Skanska AB (publ) (SKAB) Earnings Call Transcript & Summary

Ladies and gentlemen, welcome to the Skanska 9 Months Report 2022 Conference Call. I'm Alice, the Chorus Call operator. [Operator Instructions] And the conference is being recorded. [Operator Instructions] You will now be joined into the conference room.

Good morning, and welcome to the presentation of Skanska's Third Quarter Report 2022. Junelind, Senior Vice President, Investor Relations and here on the stage in our studio, I have our CEO, Anders Danielsson; and our CFO, Magnus Persson. Shortly, they will take you through the third quarter results and financials, and they will guide you through some business and market highlights. And after their initial presentation, we will move over to questions. And you will be able to ask questions either by using the conference phone number. Or you can text us your question using the text field in the webcast page or you can ask your question in person if you are here in the room. And we will answer as many questions as we can. So with that short introduction, let's take a closer look at the third quarter results. I hand over to you, Anders.

Thank you, Antonia. Before we jump into the figures, I wanted to look at the picture here to the right, it's a Harry Nice Memorial Bridge that we're building in Virginia, USA, [ well-rounded ] projects. First an overview of the third quarter. We have a solid performance in the third quarter again. We have a strong profitability in Construction. We have a historically high order backlog. And we also have attractive profit development portfolio. We'll go into that later on. And we have a very robust and strong financial position. Operating margin in Construction, 3.3% on a rolling 12-month basis. Return on capital employed in project development is at our target 10% on a rolling 12. Return on equity is slightly below our target, 17%. Carbon reduction, we have managed to reduce the carbon reduction with 54% compared to our baseline year 2015. So we go into each stream, starting with Construction. Revenue goes up in the third quarter with 21%. The underlying -- if you look at the local currency, the increase is 9%. Order book is increasing to close to SEK 44 billion, we have a book-to-bill of 102% on a rolling 12-month basis, which is really strong. And again, historically high SEK 228 billion in order backlog. Operating income SEK 1.3 billion and the operating margin in Construction of 3.4%, just shy of our target, as you know, of 3.5%. So despite everything that's going on in the market, in the world, we managed to keep up the profitability, which is the real strength. We grow the revenue, strong order intake and a solid level of profitability. If I go into Residential Development, the revenue decreased to SEK 1.5 billion. And also the number of sold homes decreased and we have started less home in the quarter as well. But we do have a very strong position in the portfolio. We'll come into the details later, but we have a high sales rate in the ongoing project and we have very few unsold completed. But the revenue is, of course, impacted by lower activity in the market. But still, we have an operating margin of 9% and a return on capital employed here on a rolling 12, 9.5%. By moving into Commercial Property Development. Here, it hasn't happened too much in the quarter, no big and large divestments. So we have a gain on sale in the quarter for SEK 152 million. Here we should look over time. In my view, if you look at the first 9 months for the Commercial Development, we have divested commercial properties for close to SEK 10 billion, I mean if you look at the rolling 12, it's SEK 16 billion. So we are sure that our portfolio, our products are really in attractive for investors, which is good for the future because we do have 36 ongoing projects, which corresponds to close to SEK 33 billion in investment upon completion of those projects. 32% occupancy rate, 48% completion rate, it's something we're watching very carefully. We don't want to get the gap to be too large. So it's something we look into. We've started one project in Q3. What we can see now is that the leasing market is slowly recovering. We can see that, especially in Europe, in the Nordics, Central Europe, that people are getting back to work, getting back to the offices in gradual incremental stages here, and we can see it also slowly in U.S. And we can also see that the activity amongst potential tenant has increased. We have more potential time of viewing our projects, and we can also see that we have signed a bit more tenants deal in the quarter. And we can also see that we have a good mix in the portfolio when it comes to offices, life science, multifamily, so that is also increasing demand for those other segments in the market. So -- and we also see, you can say a polarization in the leasing market. But with that, I mean, that project offices in very good location, high quality, high environmental standards, they are more attractive than properties in not so good location and not so good environmental standards. So -- and that is a benefit for us, of course. Investment Properties that we -- new business stream, as you know, from 2022. And here, we're targeting high-quality, high sustainable offices in Sweden predominantly. And the ambition is to grow that portfolio to SEK 12 billion to SEK 18 billion in the next few years. And we have put our first transition here, EPIC building in Malmo in the first quarter and we are preparing for more very high-quality acquisitions going forward. Before I go back to Construction and go into the order bookings. Here, you can see what I've just been talking about the order backlog development over the years. So you can see here in the blue bars that it's -- the order backlog is on a record high level. And we can also see that the order bookings per quarter is also quite stable. And the green line here in the picture is the revenue. We have been forecasting this increase for quite many quarters now due to strong order intake. Now we can see it this quarter as well, even though part of it is FX impact. And if I go into each geography, it's also a good position here. We can see that basically all geographies have a book-to-bill ratio of over 100%, overall 102%, slightly lower if you combine the Nordics, but I'm not concerned over that. We have 14 months of production in order backlog. And if you look at the total 17 month of production, which is on a good level. And you can see, of course, in a very strong order intake in U.S. and also in Europe, and that's a majority of that increase is in U.K. So good position there. With that, I'll leave it to Magnus to go through the details.

