Target Hospitality Corp. (TH) Earnings Call Transcript & Summary

So we're a little behind here, but we'll make up the time. It's always my pleasure to introduce a former competitor of mine. But actually, I was [indiscernible] when that happens. So it's sort of learned a lot from him as he was -- those of you who don't know Eric Kalamaras, he is the CFO of Target Hospitality. He was a former sell-side like myself. So I like doing little jobs here and there. Obviously, he's done this. But this is a fireside chat. So I'm going to give -- I'm going to give Eric a chance to sort of give you a state of the union of target. A lot has happened in the last year, companies transformed in a big way. It's pretty exciting. So we'll start with that, and then we'll jump into Q&A.

Great. Thanks for being here and being here for this fireside chat. A couple few minutes just on Target Hospitality, give you a brief overview. For those of you not as familiar with the story, really unique story, a story which has very few competitors in the space. Really interesting economic profile as well. We are effectively a hospitality and facilities management business that is turnkey communities and largely pretty remote areas of the United States, primarily in the Southwest. And we do that for the natural resources industry, but we also do it for the U.S. Government. And over the past few years, we've taken a pretty meaningful turn where about 70% of our business is directly tied to the U.S. Government segment, which is specifically related to housing and caring for women and children and asylum-seeking women and children as well as omni company children who are coming across the border. And so we're housing our portfolio capacity of up to 15,000 individuals potentially in any given day. And it's really been -- it's been a great transition for us over the past few years. And that's generally kind of what we've been up to the past -- in the past few years. We have a couple of large contracts and are continuing to grow the business. And hopefully, we can grow it substantially even more.

So you're at 70% today. Where do you see that going? Specific to U.S. Government.

Yes, it's a great question. So 70% U.S. Government. We are looking to take our turnkey hospitality and facilities management solutions and position that within a lot of ways within the U.S. Government. The government has -- we've been doing most of our work on the immigration side, but our full turnkey solution is pretty simple, right? We are putting in infrastructure for as many as 6,000 individuals, and we are doing it and literally start to scratch with no land, putting in the full town, whatever it takes to run a town, we are doing all the infrastructure, cellular shoots, electricity, all the municipality sewer systems, there all the food, logistics, the housing, the -- everything goes into running a modular community. And we're doing that for these folks. We put out a plan a couple of months ago that said, look, we'd like to deploy additional $500 million of capital over the next 3 or 4 years. And we suspect a lot of that's going to be allocated towards the U.S. Government side. They have a number of very large scale projects. Some of which I've nothing to do with, with the immigration and all. But it's a really large scale projects that fare really nice within our turnkey portfolio. And in addition to that, we also have our natural resources business which we call HFS business, it's hospitality and facility solutions business. Well, that business has a lot of other commercial applications as well, specifically tied to energy transition, et cetera. So when we look at the pipeline, which is in the billions of dollars, and we look at that $500 million of capital, I would -- look, I would be safe to say that well over half of that is on the government side and over the other half is probably on the commercial side, which probably keeps our mix in that kind of 75%, 25% area while potentially doubling the EBITDA again just like we doubled it 2 years ago.

So I didn't congratulate you on your BB upgraded SAP, hope you don't mind us. Just can you talk about what you've done, what's your debt reduction thus far and how you're thinking about it going forward? And what leverage target is in there? You identified a large capital need there. Just help us step through that and maybe let's start with that.

Sure. So we have pretty enviable business economics, right? So our EBITDA margins are in the 40% to 50% area. Some of our projects are 60% EBITDA margin north of the -- right? So -- and we do that and it's -- we've been doing that for well over a decade at this point. So what happens is our projects -- we deploy capital. We typically -- because we're dealing with a modular solution, these are not stick-built solutions. So stick-built solutions will -- sometimes you take 12, 18 months to develop. Ours are typically done within 3 to 4, 5 months. And so what means is we deploy capital out and we start getting cash back very, very fast. And so what that's allowed us to do is take our balance sheet from 4.5x to potentially have no leverage by the end of the year, sitting on cash as we speak. And it allows us to redeploy that capital that we talked about the $500 million. But that is not necessarily a net debt increase at all. And now the pace of that could be. But the way we see it is we're generating close to $200 million of discretionary free cash flow year. And if you assume like we did last year, a couple of hundred million dollar capital spend, we'll have that paid back down inside 12 months. And so we can deploy that capital of $500 million and still end up with $300 million or $400 million of cash in the next couple of years. And so it's a really unique spot to be in. So we don't look at -- we don't see a need for capital raise either equity and then debt, look, we have -- we took out $125 million of our notes. We'll continue to work on those and work on some refi possibilities there. But I'll tell you, Greg, I mean, it's a really unique situation to be able to deploy that much cash and amongst capital and still have for that much cash 2 or 3 years down the road.

