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

Next up, we have Target Hospitality. I'm lucky enough to have Eric Kalamaras, the CFO, to my right. I always say this, so he's heard it before. It's a little more enjoyable moment for me because he was a competitor at one point. That's like a long time ago now. So Target is a company that's transformed magnificently in the time I've been following it, just from what was more of an energy company to now a government services company. I will pass the mic to Eric to give us state of the union, and then we'll go into some fireside Q&A questions.

Great. Well, good morning. Thanks for -- thanks for joining this morning. So last -- Target over the past several months, over the past couple of years, really. I think the most interesting thing that's happened over the past few months and most impactful thing is the IDIQ process with the government has been out there for a number of months now, our nonprofit partner, which we announced in the third quarter call has received their contract with the government, which is fantastic. And we're working on our contract with the government. So when we think about Target Hospitality, we look back over the past number of years is what's changed and the business has changed so much from our margin profile to our cash profile to the business mix and all the government work. We're looking forward to expanding on all that today and look forward to having those discussions.

You have diversified your business. Can you remind us how that's progressed from, let's say, a few years ago to today?

Yes, it's been an amazing transformation, and we're still working on it. We're not done. We started 3 or 4 years ago, sort of our business was generally in the Permian Basin, what we call the HFS business traditionally Hospitality and Facility Solutions business, which is really our core accommodation business. Here we are fast forward 3 years later, we have completely flipped that. We are now roughly 25% on the HFS side and 75% on the government side, continuing to grow that, continuing to look at ways to grow that, continuing to evaluate ways, we can continue to add services to the government in a variety of mechanisms. And really, the growth is -- some ways, I feel like we're just getting started in many ways. It's been a massive transformation of business EBITDA from when we started in spec from $140 million to where we are today. And so it's really been tremendous.

Then so heard that conference of you've just completed an exchange. Can you talk a little bit -- just for those who are not familiar folks what happened we'll start with that. And then maybe you can highlight why you didn't exchange in the industry.

Sure. So we had the original $340 million in notes that were outstanding. And we have been kicking the can down the road. And frankly, bringing the next leverage finance guy, I just did not like the way the LevFin market was acting. I didn't think they were appreciating the credit profile of the story. And we were a little bit in flux with how we're handling the new contract and what was happening there. And so we wanted to really just give Mark a little bit of time to breathe, and let the equity markets settle a little bit. That has happened, decided to exchange for 15 months. We had tremendous reception and which worked out well. So now we have $190 million of bonds. We called some a little over -- almost 9 months ago. And so -- now we've got roughly $990 million in the notes, and we'll keep those in the system and then to see how the markets react over the next year or so. And before we go out and do a bigger refinancing.

The plan would be to refinance, not necessarily pay the...

Yes. It is. I mean it was really just a function of just flexibility. I think that's a corporate culture and certainly from a financial hygiene perspective, I really like flexibility. And a lot of variety of instruments we could have looked at and we did look at it. But frankly, I felt like at the end of the day, this is a better approach for us. And what's unique about Target is when you look at our balance sheet and you look at our margin profile, right? So 0.3x leverage. EBITDA margins that are 50% margins, the cash accretes very fast. And so sometimes conventional structure just doesn't always work as well. And so we're going to have a little bit of flexibility in the system that gave us that for about 15 months or so, and we'll address it as the time comes.

And then how do you -- shareholder returns, how do you think about that? What's the long-term plan?

So there's a right -- so we think shareholder returns, but obviously, in this case, we're talking about the total return aspect, right? So there's a right, I would say, cadence for all that. Target is very much a growth business. And we have tried to position as a growth business. So there's time for dividend. There's time for share buyback. But I think when we look at those at the end of the day, and obviously, never saying never on any of those. But when we look at those right now, I really think the better opportunity is to continue to grow the business and like it's better for the credit holder. I think it's better for Target at large. And that's really the focus. I mean, that's where we've been spending a lot of time in the past several years is how do we continue to grow this business. And so we look at that and say, can we continue to develop our platform and develop it where we can be a provider to the government into other organizations and not just in the modular and solution way, but also in a way where -- maybe the way that creates a bit more immediacy, right, where we can put in solutions that are a bridge to another solution to really extend that value chain and that requires capital. And then the return on that capital at the end of the day, is likely better than a dividend or share repurchase, et cetera.

I appreciate that. That leads me to the next question. So you've expanded the government business magnificently. If you can talk about the growth outlook and one of the things you've talked about in the past is you want to -- you have $500 million of investment opportunities through, I think, through 2027. What -- where are you with that, and that's my first question.

Sure. So when we made that statement, I think, last March, our view on this was to the marketplace to say the following: You see the cash generation that we earn. You see the likelihood of that continuing through our continuation with the government contracts, which we now have the 5-year IDIQ contract that we're working on. So you see that cash flow continuing into the future. And it was really designed to say, look, we have an eye towards capital deployment, we've eye towards growing the business and let's give a framework as to what that looks like. And shortly after that, we had also announced that we are working on a number of new ICF facilities. And so those are the influx care sites the government has sought, so we obviously have PCC. They are seeking another as well. And so we've put...