Thank you. So let's start with, as usual, income statement in Construction. As you can see, the revenue at the top line grew quite a lot there. We're up quarter-over-quarter around 20% as we have a lot of our activities in Construction and other currencies. Of course, there's -- and the Swedish kroner has depreciated quite a lot. We had a fairly large impact of the foreign exchange rate. And if you strip that out, we had an underlying growth of 9%. And I think on that, that also sounds like not to grow organically, if you will. But with the high inflation rates that we've had for quite some time now, a lot of our contracts are indexed to inflation. So of course, then as costs go up, we are -- have the right to be reimbursed by clients for the movements in index. And that is, of course, also driving part of the revenue increase here. So if we look at scope growth in the organization, you can say that's sub 9%. If we go down and look at the margins there, we had a gross margin of 7.2%, which is very respectable, not least given the sort of surrounding environment, S&A, quite steady, S&A margin at 3.9%, to say that’s very good level that we have, down from 4.1% a year back then. Nominally speaking, you can see S&A goes up a bit, part of that is, of course, also FX that comes into play. Takes us down to an EBIT margin, 3.4% and as Anders said, 3.3% on a rolling 12 months, very respectable performance. And I think that measure is the right measure to look at when you want to sort of assess how well we are performing in the business rather than quarter-by-quarter performance, not at least a good quarter since we have no particular one-offs really that is disturbing the comparison of these numbers. It's really the underlying business that we look at that. If we then look at the different geographies, in the Nordics, we delivered 3.5% margin, somewhat down then from last year. Sweden isolated 3.5%. As you know, we have said this before, we expect a bit higher margin from the Swedish business here than what we can deliver here in this quarter. So in Europe, 3.2%. That's a solid level. The comparison number here of that is considerably higher 3.8%. That's a very tough comparison to have. That quarter was a very well performing quarter. U.S. 3.3% continues on the -- on sort of the trajectory to improve margins and improve profitability in this business. If you look at the profit levels here, they're essentially up 40%, but you have to acknowledge the fact that we have these currency impacts here, but not only our improving performance, but we can do this steadily over time. So I think it's here a testament to sort of a good development trajectory of this business now. If we go to Residential Development. There we go, story is a bit different. As you know, the market has weakened in Residential Development. We see this, I'd say, across all different geographies we are operating in, even if the market has perhaps moved weak and quickest and most perhaps on the Swedish residential market where we have the most pronounced effects then. Buyers are generally a bit hesitant today here, and that's not so strange given where we are in the general economic climate. We see interest rates goes up. Of course, we have the inflation and just the general uncertainty. And of course, if you're going to make a very large CapEx by as a private individual that is delivered to you 6 months ahead of the time or maybe a year out in time, you really don't like that uncertainty. So transaction levels, the number of transactions on the market for new apartments here has come down then in the quarter. We delivered 9% margin in the quarter, SEK 132 million in EBIT and due to the volume, we had a very high S&A margin, as you can see, over and above 12%. Obviously, sort of the volume is too low. We have an organization that is designed for higher volumes here. So that's not a level that we should be at there. I think it's also fair to point out that with our method of recognizing revenue in Residential Development, and we essentially do that at the point of contract. When we get the signed sales contract, we recognize the revenue. Looking at our third quarter results, it shows you a very sort of true picture of where the market has been trading in the third quarter. Had we employed other revenue recognition principles, I think the P&L would look a bit different perhaps. But we -- our P&L shows the market [ variable loans ]. So you can see any changes in the market, so to speak. If we look at the different geographies, Nordics, 11% margin. Sweden 19.8% margin. That's a fantastic result, obviously, in a tough market. But here, we have to be transparent and say that part of this result, the margin is heavily impacted, I would argue, by the release of past provisions from past projects that we now release in the third quarter. And the impact on the margin becomes especially large since the volume in the quarter is so low. So just we were not trading here, underlying at close to 20% EBIT. Then we have the European part of the business that unfortunately had in part the small quarter. The reason to the 3 million profit in the third quarter, that is essentially because in the establishment of the BoKlok business in the U.K., where we now have 3 projects, we have faced sort of start-up costs or learning costs, if you will, in that in the isolated quarter. If we take that part out, that costs