Service Stream Limited (SSM) Earnings Call Transcript & Summary

Ladies and gentlemen, thank you for standing by, and welcome to the Service Stream FY '21 Half Year Results Conference Call. [Operator Instructions] And just please be advised that today's call is being recorded. But I'll now hand the conference over to your first speaker today, Managing Director and CEO, Leigh MacKender. Thank you, and please go ahead.

Thank you, moderator. Good morning, ladies and gentlemen, and welcome to Service Stream's Half Year Results Presentation for the 2021 Financial Year. My name is Leigh MacKender, the Managing Director of Service stream, and I'm joined today by our Chief Financial Officer, Linda Kow. We're recording this session today via webcast. It's open to all registered Service Stream shareholders, and we have a number of institutional investors and analysts on the conference bridge, and they're welcome to ask questions at the conclusion of the presentation. Today, we'll run through a brief overview of the company profile, moving in to provide key messages and an outline of performance highlights throughout the half year. We'll update in relation to COVID-19 and how the business has been impacted, move into some greater detail with respect to the group's financial and operational performance, both the group and divisional level. And finally, we'll touch on the group strategy and outlook, including priorities for the second half of this year. And at the end of the presentation, we're happy to take questions from those joining us on the bridge, expecting to take 30 to 45 minutes, including time for questions. Moving to Slide 2 and just briefly touching on the company profile. Service Stream is essentially a network service provider, and our core markets are utility and telecommunications, where the business provides end-to-end services associated with the design and construction and operations and maintenance of the essential infrastructure networks. Business has a strong client base, consisting of Australia's leading blue-chip industrial asset owners and operators as well as government and government-related organizations. Business has 2 reporting segments, reflecting telecommunications and utilities. Telecommunications provides integrated design, construction, engineering, operations and maintenance services across both fixed and wireless infrastructure. Key clients include nbn, Telstra, Vodafone. The company's utility division provides a unique set of end-to-end services associated with design, construction, asset installation, inspection and operations and maintenance of utility infrastructure. The key clients in this sector are gas, water, electricity, asset owners and operators, retail service providers and local government authorities. Before we move to the group results for the half year, I might take a moment to provide some brief initial commentary on the last 6 months and in relation to the period ahead, and refer to Slide 3 of the presentation materials. The FY '21 financial year was characterized previously as a transitional year for the business, a year in which the business had a large number of significant contracts reaching their natural end date and mean to be resecured. The nature of these agreements, particularly those associated with nbn, were also changing the future as programs move away from a construction focus to one of ongoing operations and maintenance, and work volumes, therefore, declining from historical piece. The group's first half financial performance, whilst down on prior corresponding period, was in line with expectations. The business had, however, forecasted a stronger second half in FY '21, and that was led by an expected resumption of previously delayed maintenance works that were paused or restricted during COVID across both telecommunications and utilities. The delivery of productive upgrade or maintenance works, particularly across telecommunication operations that have historically been biased to the latter part of each financial year, and the mobilization of work programs aligned to those resecured contracts. And all while the COVID landscape continued to improve and allow the business to recommence operations without restrictions on travel and movement. Unfortunately, the outlook has been progressively impacted in terms of lower-than-expected volumes by clients, and we continue to see restrictions on some work types commencing and longer-than-expected delays across tender cycles. With these uncertainties, we therefore, expect the second half results to be approximately in line with the first. Despite these challenges, the business has been successful in navigating through a period and resecuring a number of key agreements, which provide a strong base. We manage Service Stream for the long term and focus on continually driving and enhancing the business model's strong fundamentals with regards to profitability, maintaining a strong balance sheet, a high-quality of earnings and working with our industrial client base to grow operations as opportunities present. As we look ahead, the core of Service Stream remains strong, and diversification into utilities has been progressing well. And whilst it would take some time to progressively replace the declining revenues across telecommunications, which have been a major source of historical growth, that does provide several opportunities. The business holds a solid order book, faces into positive markets and continues to work on securing those additional growth opportunities, both organically and through acquisition, which