Just let me stop you. So I have to look these up every time I talk to you, ICF and PCC.

Yes, thank you for the acronym clarification. So PCC is our core site that provides housing for 6,400 individuals, it's specifically on company miners in West Texas. And that has been the core site that is wrapped around the $75 billion 5-year IDIQ contract. The ICF is the influx care sites, and those are the sites that the government has requested, 3 of which -- PCC is one of those 3. And so they want -- basically they said, look, we want 3 PCC like-sized sites. So we're obviously in the running for trying to capture that third site. And so we've offered up a number of opportunities for that. Those not significant capital deployments. But in those unique cases, there's also reimbursement mechanisms with the government. So -- but we're also trying to illustrate to the marketplace regarding our capital deployment was, look, we want to create a full value chain extension on the business. And right now, when you look at Target, what you see is a modular solutions business with a hospitality services wrap around, which has been worked out very, very well. However, we also recognize there's a tremendous white space for contracts with the government that also use nice turnkey wrapper on services, but not necessarily modular related. They are more temporary related and a lot of different type of contract structures. So what do we think about? We think about things like FEMA, for instance, right? Long-term contracts there, year, 2 years type contracts could be even 6-month type contracts, but it's a different application. It's not a module application. And so we've looked at a variety of ways to continue to go into that value chain. And there's tremendous opportunity there for us. And so when we look at those opportunities, those are likely to come through acquisition primarily. And again, it gets back to where we are in the $500 million of capital. So I would just say you'll sit tight on all that, feverishly working on it. And hopefully, we have some announcements in 2024 that will be productive.

So -- but it feels like you have deployed some capital towards that $500 million. Is that correct? Or it's...

Yes. We said $500 million of net capital, right? And so we actually have deployed against that a couple of hundred million dollars against that already. And so we're working on that as now, so we made certainly progress on it. But I think, look, I think when we look down the road in 3 or 4 years, we'll have met or exceeded that number.

Yes. And that's where I was going. So you had a couple of hundred million, $500 million was a goal, goals are meant to broken. So how much bigger is the opportunity? And could you get the $500 million before 2027?

Yes. It's hard to put a timeline on these sort of things. I would just say that the contract structures that and we're feel that we've missed on are in the nature of the billions of dollars. And so it's important to be participatory in that and at least be a part of that discussion. We have -- over the past decade, Target Hospitality has made itself known to the government as being a solutions provider of very high-quality services. And what we'd like to do is continue that with -- in other applications. And so to be in part of that discussion, and be part of the sort of contract profile would be very important for the business.

You say other applications, it's vague. I know it's not modular, but -- what is that?

Yes. So think about it as being more emergency oriented, right? There's a whole amount of contract structures. By the way, these aren't just government. These are also business and industry as well, right? There's other commercial contracts where there's a need for temporary structures or temporary solutions. And again, it's not necessarily -- not everything fits to modular solution, right? The modular build time is 3, 4, 5, 6 months. Sometimes, there are contractual needs whether it's for the government or its business and industry where the solutions may not last that long, right? They may not last for 2 or 3, 4, 5-year contracts. There may be multiple contracts for the last 6, 12, 18 months. And you stack those up and the contract value is tremendous. And there's a lot of turn, which is okay. It's fine. It's a little bit different mechanism, but it bolts in actually very nicely with what we're doing on the modular solutions side.

I'm sure you get this question a lot. I think the answer is it doesn't change, but how does -- who in the White House impact your business? Does it -- if we had a Republican to take office in the next election, would that impact how things -- how your business grows?

You're right. We do get that a lot. But here's the thing on that. What's really important to understand about Target. And the answer is -- the short answer is, I don't think it really matters. And here's why. When that question is asked, it's often asked about in the context of immigration and what's happening with immigration. And the key critical piece of information that is important to remember about Target is who our census is in our communities, right? So we have had our daily community for -- going on nearly a decade now. The census, the primary census over that time frame is been women and children, asylum seeking women and children. In the case of PCC, it's all children, all accompanying minors. However, under Title A, under federal law, which has been for over 40 years. Once a child under the age of 18, steps foot in the U.S. oil, they are here, and they have to remain here. Absent any sort of other situation with Interpol or child abduction or something like that. And what that means is that once the child sets foot in the soil, they're here. And so those -- that further means a further extension is the facilities we have are needed. The whole purpose around why Delhi has been in place for 10 years. The whole purpose around why the government spent 2 or 3 years going through emergency funding to then fight for a 5-year IDIQ contract to let that last, right, which is critically important because that's the funding mechanism, which is not easy to get that creates funding for a number of years for this. And the government doesn't go through all those steps if they don't see an absolute need. But the need you have to come back to the census and the census is the child, and that's what's critically important to understand. And for that reason, we've been through a number of administrations, we've been through 3 already, and maybe we go through a fourth here.

So you alluded to the contracts that you have. So could you talk about the quality of contracts. And then the 5-year contracting vehicle that's been established early this year with the U.S. government for ICF contract awards. Help us understand that. And then you also mentioned that it was key to securing a long contract for the existing Pecos Children's Center, PCC.

PCC, right.