associated with that out, the other part of the European Residential Development business, which is then Poland and Czech Republic, outperforming really well. You can see that in our numbers, which is why I thought it was fair to point it out then. If we then move on to homes started and sold. Sales were obviously down given what I just told you about the market sold close to 340 units then. And we do expect the market to remain slower, the number of transactions to remain a fewer for some time until we can get out of the most immediate uncertainty that we now have in that part of the market with clients then. And when that happens, transactions will come back and that will probably take some time then. Also the quarter with slower or fewer started units, it is a bit more challenging these days to find the right business cases. We have had cost inflation obviously and right now we have more difficult time with the revenue visibility given that the level of transactions are fewer on the market. So business case becomes a bit more difficult to sort of get together. But our ambition here is clearly to continue to drive this business and start new projects. And then we have both the financial capacity and the risk tolerance to do so. If we look at homes in production, we have close to 7,900 units that are in ongoing production at the end of the quarter. We had sold already 71% of those units. So it's a very derisked portfolio, if you will. And of course, as it happens when the market goes down a bit, sometimes the sales rate decreased a bit. So we have a very good starting point coming into a bit slower market here with this high sales rate. Completed unsold homes, 92 of them, very few. I think we had -- we added 20 completed unsold since last quarter. It is still a very, very low figure here. You have to relate that to the 7,900 units we have in ongoing production. So we really don't have an issue with that at the moment. If sales becomes a bit slower, if we have a practice in the market when customers buy a bit slower, we saw in 2017, '18 that has happened. Unsold completed might come up a bit. That's nothing alarming for us. It would not be, I would say, expected. And the important thing with that is that we keep our eye on the churn of those units. So we don't get unsold completed units that are owed. We don't have that problem today and we will work so we don't have that problem in the future either. Commercial Property Development, as Anders already said, was a very slow quarter in the CD. We made no material transaction. We handed over a major property in Poland and have good proceeds from that. But that's obviously not in the P&L, that comes in the cash flow. So we can move on. Unrealized and realized gains. I think where the market is now it's good to point out that we update our property valuations every quarter with rent assumptions, yield assumptions, leasing space and so on and so forth. We see very little changes in the expected future gains from our portfolio here between the last quarter to this one, we are close to SEK 10 billion in that then. And when we value properties, we normally employ quite cautious sort of deal assumptions on that because we value them out when they are completed, which can be 2 to 3 years ahead. So when we start the project, of course, are very cautious assumptions in that. So they're difficult to anticipate where the transaction market will be 2 to 3 years out. So no major changes on that and we still see a good interest from investors in the properties that we have. Look at the completion profile, we had about SEK 6.5 billion in properties that were completed in the portfolio. These were leased to around 72%. And then we moved one property in the quarter between ongoing to complete, it was a Swedish property that was moved from the southern part of Sweden. We expect to complete another 6 properties during the fourth quarter. And going forward, you can actually see on the chart here how we expect to complete them. And so then we will increase the amount of properties expected to be completed throughout each quarter over the coming year here then. Leasing, we had in the portfolio of 30%, 32% of the space available was leased at the end of the quarter, and we had a 48% completion rate. And then you should track this on a rolling 12 months basis. And now we leased 175,000 square meters over the last 12 months. In the third quarter, isolated, we leased 44,000 square meters. That's actually quite a respectable leasing actually. And as Anders has already alluded to what we have been saying for some time is that we have a good underlying dialogue with a lot of potential tenants. So at the end of the third quarter, we actually started to see a little bit higher pace in the signed lease agreements as well. And I think that is a very good development. So let's work for that this development continues. But right now these are early but very positive signals. On the tenant market, we observed the same trends as we have talked about before. Flexibility is important for tenants these days. It can be both sort of physical flexibility, expansion and contraction options and more contractual flexibility in terms of rate resets and a little bit shorter lease terms and so on. And also that we do see a higher focus on these modern well-equipped properties with the right locations that are energy-efficient and so on. So we feel