demand remains for our heavy equipment, and we expect this throughout 2023 and into 2024. We likewise expect our maintenance teams to continue their strong work and correlated improvements in the mechanical availability of our fleet. We remain on track with our utilization goals to be in the targeted range of 75% to 85% on an annual basis with the trailing 12-month average now at 70% compared to the 65% we posted in 2022. Moving to the financials, Slide 6. Combined revenue of $277 million represented the highest level of revenue this company has ever had in Q2 and correlated to the typical impacts that the spring season has on equipment utilization in the oil sands. Return on invested capital of 15.3% is the highest we've ever achieved and surpassed the company goal we had set of 15% as trailing 12 EBIT of $143 million outpaced increases in invested capital, which now sits at $731 million. Slide 7. On a combined basis, revenue of 21% -- revenue was 21% ahead of Q2 2022, and Reported revenue generated primarily by our core heavy equipment fleet was up 15% quarter-over-quarter, with the drivers of this increase being slightly improved utilization and the adjusted equipment and unit rates, which were applied in Q3 2022. ML Northern acquired on October 1, provided another full quarter of operations of fuel and lube delivery. And as we approach the 1-year anniversary of welcoming them to NACG, we are happy to consistently report the strong performance of that critically important support fleet. Our share of revenue generated by joint ventures and affiliates was $83 million compared to $60 million in Q2 2022, but notably up from Q1 2023 revenue of $78 million as their projects are not as significantly impacted by the spring season. The Nuna Group of Companies had another busy quarter of activity at the gold mine in Northern Ontario. Of particular note, though, the primary drivers of the increase in combined revenue included the continued growth of top line revenue from rebuild ultra-class haul trucks and excavators now being owned by our joint venture with the Mikes and the increasingly important impact of the joint ventures dedicated to the Fargo-Moorhead flood diversion project. We had another full quarter of construction work at the Fargo project with the project passing the 10% completion mark and hitting its stride. Combined gross profit margin of 13.1% was a quarterly improvement from the 9.6% we posted last year as our operations in the Fort McMurray region experienced the challenges of Q2 weather. Our joint ventures continued their trend of strong, consistent operating margins and margins benefited from the ML Northern acquisition from lower internal costs as well as strong margin from services provided to external customers. The second-life rebuild program commissioned and sold another ultra-class haul truck during the quarter. Moving to Slide 8. Adjusted EBITDA of $52 million is the best Q2 we've ever posted and reflective of the commentary thus far. Included in EBITDA is general and administrative expenses, which were $7.2 million in the quarter, equivalent to 3.7% of revenue and remained under the 4% threshold we've set for ourselves. Going from EBITDA to EBIT, we expensed depreciation equivalent to 10.4% of combined revenue, which reflects the depreciation rate of our entire business. Diversification efforts into less capital-intensive services continues to have a noticeable impact on the depreciation percentage. When looking at just the wholly owned entities and our heavy equipment fleet, the depreciation percentage for the quarter was 12.6% of revenue and reflected an effective use of our fleet during a challenging quarter. Adjusted earnings per share for the quarter of $0.47 was $0.30 up from Q2 2022 as revenue increases translated down to net income. EPS was driven by $23.1 million from adjusted EBIT net of interest and taxes. The average rate for Q2 was 6.9% as we trended up slightly from Q1 -- the Q1 rate of 6.7% from continued interest rate increases. Excluding the acquisition, Joe will discuss the gross interest expense of $7.5 million should be a high watermark for the year as free cash flow is generated in the second half, and we paid down debt. Moving to Slide 9, I'll summarize our free cash flow. Net cash provided by operations of $40 million was generated by the business, reflecting the strong EBITDA performance. Free cash flow was a use of $4 million as sustaining maintenance capital of $38 million was invested in the fleet. Moving to Slide 10. Net debt levels increased $10 million in the quarter as $4 million of free cash flow used was financed with debt in addition to the growth asset purchase, growth assets purchased and dividend payments. Despite the modest increase, net debt and senior debt leverage remained fairly steady at 1.4x and 1.3x, respectively. Slide 11 provides our bid pipeline, which according to our estimating team is the fullest it's ever been and highlights strong demand and active project tenders. Similar to last quarter, we added another $300 million in new tenders, about half of which is outside the oil sands and roughly matches our diversification. The process for the regional contract in the oil sands is going as expected, and we estimate that process to ramp up in early Q4. We have close to 50 average active projects and remain encouraged by the activity we see across various commodities. Our contractual backlog now sits at $920 million as we complete the scopes awarded to us, and we continue to have expectations of exceeding $2 billion before the year is out. And with those comments on the quarter, I'll pass the call back to Joe.