So you did reduce the notes by $125 million. Do you think that's permanent or as you think about the capital structure with growing EBITDA, is there a larger...

I think it's permanent. I mean we could potentially -- if you do a refi, the refi ironically, any increase in debt on the refi is, frankly, just a function of market efficiency, right? You try to do $150 million, deal is not very efficient, so it's really -- we'll have to work around the capital efficiency and really what we can get there. But as it relates to specifically needing incremental debt to manage the business, we actually do not, at this point. Now what will change that is the pace of the projects, right? So if we have a few of these come through in a very, very short period of time, you could see us come back to the capital market just to turn some things out. But if it's the pacing is what I think it's going to be, we can do this largely organically on our own balance sheet.

Do you think that makes sense to have bond as well as prepayable term loan or...

Yes. I think -- I don't -- actually, based on what I'm seeing now, I don't see a large need for a term debt structure, frankly, in the portfolio. I just don't see this application. That may change over time. But I think it made sense when we came out of a SPAC, I don't think it makes sense today.

Got it. So what are the -- when you think about it, what's the right leverage for this business? If...

Well, look, conventionally, you would say to maximize the NPV of the equity of the business, you'd say, roughly 2x to 3x. But the reality is because we generate so much cash, it's really closer to 1x for us because that's just basically the way we can modulate the best. And I would tell you, we're largely overequitized, but I think the business stays in an overequitized position. Frankly, our growth profile really can't at this point, which is unusual. It can't really outrun our cash build and because our margins are so high, right? When you have a 10% or 15% margin business, you can easily -- or your capital needs easily outgrow your cash build. In our situation, when you're running 40%, 50% business or in some projects, 60% EBITDA margin, your cash builds supersede your spending need. And so for us, we're in a very unique position that way.

So as you think about all excess cash, is there a shareholder return strategy that involves cash being distributed?

We haven't done that and it's not something that we put a lot of thought into. We -- I will tell you, we have a share buyback program in place, but we -- it's really about optionality at that point, right? And I think it's a prudent thing to have out there. It's a prudent thing to do. But as it relates to dividends or something of that nature, we haven't pursued that at this point. And I think maybe that's a topic down the road. But I think right now, I'd like to continue to see how these projects manifest themselves and then we'll make a decision maybe sometime into next year.

So you talk about the margins in this business. So 40%, 50%, 60% seems extraordinarily high. So you talked a little bit about why, how, what are the competitive dynamics that allow you maintain margins like that? This give us a sense of share...

Sure. Why that exists. So our business is generally modeled off of a specialty rental business, right? And specialty rental businesses generally have a higher margin profile. In our case, what we have is we have -- there are 2 areas, right? So we have our HFS business and we have our -- obviously our government business. But the HFS business, I'll just use that as an example, which is our legacy business that we have for natural resources customers. We have an effective market share of 40%, 50%. And so when we broaden that out to include all competitors, our market share is 25%, 30% plus. And so that obviously allows us to drive some pretty meaningful economics there. Typically, in a new build project we'll have in our HFS business, we're looking at paybacks between 2 to 3 years. And so -- and we've been able to do that for well over a decade. In the case of the government side, those margins are frankly even more attractive. For a variety of reasons. And I think everything that we're seeing, we can continue to keep this economic profile. There have been questions about, look, this almost seems too good. How long can you all do that. But it comes back to the nature of the businesses that we're in and the competition. And so the way that I would articulate it is this, if someone comes to you and says, I need a purpose-built community for 6,000 people, 6,400 people. And I need it in the middle of nowhere, I have no land. I have no infrastructure. It needs to be full turnkey and I need it inside of 6 months. How many companies in North America can do that? And the answer is there aren't many. And frankly, there is a return of capital for that. And that's something that we've been able to focus on and enjoy.