that our portfolio is very well strategically positioned actually to take advantage of this development in the market. Investment Properties. We had very little movements in this business stream in the isolated quarter. As you know, we have only one property there with 12,000 square meters, it's fully leased and it is performing very well. If we go to the group, together, the business streams, we had around SEK 1.5 billion in EBIT. And then we have central costs, which this quarter actually is a central profit of SEK 112 million. The reason for that is that we divested very successfully the final remaining PPP asset in the U.K. part of the infrastructure development structure that we have put as a legacy business and that we are dismantling, gave a very good profit on that and the profit essentially consists of 2 parts. One is the gain on sale. And the other reason is that we -- because this is the last remaining asset of this type we have in the U.K., we can essentially roll back all accumulated exchange change differences to the equity position. So it's a fairly big impact the profit in the isolated quarter from that. The other part of the central line in the P&L, that is our headquarter costs and those are roughly the same. We move down to net financials. You can see we made approximately SEK 70 million net interest here. And the reason for that is our big net cash position and the fact that our internal bank have been very successful in managing deposits and short-term investments to make use of the changes in the interest rate curve. But at the same time, as well a very low amount of external debt in the company. So it's a good balance. Taxes, we have SEK 300 million in taxes, 19%, which is higher than last year at 16%. And the chief reason for that is that we -- last year, we were able to utilize past losses in 3 European countries for tax deductibility reasons. We will not have that opportunity this year. So we are moving more towards a nominal tax rate this year than we did last year. If we go into the cash flow. We had a good cash flow, not the least because we handed over these big properties I alluded to in Poland, SEK 2.8 billion inflow. Apart from that, we had obviously no dividend or strategic divestments. So total cash flow here in the isolated quarter, SEK 3.1 billion. So that's a good number. If we then look at the working capital, the bar here represents a negative working capital of over SEK 30 billion, and this is the highest position we have ever had in that. I think the reader, if you're an analyst or whatever invest, you should sort of understand that these are balance sheet items and balance sheets move with currency. So part of the increase we have seen lately in the net working capital position, nominally speaking, that is due to currency changes. To neutralize that, you should look at the green line, which hovers around 19%. That is also very high and very respectable figure, obviously. And we do not see any real structural reasons to -- that this will change. But of course, we were respectful for this because it's a very strong position and we are cautious in extrapolating it too far out into the future. Look on the investments, the divestments and capital employed. We had -- we're still a net investment territory in the group, which is the green line below 0, and that's exactly where we would like to be. We have a lot of sort of free financial assets that we would like to employ. So that's good. We have a small uptick, as you can see in the last quarter and that is chiefly due to this big transaction that we had in -- handover that we had in CD in the Central European business then. Capital employed increases to SEK 54 billion, respectable sum. It really shows that we are sticking to the strategy of long-term growing, also property development there. In the RD part, the SEK 16.5 billion, of that, there's, of course, underlying assets, this is capital employed. Of the assets, SEK 15 billion of the assets are ongoing projects right now. Of that, we have sold units sales rate to 72%. That is roughly worth SEK 9 billion. So it's a very derisked, you can say, exposure we have in the capital employed there. Similarly, in Commercial Property Development, we have ongoing properties in the balance sheet worth SEK 15 billion and then we have completed properties on the balance sheet to SEK 6 billion. These are then leased to 30% and 72% respectively. So also that shows a high degree of the sort of derisking of the capital employed that we have put into property development in the group. If we look at the funding situation, there's no change in this one. We have still the same maturities. We have a couple of maturities next year and a little bit larger one in 2024. SEK 20 billion in available funds, of which SEK 7 billion is thanks to committed credit facilities that are undrawn. And our financial position remains very strong. Equity SEK 52 billion. We have an adjusted net cash position of SEK 14 billion. And given where we are in the market with somewhat higher market uncertainty, I think we have the staying power to continue to see through development projects in a good way and run this business. And also, this gives us the firepower actually to act on opportunities that may come out in a weaker market. So we are very well served by having the solid financial position in this moment. With that, I hand back to you, Anders.