has served as a catalyst to delivering a step change in future growth. Moving on to performance highlights, I direct you to Slide 4. We have an overview in relation to the group's financial, operational and strategic performance over the most recent period. In relation to financial performance, the business reported EBITDA from operations of $40.2 million, and whilst down on pcp, was in line with expectations with a period -- with the prior period holding construction-related programs at nbn, which have concluded, and the activations of such connections profile reducing over time. Group EBITDA margins remain steady and healthy when compared to industry averages, with movement really reflective of scale benefits that we've seen when work volumes are higher. Strong cash flow generation with EBITDA to OCFBIT conversion rate of 108%, particularly positive, and working capital continues to remain at a low 1.3% of revenue. On the back of these results, the Board announced an interim dividend of $0.025 a share, which was down on prior periods, maintaining a historical payout ratio of circa 60%. In terms of operational performance, the re-signing of both the unified services and networks agreements with nbn, cement Service Stream's role as a major service provider and provide work over a potential 8-year term, expecting to generate in excess of $800 million in revenue. The business secured the next contract iteration with Telstra for the design, construction, operations and maintenance of both wireless and fixed line infrastructure. And the utility segment secured a number of opportunities over the last 6 months, most notably an agreement with SEQ Water in Queensland and several clients in New South Wales. In total, the business has resecured an excess of $1.5 billion in works over this recent period. And finally, the most important aspect of the business operations is our safety performance. And we're very pleased to see the business continue to deliver positive improvements across key indicators. Finally, touching on strategic highlights. Diversification strategy in utility is progressing well and supporting opportunities which will assist in replacing those historical nbn construction and activation revenues across a more diversified base. Comdain infrastructure, which is a major step in the diversification program, has performed well, with work in hand that's on target to deliver 15% growth in revenue during the year. The business, more broadly, has a solid pipeline of organic growth opportunities across both markets. And we continue to assess a number of M&A opportunities, which should further support the expansion of addressable markets, diversification of group revenues and a platform for future organic growth. Moving to Slide 5. I'll provide an update in relation to the COVID-19 pandemic and how this has impacted the business over the recent period. As I mentioned in my opening comments, the group's balance sheet, cash flow, liquidity all remain strong, and the group's exposure to essential infrastructure markets has certainly limited the impact that COVID-19 has had across the business. There have, however, been impacts, and some of which we do expect to continue over the near term. And these are most notably across delays to client procurement programs, many being pushed back several months. Restriction on the movement of people, both within state borders and across borders, has really handed the business's ability to effectively mobilize and support some programs and restricted the ability to move resource across borders to capitalize on opportunities as they present. We incurred client schedule delays to proactive maintenance programs across utilities and telecommunications networks, such as the continued moratorium on gas and electricity disconnections and reconnections as well as meter exchange operations, which still exists today across many states, but are starting to ease with each month the passes over the year. Victorian operations were also heavily impacted in the last period due to Stage 4 lockdowns, particularly across our inspection and quality assurance operations. All of the above have previously been outlined and certainly top of mind in terms of the key variables that the business needed to monitor over the course of the year. Moving on to Slide 6 and the group's safety performance. Service Stream is incredibly proud of the safety culture and industry-leading performance that's delivered by the organization. Our HSE performance remains one of the major priorities for the business. I'm really committed to ensuring that our people, our customers and the community with whom we engage with while we deliver our services remain safe at all times. As you can see from the lag indicator performance graphs outlined at the bottom of the page, our total recordable injury rates decreased, reaching a new low of 1.57. Medically treated injury rates continued 1.12, a further reduction from the prior period. And finally, our lost time injury rates continue to be maintained at low levels. Safety is one of our core values and an area where despite our positive results, the business really needs to continue to place great emphasis and strive to deliver further improvements as we continue on our journey towards 0 harm. Also, I'm very proud of the group's performance, and the business continues to work on targeting high-risk work activities and identifying further opportunities to improve the safety of our operations. I'll now hand across to Linda to run through the key financial performance in greater detail.