Thanks, Jason. As a company, NACG has always been very selective in how we use our capital. And when it comes to our M&A, we have been determined but patient in selecting the right businesses, people, geography and markets to enter. That is why today, I'm extremely excited to announce our largest acquisition to date, the MacKellar Group. This transformative transaction is a combination of thorough operational and cultural diligence over the course of multiple years and a deal that makes clear strategic sense. We believe this transaction is financially compelling and more accretive to our shareholders than any other use of capital. I hope at the end of this presentation, all participants will agree that this transaction fulfills our stated objectives and provides a meaningful step change in our project execution capabilities and growth profile. In this slide deck, I'll present and discuss a high-level review of MacKellar and the financial highlights of this transaction, followed by a review of how this acquisition fits our corporate strategy for growth and diversification and ending with a few slides on our next steps and outlook for 2023 and 2024 before taking any questions you may have. On Slide 4, founded in 1966 by Allister MacKellar, having equipment mechanic or fitter in Australian terminology, the MacKellar Group has grown over 450 pieces of heavy equipment operating on more than 15 projects with more than 1,000 employees, of which over 375 or highly skilled maintenance personnel, operating in a system focused on safety and innovative ways to lower equipment costs and extend asset lives. As a leading provider of aviator solutions to mining in several sectors, MacKellar provides a meaningful entry into Australia at a time where every equipment is in peak demand. Moving on to Slide 5. We highlight some of the key financial attributes of the transaction. Starting with the purchase price below book value of assets and a favorable purchasing structure, our strong underlying business has allowed us to finance acquisitions with our own balance sheet, resulting in exceptional accretion. Our fully underwritten financing supported by our lead lender shows the confidence in our business and the vendor provided financing aligns management teams and mutual incentivizes exceeding performance targets. Although fully debt financed using the strength of our combined balance sheet, the leverage is expected to be 1.8x at year-end and below 1.5x by the end of 2024. Last but certainly not least, MacKellar adds over $2 billion in incremental backlog, providing a predictability and sustainability for the business that allows for longer-term investments for future efficiency and growth. Measured on all metrics, this deal was a rare opportunity, and I'm thrilled to be announcing it today. On Slide 6, we provide a bit of a time line and approach we took to the transaction, starting with an introduction through our team at DGI, who we acquired back in 2021. MacKellar is a long-time customer of DGI and the founders of each company have had both the business relationship of personal friendship for several decades. Seeing the similarities between NACG and MacKellar's operating philosophies and corporate culture, DGI facilitated the introductions. After several initial conversations, it was clear that our 2 companies share common values and culture and can make a great combination. We likewise each tour the other's field operations and confirmed the words were matched with what we saw in the business execution. Once the fit and potential combination has been mentally established, we progressed with the ethnos diligence through continuous and transparent dialogue for over 2 years, resulting in agreement in achieving both companies' transaction criteria. This disciplined approach provides us our Board and the MacKellar team with significant confidence of the ability to successfully integrate and execute our strategic plan moving forward. On Slide 7, we provide a bit more detail into the transaction rationale. First and foremost, MacKellar shares our same core guidance of safety and focus on operational and maintenance excellence to be the low-cost provider and contractor of choice. In my opinion, this cultural fit cannot be overstated as it is key to integration success and amassed is so similar that I would expect anyone knowing NACG and speaking to a MacKellar employee to feel like the only difference was the accent. I'll move on to the other points we will discuss further on subsequent slides, but this cultural match is definitely a unique and favorable sign, providing confidence in our future together. Along with the transaction that has minimal integration and financing risk, we're acquiring a large, newer and well-maintained fleet at below book value with significant room for growth and diversification in the various commodities research rich areas of a mining-friendly country. With new equipment lead times ranging from 1 to 2 years, acquiring a fleet of this size provides immediate scale during peak demand. I would also note the relatively young age of the fleet with just over 40% of the fleet being purchased in the last 5 years and just under 30% in the last 2 years. With these most recent purchases still having a couple of years before requiring major -- any meaningful major component sustaining capital. With significant contract awards expected in NACG's core business before year-end, we expect a combined backlog of greater than $4 billion, providing consistency that allows for planning and efficiency of our workforce and our fleet. Moving on to Slide 8. Both NACG and MacKellar are committed to the health and well-being of our employees and minimizing our environmental impacts through individual commitment and proactive