Yes. I will go through the market outlook, starting with the Construction stream. If I start with the field market is stable and basically stable in all countries in Europe and a strong -- continue to be strong market outlook in the U.S. And that the reason is that we can see Federal money coming out in the system together with the states, they invest a lot of the infrastructure and we expect that to continue and the need is very high for that in the U.S. That is also good that we can see a stable market outlook when it comes to nonresidential construction in our important markets, Sweden, Norway, U.S. market is stable. So we are -- the predominant part of our business are in the right segments. Of course, the residential market -- construction market is weak, continue to be weak, depending on the interest rate that was up and the hesitance we can see amongst the buyer by people who are about to buy apartments. Going into Residential. Our outlook is continued to be slow and we expect that to continue for the next 12 months, but the underlying need for apartments are really, really strong. We are in the right places there as well. And I expect that to be -- I strongly believe in the market in a more long term. Commercial Development, Property Development, leasing markets continues to be slow, even that we have seen -- both Magnus and I talked about it earlier, we have seen higher activity and we also actually signed more agreement this quarter compared to the same quarter last year. And again, polarization, definitely, that has happened in every downturn in the market that high-quality, the right location of the offices, they are attractive in a more difficult market this time as well. We expect that. So to summarize this, solid performance in the third quarter. We have a strong profitability in Construction, historically high order backlog, very attractive property development portfolio, again, very robust financial position, strong net cash of SEK 14 billion. And the strategic direction remains for the company. We're going to keep the discipline, continue to improve the profitability in Construction and grow some part of the profitable business responsible in a responsible way. Leading residential developer, that's absolutely our strategy and ambition. And we, on the long term, want to grow their Commercial Property Development in the market. I can see the largest opportunity for growth in the Commercial Development is in the U.S. And here again, life science is strong demand in certain part of the operation we have there. And we, of course, going to continue to build up the investment portfolio and that is really strategically really good for the company. Now we can work in the whole value chain, and we can get a lot of synergies with that strategy. With that, I'll leave it to Antonia to start with Q&A.