Thanks, Leigh, and good morning, everyone. As Leigh has outlined earlier, the FY '21 first half results reflects reduction in nbn telecommunications volumes and continuing COVID effects restricting near-term performance. Revenue for the half was $409.9 million, which is 17.7% lower than the first half of FY '20 and driven by the lower telco segment revenue. EBITDA from operations was $40.2 million, 30.8% lower than pcp but consistent with our expectations of a much lower first half due to the reduced telecommunications revenue and compounded by additional operational impacts from COVID. EBITDA from operations excludes $1.1 million of nonoperational expenditure associated with the assessment of M&A opportunities during the period. Adjusted NPAT or NPATA for the half was $20.1 million, a 37.8% reduction compared to last year. In addition to the nonoperating M&A costs we exclude from operating EBITDA, this metric excludes the amortization of historical acquired customer contracts to provide a view of underlying business performance. Statutory NPAT, inclusive of the nonoperational M&A and amortization expenses, was $16.2 million. Net cash at December was $10.5 million compared to a net debt position of $4 million last year. The group had a very strong cash flow result for the half, with EBITDA cash conversion or OCFBIT percentage, as we define it, of 108%. On dividends, the Board has declared an interim dividend of $0.025 per share, fully franked, which maintains the group's payout ratio in the range of 50% to 60%. The record date of the interim dividend will be the 26th of March with payment on the 14th of April. Slide 9 sets out the group's key financial measures, both operational and the statutory reported equivalents. I refer you to Appendix 2 of the results presentation for a reconciliation of the adjusted profitability measures factored in statutory or IFRS equivalent shown here. I've already spoken to many of the financial metrics outlined in this page, but we'll touch on the group EBITDA margin, which was 9.8% for the half compared to 11.7% in the last half year. Again, this is mainly driven by the reduction in telecommunications. And also noting the margin achieved by that segment during FY '20, there is scale benefits from much higher volume of work. We have previously indicated there is a 1% to 2% margin variability across telco depending on work mix and volume. Now moving on to Slide 10, which is the segment result. Across the group, the utility segment share group revenue and earnings has continued to increase as the business shifts from the Comdain integration program to growth. Utilities now account for 49% of group revenue, up from 40% last year and 34% of group EBITDA, which is up from 25% last year. Utilities revenue for the half was $199.6 million, just slightly up on last year. However, within that segment, Comdain revenue increased by 5.1%, but was offset by a reduction in metering and technical services revenue of $7.1 million or 37%, primarily due to COVID restrictions. Utilities EBITDA was $14.7 million, 5.2% lower than pcp due to margin mix between Comdain and metering revenues and COVID-related impacts. Telecommunications revenue for the half was $209.9 million, which was $88 million below pcp due to 2 main factors: firstly, OMMA activation and insurance revenues decreased by $42.5 million, following peak nbn activations in FY '20; secondly, the prior comparative period includes $40.6 million of revenues from the nbn D&C construction program, which was completed in FY '20, and therefore, not repeated this year. Telecommunications EBITDA was $28.7 million, a reduction of 36.6%, driven by the reduced revenues, as noted. The P&L items below EBITDA are relatively straightforward. Overall D&A, including depreciation of lease assets, has reduced slightly with savings and depreciation expense on owned assets offset by an increase in depreciation on leased assets. Tax expense for the half was $8.6 million, tracking at an effective tax rate of approximately 30%. The group is not expecting to derive any significant tax benefit from government incentive for CapEx incurred up to December '20. Adding all that up, adjusted NPAT was $20.1 million, which is $12.2 million or 37.8% below last year. Now on to cash flow and capital management, which is on Slide 11. As touched on earlier, the group derived a strong cash flow result for the half, emphasizing the quality of earnings. In conjunction with the group's balance sheet position and the recently completed refinancing, this places the group in an excellent position to fund future growth. Cash flow EBITDA to OCFBIT conversion was 108%, which is well in excess of the 80% target we have generally guided to. Working capital as a percentage of LTM sales remained highly efficient at 1.3%. We do expect this to normalize over the full year with the mobilization of new project works and changing work mix between the segments. Net interest and financing payments increased by $0.8 million this half, reflective of the refinancing undertaken during the period. CapEx spend was $4.6 million and in line with expectations and primarily relates to the Comdain IFS implementation and customer-related IT solutions. Free cash flow was $15.6 million, an improvement of $7.9 million from the corresponding half, and the group closed the half year in a net cash position of $10.5 million. The group's existing debt facility, which was due to expire in September 2021, was recently refinanced and replaced with a new 3-year syndicated debt facility, which has increased to $275 million to provide headroom to fund future growth opportunities. The new facility incorporated improves commercial terms, covenants and operational flexibility and the ability to increase debt further over time to fund further growth. The refinance was well supported and with an expanded banking group and the offer was oversubscribed. And finally, the refinancing enabled a net reduction of drawn borrowings of $20 million, which can be seen in the cash flow. And that's all for me. So I'll hand you back to now -- so I'll now hand you back to Leigh to take you back through the rest of the presentation pack.