So just for those of us that -- when is the last time you built more than 6 months, and what were the challenges that you faced? And as you think about scaling for a lot more opportunities, how -- where could there be setbacks and what do you need to do?

So we've done it twice in the past 2 years. And so we did it. We were asked by the U.S. Government to put the first facility together for 4,000 individuals. Again, we did that inside of 4 months. That was in the first part of 2020. And then again, we did it last year. And when they came back, it was 2021. We did it last year when they came back and asked from expansion on it. And so that was another 2,000. And so again, we did that in about 5 months. And so we've done it twice. But this is our business model, right? And so we're frankly doing this all the time. Now they're always not that large, right? Typically, the typical community is about 500 people or so, but they're all within the same time line. We typically will do these within 3 to 4 months. And so for us, all that's really required is we need enough lead time. We need about 3 months' lead time. And if we can get 3 months lead time, and we can get the capacity, then we can go ahead and we can do it. It's -- we've got an amazing construction team, and they kind of pull off the miracles when it comes to this.

Have you been able to handle inflationary forces and passing that through? Is there any challenges to that?

No, we have not had much inflation impact. Our business is inflation driven in a couple of areas, which we try to moderate. One is obviously labor. We haven't seen much impact on the labor side. Second is utilities. Obviously, that's a movement in commodity and natural gas prices, specifically with power generation. So that does ebb and flow. But in our HFS business, right, it's a natural resources business. And so we feel like we have a natural inflation hedge there. over time. Now it's not necessarily 1 to 1. But over time, we do get a bit of a natural hedge there. And the second area where we have inflation pressures occasionally, which we've been able to manage pretty extensively, particularly last year. We're kind of -- it's kind of catching our margins a little bit of a surprise this year, but that's in food. And so we are one of the top 20 largest food U.S. food purchasers in the United States. And so we do have a huge food component and that there can be some inflationary impacts there. Inflation has been little stickier than what we would have otherwise expected.

Are you serving more chicken wings than...

We are -- it's funny. We had -- there was a 300% increase in chicken wings last year in terms of cost. And so you've heard us talk about the chicken wings. It turns out that chicken thighs taste very similar to chicken wings and you put in barbecue sauce on it. And so we ship -- we're able to shift our menus, right? So each location, we have 26 locations, 47 locations, depending how you want to count it. Each one of those executive chefs has budgetary control. And so as long as they stay in their budget, they are free to adjust their menu, however they see fit. And that has really allowed us to work through inflation pressures.

Okay. That is probably chicken taste. So who are you competing against? And why aren't there more people entering this space?

So it's a great question. So in the HFS side of the business, our competitors are much, much smaller, undercapitalized kind of, I'll call them mom and pops, if you will, not to be pejorative to mothers and fathers, but it is -- they are typically undercapitalized businesses. Our -- take us back and who's our customer base. Our customer are large, integrated energy service companies and producers. So we are not -- our clients are not an E&P producer or a midstream producer. They do not have a big enough labor footprint. What we are seeking are the top 4 or 5 global energy companies and in particular in our natural resources business, whereby they could allocate labor all through the entire Permian Basin, right? So those 87,000 square miles is where they allocate their labor. And we're doing it under a long-term contract. Now there are very few companies that can support Exxon, Chevron, Occidental through 26 locations and can have capital in the balance sheet for where Exxon comes to us and says, I need another location for 500 people and even 4 months and we're going to add that to our network. And by the way, you can utilize any of our other assets within that network. That is literally a $500 million or $600 million capital investment to build that network out, I don't know, in those 87,000 square miles. For that reason, we are offering something that other parties just simply cannot offer. And we have it built out and the network is, frankly, a pretty significant competitive moat.

And that's -- you're talking about that sort of the energy side, but what about the government side?

On the government side, what they're looking for is full turnkey solutions. And so when you think about the ability to do full turnkey, that is a -- this is specialized space. And certainly, people and other companies can offer modular accommodations. Certainly, other companies offer food management and logistics but there are very few that can actually bring it together. And so what we do is bring the full turnkey solution. And that's a very unique part of the business model. U.S. Government is not trying to go to as many parties as they possibly can to facilitate their contracts. They're generally trying to find solutions for this. And so that is the reason why when they came frankly, then they came to us 2 years ago because of our existing assets that we had supporting women and children that we've had for well over a decade. The government came to a nonprofit partner and said we need support for working with these 3,000 children. They said, Great, we're happy to do it, but we don't have any infrastructure. And they said, You need to talk to Target because they knew of our footprint before, they knew of our execution capabilities and that business development was effectively pushed to us.