Thank you. Yes. So now it's time for your question. [Operator Instructions] But we will start with questions from the conference call. So operator, do we have someone calling in?

[Operator Instructions] Our first question from the telephone comes from the line of Pam Liu with Morgan Stanley.

This is Pam Liu from Morgan Stanley. I have questions on the Property Development business, please. And the first one is regarding Residential Development. I'd like to know how you think about the potential cancellation risk. So should we expect that the contract signs so far may be canceled when it comes to full payment at completion because of higher interest rate, difficult in getting a good mortgage? And what sort of historical cancellation you have seen in previous housing market downturn, please? The next questions are related to Commercial Property Development. I'd like to understand how you see rental yield developing in the Commercial segment in Sweden? And how do you reflect that in the valuation of your own Commercial Property portfolio? The second question there is you obviously have a very strong balance sheet with little external debt. This is actually quite different from many of the other property developers in Sweden that may have a more leverage position. So are you seeing any full sale by competitors in the market yet? And how does that impact your valuation of your properties? And how do you see the opportunities there? And the last question. So on Page 20 of the Q3 report, I can see quite a big difference between segment reporting and IFRS for Commercial Development revenue recognition. Could you please just remind us what is the difference? And why this is this big this quarter?

I will start with the first question, Anders here and Magnus will address the other one. On the order side, yes, about the cancellation, we have not seen a large number of cancellation and it's a fair question. But in the past, our sales, our agreement, they are binding. And so -- which means that the people cannot sign up for the binding agreement if they don't have the financial financing in place. So that makes it secure for us and the client, the buyer to be able to fulfill the agreement. So the short answer is as we have not seen a lot of cancellation. I don't expect that to happen in a large scale going forward.

This is Magnus. I will continue with your other 3 questions. And this is a bit of a memory test, so if I fail miserably, you can remind me perhaps. But I think your second question related to Commercial Development and our yield sort of outlook, if I'm not mistaken and on the Swedish market. And first of all, there's not a very large amount of transactions that are happening. So as everyone else, you sort of look at the market, that's the transaction that happens and then you see what people are buying and selling to. So I say the underlying facts to that is very difficult. So it leaves everyone in a bit more -- maybe a bit more dark than in a strong market then. What we have noticed in Sweden is that the transactions that have been made have been made at very attractive yields. Maybe surprising given what is going on around and also given where the interest rate is going and so on. And we can also see a slightly more, if you will, aggressive take from equity buyers than from leverage buyers, which doesn't surprise me, actually. So that -- on that, then you had a question regarding the balance sheet and have we seen any fire sales from competitions, et cetera. Not really. We haven't done that. When the market goes -- sort of weakens, it's not unusual that that happens, for instance, land pieces, et cetera, you need to -- if you don't have our balance sheet, you might need to free up capital and to use that in other places. Maybe you're stuck with loan covenants and so on. Maybe this happens this time around. If it does, we will certainly be prepared to look at such opportunities. And your final question regarding the segment versus IFRS accounting. And the answer is very simple. In the segment accounting, we recognize revenue at the point of contract, meaning when we have a binding sales contract. In the IFRS accounting, we recognize revenue when we hand over the property to a buyer. So the reason that you see a big difference in the third quarter in Commercial Development is that the property that we handed over for SEK 2.8 billion in the third quarter to a buyer, that was -- that contract was written in another quarter, but we handed over it now. So we had segment recognition of that revenue earlier and IFRS recognition of that revenue in this quarter.

The next question comes from the line of Markus Henriksson with ABG.

Do you hear me, everyone?

Yes.

Perfect. First off, you highlighted positive one-offs in Residential Development in Sweden and a negative one-off in Europe, we see EBIT margins of around -- what was it, 20% and then around 1%. Could you highlight how large these one-offs were?

We don't do that. And we haven't -- sort of don't speak about these things because it's very difficult to assess how much is a normal level of provisions that you let out with that way of recognizing revenue, which is done then as I just described at the point of contract, we are always cautious in recognizing revenue in the early stages of a contract. If things change, if we are not able to handle the risks, we would like to have that caution to sort of protect the financial position of that project. And that means that in a successfully delivered project, we will be able to release these reserves at the end of the project, which in turn means that every quarter you look at in Skanska, you will have a positive impact, hopefully, by the release of some provisions. And that can be larger in some quarters and smaller in other quarters depending on what projects we happen to complete. So it's very difficult, not really meaningful to sort of go into that differential. But I think in this case, given the low volume we had in Sweden, the impact of the release of these provisions and to our favor settled claim, were very big on the margin. And we don't want to sort of send you off in the wrong direction of our trading results. So it's a big impact on the margin.

Very clear answer. Then also you intend to continue to keep production starts high in RD. I guess, preferably, sales ratios would be 40% to 50%, maybe 20% to 30% in the current market. But at what time is the sales ratio in new projects become too low, if it's 0% to 10%, for example, would you wait with construction starts and focus on SG&A?

Anders here. We decide that sales requirement for each and every project. And as we said, we have a very good position now in the portfolio since we have a high sales rate where very few unsold completed. And we have the financial strength to start new projects. So we can take that decision on our own. And also I can say we have a very good pipeline. So if we believe that the project is in the right location, we strongly believe in the future of the order business, we can start it with a very low sales rate because we have the financial strength to do that. And I can also see that the trend here in the market, which is similar to other downturns in the RD market is similar that people tend to buy -- they want to buy and sell in the same market, which means that they want to buy closest completion. And that actually is a benefit for us because we have a competitive advantage, we can start projects with a lower sales rate. But it's again decided project by project.