participation at every level of the organization. Combined, we will continue our commitment to achieving industry-leading results and relentless pursuit of 0 harm and getting everyone home safe. You can likewise expect to see more details of an integrated ESG plan in our next annual sustainability report, which demonstrates further commitment to key items such as reducing our carbon footprint, expanding our digital relationships, increasing diversity in our workforce and improving the communities we work in. On Slide 9, we highlight some of the key skills and characteristics of MacKellar and know how well they match ours. Whether it's an indigenous customer or vendor partnership, MacKellar values them all and treat them all with respect, honesty and a genuine desire to be mutually beneficial. MacKellar has continued to innovate and build their skills through in-housing of equipment maintenance, component remanufacturing and equipment rebuilds. They have successfully and continually demonstrated these skills through lowering costs and extending component and asset lives. The hands-on solution focus extends from an executive team to the front line with demonstrating commitment to safety, ethics, communication, people and performance. In our next section on diversification, I'll quickly go through these slides to show what will be achieved pro forma with this transaction and what the opportunities are to further grow and diversify the business going forward. On Slide 11, we show our geographic diversification into Australia and highlight all the key characteristics that make it such a great resource market. With this concentration of resources in Western Australia and Queensland, the country provides a great growth engine as we look to expand further into these mining-friendly regions. On Slide 12, we highlight on the left, our significant geographic diversification progress and fleet expansion since 2018. And on the right, the tremendous resource richness of Australia, including many transition metals, which we believe provide strong potential for future further growth and diversification. Australia has some of the largest and most actively mined resources in the world, and we are confident that the region presents a massive opportunity. Slide 13 shows the diversification progress since 2018 in EBIT and the expansion of customers from 5 to 35. The pro forma business maintains a long history of working with quality blue-chip customers while reducing the contribution of our largest end market from 94% to 35%. We also have a strong history over that time frame of not only achieving diversification targets, but improving margins while achieving that, which is an accomplishment we are particularly proud of and which we expect to continue as we expand. Slides 14 and 15 illustrate the wide spectrum of MacKellar's quality customers and long-standing relationships. MacKellar strong reputation has earned at various major projects and it now has operations on numerous sites, a few of which are highlighted here on Slide 15. In our closing section on Slide 17, we have provided a brief overview of the transaction time line. After today's announcement, we'll be working towards a targeted close date in Q4. Once completed, MacKellar will be business as usual with an already in place, high-quality management team, but with the full support of NACG now behind it. We plan to share best practices and systems, strive to continually drive down cost and improve operational performance. On Slide 18, we provide a bit more detail on our focus over the next 12 to 18 months. One key area I would like to delve into is the focus of the small NACG transition team and implementation of ERP systems and procedures. With MacKellar's strong growth and continued internal maintenance focus, their existing systems are beginning to get stretched and limiting management's ability to get good data. This is almost exactly the position we were in around 5 or so years ago, and our transition team and corporate support will be absolutely focused on helping to design and implement these systems and procedures at MacKellar using all of our past learnings to get the gains of what we did right without enduring the pains of what we got it wrong. Although I consider both companies' top-notch and maintenance skills and innovation, the skills aren't identical and there is much to be gained by cross-training and curing of best practices. We both have in-house maintenance work that was once being performed by vendors and where the tasks are the same, we will review each step in the process, compare and pick what works best and combined to create an improved process. And where the in-house stats are different, we'll evaluate the opportunity and see if that task can be in-house, we're not currently performed. Ultimately, we expect the sharing and systems improvements will support the company as a whole into continuing to lower cost, improve margins and increase utilization, all while focusing on continued growth and diversification opportunities. Finishing on Slide 19. We are reaffirming our outlook for this year while increasing it for the combined impact of the fourth quarter pickup. We are providing a meaningful step change to our financial profile with increased ranges across the board. We expect to provide updated 2024 guidance later this year, but I would like to highlight the incremental impact of MacKellar as they are material. We anticipate a 2024 increased EBITDA and EPS of over 50%, have enhanced our backlog and see a clear path to deleveraging to net debt of less than 1.5x by the end of 2024. I've never been more bullish on NACG's future, and I'm thrilled to welcome the MacKellar to the NACG family. With that, I'll open up for any questions you may have.