Okay. Let's turn something a little bit more specific, that's right in front of you. So there's a lot of questions around sort of Title 42, right? And you have a contract that's you just extended for 6 months associated with that U.S. Government wants more help on the border. We also talking about something longer term there. What does that look like? And it sounds like that's in the works.

Sure. So the -- it's a great question. And there is a bit of a confusion because the -- like most things, the government doesn't go out of its way to make things really, really transparent. So it's a couple of things to bear in mind. So they came to us a few years ago. They came to us on an emergency order. And the emergency order allows for a 1-year contract, right? It's not -- it doesn't go through a typical appropriations process. And so by definition, you can only have a contract for one year under emergency order. Well, they did that 2 years in a row. And so we are now into the second year actually a third year of this emergency order, but shifting over into what's called IDIQ, right, which is an indefinite delivery, indefinite quantity. Which basically means that it opens up a platform for you now to do multiyear contracts. And what we're doing is we're shifting our emergency contract over into a longer-term multiyear contract, which could be as long as 10 years. And similar to what we have in our daily asset, which is now -- which was a 5-year contract that we did during COVID. And -- so right now, we're in that negotiation for the contract. But it's not a negotiation in terms of whether the contract exists or doesn't exist. It's a negotiation in terms of -- the government came and said, we only -- we want not only your facility, we also need 2 others like it. And what they're doing is relooking at how they handle the entire influx need. And so the discussion with them is how they put these other 9,000 total, children, how they put these influx care facilities together. And so we're part of that process for that multiyear awards, and that's what they'll be doing. At the end of the day, they'll be awarding 3 multiyear contracts for what a total on 9,000 omni company and minor children. And so that's the process. And so the discussions aren't just about our contract going to for 5, 10 years, it's really about our assets and then 2 others.

And are you actually -- is there a real competition there? Or this is more of a process that they have to go to.

Well, I think it's a function of what the government ultimately wants to do. There's always some competition, right? People are always trying to be helpful. But look, we have a great asset. We have a great portfolio that we can show them. We recently acquired a strategic asset that we announced a couple of months ago that I think is very helpful in our conversations with any new influx care communities.

So you've shifted me perfectly through your M&A strategy. So you did buy something. Like what was that -- would that do for you? And do you need more?

So the government has consistently said that we want more influx care sites. And an influx care site, think about it this way. In our case, it's a 6,400 person facility on 250 acres of an open campus, and it's a beautiful facility. And what they're looking to do is put 2 more of these in place. And so what we said was, look, let's offer a solution to them. And so we acquired an existing asset. We've said -- we have not disclosed where or what that asset is. But we feel that it fits very nicely with the scope of what they're seeking. And so it allows us to bring a solution to them because they've already said, hey, look, we need 2 more. And so we're certainly happy to provide them that. And so we've acquired that, and we could have that up and ready within a few months to the extent they're desirous of that.

Does that mean you have to buy another?

We'll wait -- look, we -- if we could get another one, that would be amazing. Trifecta would probably be unlikely. But we would look to certainly build some more assets in and around the acquisition that we just made.

And presumably, you're repurposing something that people didn't realize was...

So one of the nice things about our modular assets is we have the ability to relocate and they are built to stay for 30 years, but we have the ability to relocate. And so it's allowed us to really take advantage of having optimizing capacity in our portfolio. So we've done that extensively and it's been very, very helpful. But as it relates to the acquisition strategy of itself, not only did we acquire a new asset, which we would love to deploy, we're also looking at a host of other things as well. And so in -- we're doing that as a way to kind of augment our existing service offerings, right? So there are a lot of things that we can do with the government. There are a lot of things we can do with other business in the industry. There is a number of companies out there that we think are nice adjacencies to us, primarily in the facilities management space, modular services space, food logistics space. There's a lot we can do there.

Just remind us, did you disclose how much you paid for that? Or...