Thank you, Linda. I'm now moving to the divisional highlights and work through both reporting segments, starting with utilities on Slide 13. So much of the focus of the utility division over the first half of the year has been on building momentum across our BD pipeline and securing growth opportunities, whilst we also continue to drive improved systems and processes. A key component has been the migration of Comdain across to the group's ERP system, which has gone well and is expected to go live in a matter of days. That will provide enhanced levels of control and visibility across operations, ensuring as the business grows, it does so with a solid foundation. Linda has touched on the headline numbers already, and we see revenue largely flat on pcp, with EBITDA of $14.7 million. To pick this apart, the metering operations were down, largely associated with COVID impacts that I've previously mentioned, particularly associated with Stage 4 restrictions and the moratorium on reconnection/disconnection works. The decline in metering services revenue was, however, offset by increased revenue growth of 5% across Comdain operations as the group was successful in securing a number of opportunities in the preceding period, which is starting to deliver benefit. The business has recently been successful in securing a number of work programs and maintenance contracts. One reference here with SEQ Water in Queensland for the provision of a 27-kilometer water pipeline, bulk water storage and pump station infrastructure, supporting the business's ability to grow our Queensland presence, which has only commenced over recent years. In summary, a pleasing result for the utility division, considering the impacts of COVID and the restrictions across our operations, with Comdain on track to deliver 15% growth ahead of the full year. Slide 14, in telecommunications. As for the headline numbers, the division generated $209 million of revenue and $28.7 million of EBITDA during the half, down on the prior corresponding period, which included those onetime nbn construction programs that management have previously talked about not reoccurring and a higher proportion of activation volumes being completed. Revenue from the activation and assurance or maintenance operations in the period was actually higher than we expected, with a favorable work mix and additional ad hoc programs of work offsetting the reduction in the overall volume. Wireless revenue of $33 million was down on pcp, and this continues to be an area which is difficult for the business to predict work volumes, and we continue to see a slow ramp-up of 5G expenditure. The last half has been a busy and productive period for the telecommunications division as many agreements came up to their natural expiry date. Pleasing that the business is able to achieve favorable outcomes and resecured all agreements. Of these, important to note is our agreements with nbn under unified services and networks, previously referred to as OMMA and NMRA, and may cover the provision of activation, maintenance, both planned and reactive works across the nbn network and each being secured for up to an 8-year term. The business announced in January that we're successful in securing a new agreement with Telstra for the scope of work, including fixed line and wireless infrastructure upgrades and deployments. Each of these agreements provide the business with the opportunity to expand our market share and grow work volumes on the back of positive performance, something which the business has done historically very well. So as we look ahead, the business is working to secure work under nbn's future upgrade program, which was announced last year. We're currently taking part in initial trials and responding to nbn's formal RFT process, which will determine the volume of works to be awarded as one major opportunity for growth. We've also referenced additional opportunities in terms of broader mobile infrastructure customer base that we believe will be an opportunity for the business over the coming 12 months. Moving now into the group strategy and outlook, I direct you to Slide 16 and provide an update on some of the key focus areas. If you look at our current state. The telecommunications work, which have been a large portion of the group's historical growth, have declined from their historical construction-led peak in FY '20. As a result, the group will need to continue to work to replace these revenues across a more diversified base to support future growth. Our strategy over recent years has been focused primarily on diversifying group earnings away from what was a strong bias to telecommunications. That's certainly not to say there's not immediate opportunities to secure additional growth programs across the telecommunications sector. It's quite the opposite. And we've referenced 2 immediate opportunities over the next half associated with nbn's upgrade and other wireless infrastructure works, which are pleasing and positive. The nature of these works is the infrastructure is heavily impacted by advances in technology and will require regular upgrades to support into the future. Business is well positioned with the agreements that are now being resecured in this most recent period to capitalize on these opportunities as they present. A key component to the group's diversification strategy was the acquisition of Comdain 2 years ago, which provided the business with solid earnings and expanded capabilities. Business has access to a wider addressable market of infrastructure projects, and the operations, as stated earlier, are on track to deliver revenue growth of 15% over FY '21 full year. More broadly, the group's operating model is strong and fundamentals are robust. This will provide a platform which will support the next change in growth as we look to further diversify our revenue and serve as a catalyst to support a step change in future growth. As we look ahead, the group is focused on maintaining that strong focus on enhancing our core fundamentals, continuing to execute works well and meeting or exceeding our clients' expectations, whilst working to secure organic growth opportunities across what is an expanding pipeline and a recently secured contract base, all while ensuring that we maintain a flexible and scaled model and a proportionate group cost base to protect margins as work volumes flex. And as I stated earlier, diversification is certainly a key focus. The business will continue, though, to take a disciplined approach to assessing M&A opportunities, which will support that next step change in growth. And finally, we move to the group outlook on Slide 17. The group expects continued demand for services across core markets. However, the outlook for FY '21 has been progressively impacted by the COVID landscape and client delays to work programs. This, unfortunately, occurred at a time when revenues across our telco construction-related operations have concluded and activations were declining from historical peaks and the business entered a cycle that needed to resecure future agreements for their next contract cycle. Taking this factor into account, the group now expects the current trading conditions, including the COVID impacts, to continue throughout half 2, with results approximately in line with half 1. Business fundamentals, as I said, are strong with regards to profitability, the strength of our balance sheet, quality of earnings and our favorable industrial client base and the markets which we face into and operate across. Our priorities for the second half are outlined on the page on the right-hand side, and they include the mobilization and transition of those recently secured agreements; securing additional organic opportunities, most notably associated with nbn's upgrade program, but more broadly across our entire client base with many opportunities across the utilities and a growing pipeline, whilst we continue to assess those external growth opportunities to support that step change in future growth. That concludes the presentation of the results, and I'll now hand back to the moderator. I'd be happy to take questions from those joining us today.