[Operator Instructions] Your first question comes from Aaron MacNeil with TD Cowen.

As it relates to MacKellar, if you look across the 15 projects, can you give us a sense of what the remaining mine lives are and if there's any history of recontracting? I guess I'm trying to like think about it in the same way that you talked about your oil sands contracts, and maybe you could also differentiate between met coal and thermal coal, if that's possible.

Yes. I would say it's extremely similar, Aaron, that they're long-life resources. So in Western Australia is predominantly gold and iron ore. Gold fluctuates highly in the mine life, and iron ore is generally extremely long mine lives. And then their major operations in Queensland are split between thermal and metallurgical coal. And those mines -- some have already been around similar to oil sands for 50 years, but they all have very extensive mine lives, I'd say, in the 10 to 40-year range.

And in terms of re-contracting, they've been around since 1966, like they had the same contracts that have been?

Yes, many of their customers, especially in Queensland have been customers continuously for multiple decades. We can certainly highlight this a lot more in future tech.

Yes, yes. No, I understand. I think you've made it pretty clear that debt reduction will be the priority, at least in the near term, but how are you thinking about capital allocation more holistically? Like, will the focus be to reduce debt further? Does MacKellar open up opportunities to further consolidate in Australia? And is that something you're interested in? Like how does that rank against the NCIB and the dividend. Just maybe give us a sense of where your head is at with this acquisition and what capital allocation may look like?

Yes. I think, Aaron, we're always evaluating at any point in time with share price, M&A opportunities, debt repayment, I mean that certainly becomes more trackable, more attractive as interest rates keep going up. And certainly, it has the lowest risk of any. But we're always comparing and evaluating risk versus reward. Even after this, we have a significant amount of liquidity even after this deal, and then certainly, by the end of 2024, at 1.5x, we have a significant liquidity to do other things if they're there.

Next question comes from Kevin Gainey with Thompson, Davis.

Congrats on the quarter and I think for you first, Joe. You kind of talked about it a little in the prepared -- the mechanical capabilities of MacKellar. Maybe if you could go in some of the similarities or differences.

Yes. I guess the biggest similarity is they're extremely focused on maintenance efficiency and innovation, which is very much what we do. I'd say we do a lot of our component remanufacturing in-house or with partnerships. They do the same. When I talk about sharing of best practices, what I really mean is that there's a lot of those things we do and they do that are the same, but they're a lot of a little different. I'll use a doser track frame as an example. We rebuild a track frame, which is kind of the middle piece of it, and they rebuild tracks, which is obviously what -- think of it as the rim of the wheel and the tire of the wheel. And -- but we don't do each other's activities, and we'll be able to evaluate those remanufacturing options and see if we can bring them in-house at each other's place and continue to drive those costs down. So they're a very maintenance-focused. The founder was a McCain very maintenance-focused group as we are, and we understand as they do that, the biggest driver of our cost is equipment. And as much as that as we can control and drive down is going to increase our competitiveness or our margins.

That sounds good. And maybe for Jason, if you could maybe talk about the seasonality of MacKellar from a revenue standpoint? And then also more modeling-based maybe the interest expense run rate that you're thinking post transaction?

Yes. Thankfully, MacKellar is actually very flat from a seasonal perspective. So our midpoint for next year is kind of the $145 million EBITDA run rate. And when we look at that, even for how they're performing this year, it's very consistent quarter-over-quarter. They have a little bit of weather issues in December and January, but nothing like we experienced in the Canadian oil sands. So that should really help for quarter-over-quarter volatility in our results. So that's kind of the easy question to answer. And as far as the run rate, our $125 million midpoint for EPS in our ranges assumes a 7.5% interest rate, which is a combination of the vendor take back financing the equipment leases we hope to have in place as well as the revolver, which is currently tracking in kind of the high 7s from an interest rate perspective, but 7.5% is a good base case, and then we hope to beat that with -- primarily with equipment financing, which is quite competitive.

Your next question comes from Tim Monachello with ATB Capital Markets.

Just a few questions on the acquisition. And so starting with the Australian competitive last date. And I know, Joe, you've worked in Australia before. I'm wondering if you can maybe parallel the competitive advantages that MacKellar might have in the Australian market versus how you guys are positioned in the Canadian market. Obviously, you have a very strong competitive positioning in oil sands. I think that the Australian market is a little bit more fragmented and perhaps more competitive, but it looks like MacKellar still has pretty strong profitability and margins. So just wondering if you can lay that out for me.

Yes. I'd say it's extremely similar to ours. I mean the Australian contract mining and North works marketplace is big. It's much more prevalent for mine sites to contract than in North America. But with that, there's more competitors, both public and private. But the focus there is similar to us is the way you maintain consistency in that marketplace is to be the low-cost provider and focus on safety. And they're in-housing of maintenance, be it the component remanufacturing or second-life rebuilds of equipment, which they've likewise been doing for many years now. It is very much where we focus because that's the biggest driver of cost. And we'll certainly look for other areas of operational efficiency, but that's what drives their competitiveness. And it's -- but we'll use -- similar to what we've done in our core oil sands business to diversify and get into other areas is we'll look to do the same thing with MacKellar and using that low cost such that you can go out and diversify without losing margin.