We did. It's a subsequent events disclosure, yes, we did. It's a small transaction initially, but there's a fair capital spend that goes with that to the extent that this asset is actually selected. So it's a small $5 million transaction. It appears not meaningful on the balance sheet. However, I will tell you it is, we view it as being highly strategic.

Got it. And just in general, how many -- how much think you could spend on M&A for strategic assets over the next couple of years?

So we've looked at a number of deals, but yes, we haven't done anything. And the reason is because we've tried to be very patient. But when you have an economic profile with the margins that we have and the cash generation we have, we've been very thoughtful around not diluting any of that. And our growth profile, we've been able to double the business without doing any transactions. So look, the things we're looking at are not earth-shattering in terms of size, think about anywhere between $200 million to $400 million. And so we'll just have to wait and see if those manifest themselves. But it's not something where we think it would really stress our financial profile. Yes. We're a $350 million EBITDA business and doing a transaction of a couple hundred million dollars is not overly stressing the business.

I' going to turn just to see the audience view of any questions. I have one more here that may have -- Eric?

So how do you -- how should investors think about the longevity of the cash flow this year? How -- what's the weighted average contract length -- just having? How should people conceptualize that?

Sure. Eric. Good to see you again. So our weighted average contract is about, call it, 40 months or so because we typically do -- so we think about our portfolio. About 70% of our all revenue is gone in our minimum revenue contract. And so let's say that's about 40 months or so on average today. So I think anything we do generally is going to require a minimum revenue commitment tied to in some capacity. We're not into the spec newbuild type approach. That's not something we do. When we put a new asset in place, it's because someone has come to us and said, we need x and we're willing to do that community. There's got to be a contract tied to that. I see no change there. Now to the extent that we moved through the IDIQ process, and that turns into a 5- to 10-year type deal, obviously, that we leverage contract length goes up. But typically, we're looking for somewhere 3 to 4 years on a new contract. And we have a -- our retention rate on contract renewals is well over 90%. In fact, in the past 4 or 5 years, I can't even think of a customer that's left and has not renewed with us. Hopefully, hopefully, that's helpful. But we see -- we see no change in terms of how we think about contract structure, and we see no change anything we do going forward about how we think about economic return. That's one of the questions we get is, can you continue this economic profile? And the answer is yes.

Maybe the business is too young to have an answer yet, but like how long does the average project stay before you have to relocate it?

So we generally are not project based. Okay? So there are companies that do that, and we generally do not do that. And the reason because it becomes too much asset turn, right? So -- and ends up being a lower margin profile. So our assets, many of them have been in place for 5 to 10 years. So most of them have been in place for that long. We did relocate some assets out of North Dakota to help facilitate the government project. Those had been in place for about 7 or 8 years. We did choose to relocate those. But because they're modular, we have the ability to relocate pretty easily. So generally speaking, we're not moving much. I mean our asset turn is certainly less than -- well less than 10%.

Then I'll ask one more just to close it up. So the energy transition business, you've mentioned that as a growth opportunity. How much of that is near term or and how much is more 3, 4, let's say, next 1 to 2 years?

Yes. So the -- so that's really interesting. So we have -- we would love to develop another -- when we look at our 25 locations for the HFS side of the business that are in the Southwest, it's a beautiful regional footprint. And it's really a great economic moat. We would love to develop another one of those. And we think that energy transition provides potentially an opportunity to do so. I'm not going to say there's 1 for 25 locations, and that's where $500 million of capital goes. But I will tell you that there is real growth there, and it is meaningful. The U.S. has not had a sustained EV transition profile. And so there's a lot of development that needs to happen, whether it's copper, whether it's lithium, whatever it happens to be, whether it's carbon sequestration or carbon-neutral natural gas and to actually be refined to go into net-zero carbon gasoline. These are things that are extensive capital programs and lasted a long time. And so I will tell you, there are billions of dollars of pipeline that have been supported through not only commercial and industry but also through the Inflation Reduction Act that have been supported through various grants to the U.S. Government. So look, we are -- I will tell you we are knee-deep in it, and there are things that are -- that is not a 2- or 3-year event. It could be, I hope it is, but it's also something that we could see potentially before the year is out.

Okay. Look, this was fascinating. I really enjoyed the time. Again, great to see you up here also. Have a round of applause for our speaker. Thank you.