[Operator Instructions] Your first question today comes from Piers Flanagan from CLSA.

Just a couple for me, if I can. Firstly, just on the guidance, maybe a bit more color on the second half. Obviously, telco revenues rolling off, and you've called out a growth rate for Comdain. I mean do you have full sort of visibility on that revenue for the balance of the year? Or is there any sort of ongoing sort of COVID risks?

Yes. Thanks, Piers. I mean, as you know, the nature of our operations, we don't have guaranteed volumes across our work programs. So we work closely with clients to try and understand their future forecasts around all of our programs. And we've taken that into account when we've reflected that statement and expectation around sort of a flattish second half year or in line with the first. In terms of COVID, we've had to, unfortunately, look at the current environment and expect that to continue. We do expect to see continued restrictions around movement across borders. And that will impact our ability to sort of mobilize and support some of those other opportunities. So we've certainly taken many of those factors into account.

Sure. And then just on telco margins and sort of COVID implications aside, I mean, how should we think about our sort of the telco segment margins going forward as you roll on to these new nbn contracts?

We're pretty comfortable with the margins there. As I've always stated, Piers, at every reporting period, we always do have that sort of 1% to 2% flex, just driven by work volume and the work mix. So that's always something that we do caveat. But in terms of the rates in detail agreed, we're very comfortable they're pretty much in line with where we've historically performed. And we're now mobilizing for the Telstra piece. That's obviously a major focus for us moving forward. But again, pretty comfortable where that is expected to land.

Sure. And then just looking ahead, again, in the telco division. I mean sort of aside from existing growth or growth opportunities sort of from existing contracts, can you maybe give some color on sort of what other opportunities with new customers are out there or potentially some near-term tenders that are out there at the moment?

Absolutely. Well, we've obviously talked to one many times before, which is nbn's upgrade program. We're currently partaking in trials there and working through that RFT process over the next few months, which will determine award scenarios and work volumes. That's one major opportunity there. There will, of course, be in the telecommunications sector other opportunities around mobile infrastructure. We're seeing historically low spends from our clients in that space in terms of the work we've received. I think there's opportunity there for us to grow that into the future. And there's a couple of additional opportunities where we don't provide mobile or wireless infrastructure services for clients, and they're indicating their interest to go out to the market and look at securing service providers for the period ahead. So there are a couple of the major opportunities there. You'll also continue to have organic-driven opportunities across our contract base. And we've referenced some of those here, which assisted the telco division in the most recent half. Ad hoc work programs, et cetera, naturally, given the contract base. I think the business is positioned well to secure some of those who move ahead. But very conscious that we need to continue to focus on that as those revenues, particularly around activations, will continue to decline over the next period.

Your next question comes from Marni Lysaght from Macquarie.

Piers has beat me to it and asked about the bridge with the revenue growth given you flagged the growth of 15% in Comdain. Just another question I have, is this more around -- I understand what your exposures are. You're not exposed to guaranteed volumes, but is there any opportunity in the utility space to obtain work that does have some guarantee on volumes? My understanding is that telco, traditionally, like you have no guarantee on volumes, but that may be -- there may be the potential for guaranteeing volumes in utilities.

Yes, no problems at all, Marni. Certainly, in relation to utility work, if you look at the nature of those operations, when it's designed and construction work, that's obviously probably one of the better opportunities to sort of have a firm view on the expected value of revenue associated with individual opportunities. You've then obviously got questions around the ability to do that over what period of time. But that's one area. Some of our operations and operations across states are moving to different models. So total operating costs or outturn costs. And we've seen that in the water space, and particularly. So some of those opportunities as we move forward, I think, will provide an ability for the group to sort of understand what will be a stated base as we move forward.

And like how soon can we exploit those opportunities? Because you've given commentary on the diversification into utility being quite robust. Is COVID impacting your ability to pursue business development in utilities?

No. The business development pipeline has been really strong, Marni. We're actually tendering on a large number of works, and we have been, obviously, over the last 12 months as we've reflected, and we see that now in what Comdain are delivering in terms of growth. So the pipeline is strong. COVID has impacted, as I said, some of the BAU operations but also impacted our ability to mobilize some of those operations across state borders. We talked previously about an example such as Western Australia, where we've secured some work there. And that's been a real challenge for us to mobilize resources from Victoria and New South Wales, Queensland in to assist with various aspects of that. So that's been a challenging period as well as movements up into Queensland. So the COVID restrictions certainly impacted our BAU metering operations and inspection services and did inhibit, I think, some way of the business realizing potential growth around design and construction operations in WA and potentially a little bit in Queensland. That's been the main areas that COVID impacted the group.

That's understood. And I can tell from nbn disclosures that they've scheduled a trial late last calendar year for the new -- for the $4.5 billion spend and another trial recently. But do you have any visibility just in wireless, in terms of that 5G spend potentially gaining momentum? And because that -- there's some -- I'm sure there is a focus in the industry on 5G. But could that ever recover or the ramp-up of the spending improve?

I think there's certainly -- absolutely, there's a bias for upside there. We've seen historically low levels of work across our mobile space from what we've received. I think the re-signing of our Telstra agreement now provides that stable base for us to engage in Telstra around their future volumes of work. We've got defined areas where we'll be mobilizing into. But unfortunately, there's been a delay from where we had intended that to mobilize. And we're now looking at that transition occurring around July in terms of the new contract model. So that will provide an opportunity then to work on how we forecast forward and what visibility the group receives. Certainly, opportunities around the broader client base with Vodafone, Optus and others, where we're seeing low volumes of work. We understand they're trialing and moving to the new technology platforms, and they work closely with the equipment vendors during that mutual period. So certainly, that will be a major focus for us to just ensure that we are closely engaging with those wireless providers to see opportunities to grow.

Your next question comes from Steven from Bell Potter.

Just a quick one. Firstly, the dividend was obviously cut and you've got the big new debt facility. So there's a clear indication of a larger M&A focus. If you're just able to talk to your thinking of strategy behind a potential acquisition, are you thinking something big like another Comdain or maybe 2 or 3 smaller acquisitions just to get your foothold in a new service or market, which you can then build internally, just your thinking there.