And plus care facility contract. So how...

So I'll walk through this contracting process briefly. We can make it really complicated or we can make it really simple. We'll take the simple approach. It's more effective. So the government creates a funding mechanism, and it's important to understand this, the government creates a funding mechanism. And prior to doing this, the government was under emergency financing emergency funding -- emergency funding. And emergency funding by default means the government can only effectively fund 1 year for any project, which is the case with PCC, right? There was panic at the border, children were coming in, there was not enough space at all. Prior, they were sitting on an army base and it was not a conducive solution. And so we created the PCC, went through a couple of years of emergency funding. And during that time, we've worked with our nonprofit partner and are part of the $75 billion multiyear funding mechanism. So it's 5 years and then potentially 5 years after that. So we look at this and say, look, this is probably like a 10-year deal at the end of the day. But -- the government when it creates that vehicle, effectively what it creates is, is an underwriting process. And they go through that underwriting process for funding for multiple years. And what happens is when you come into your yearly turn, they have removed all the administrative burdens. They've already prefunded it. And then basically from that point in time to go some capital spending budget into an expense account effectively, and that's what we call the period of performance. And so every year that goes from capital to think about as being expense and we then, with our nonprofit partner, receive the funds for the year. That's super important. It was a huge milestone for the company because it got -- us and the government and our nonprofit partner, we got everyone out of the mode of look, PCC is here, gave the government surety, gave us surety, gave the marketplace surety. And so critically important. That was the nature around PCC and the IDIQ and why that was so important.

Maybe shifting gears, just the traditional hospitality services business for the energy services. What's the outlook there?

Yes. So look, that business has been really a GDP-plus type business. And we continue to afford to remain that way. We have a dominant market share. We have nothing on that has changed. We have -- I think we've done a pretty good job of taking supply out of that business from a competition perspective. And so we've really solidified ourselves there, even stronger than where we were, I think, even a few years ago, margins there continue to remain very healthy in the mid-30% area. We expect those to hold in that area, hopefully, even go up here in 2024 with some additional improvements that we can make and some -- perhaps with some help from some costs items. And so that -- look, that business continues to generate a significant amount of cash. I mean you want in your portfolio every single day. It's effectively -- it's a little lower touch. And from a -- at least from a management perspective, it's a higher touch from a customer perspective, but from a management perspective, it's lower touch, and it generates a tremendous amount of cash. So look, we continue to harvest that business in terms of it's caring and feeding. We'll continue to tuck-in things there to the extent we see them. We did 1 almost a year ago. The small transaction. We'll continue to do those to the extent we do see opportunity. We'll continue to put some capital in place where we need to. But by and large, it has been wonderfully self-funding.

You were talking here earlier on the stage about when you reported earnings, your stock -- there was some misunderstanding. Maybe you could talk a little bit about that.

Yes. I appreciate you asking that. So I think there was a misunderstanding around how the contract works with the government and a misunderstanding around what the contract really means. And I think when people understand the nature of the IDIQ process and the longevity of that and the funding and the underwriting, couple that with the fact that we're still looking at another ICF opportunity. I'm not sure the marketplace fully appreciate all that's happening. And I'm not sure that they appreciate the value chain extension opportunities that are in front of us and then would -- the amount of contract value we're seeing that we could potentially go after. And there's a lot of, I'll say, a lot of white space that is very much left untapped here. I think once some of that clear becomes more clear, I think the market will start appreciating kind of where target is in a better spot.

And just last year, everything was about inflation this year, it's about deflation or -- where are you seeing deflation. Can you talk a little bit about that, how that's impacting your business?

Yes. No, it's a great question. So we -- interesting, so we were probably one of the last companies that at least that I follow that were getting impacted by inflation. We have one of the top 5 largest wholesale food purchasers in the United States, produced 15 million meals a year. And certainly, that pricing power helped us. It did catch us a little bit towards the end of last year. As we look forward though, we do start to things moderating. That is happening. The tricky thing with inflation, though is rate of growth, right? And so what we're not so much seeing is, we're not seeing on a notional across entire portfolio. We're not seeing aggregate costs necessarily come down. You are seeing input costs though, come down, right, which is helpful. I mean, if you look at most of the commodity curves, particularly sauce, they -- are starting to see some back -- there, which is nice. And so that will start to flow through. So I do think by the time we exit 2024, probably been a fair bit better spot. But inflation, unfortunately, it's geometric growth, right? It's growth on growth. So we're probably here at our levels than we would otherwise like to be, but I think we're going to be a much better spot heading into back in 2024.

I'm trying to remember what you substituted for chicken. It was chicken wings?

Chicken thighs.

Chicken thighs, cheaper than chicken wings and you're still serving chicken thighs?

We're moving back to chicken wings. Chicken wings are crowd pleaser, right? Chicken wings are crowd pleaser.

I don't think we're serving on here this year, and there was definitely a test for sure. Now you mentioned M&A, you talked about that as an opportunity set. How big can that be?

Yes, it's a good question. So historically, we have not been very acquisitive. You say, why is that? And the reason is because we have been exceedingly disciplined. I can't tell you how many opportunities we've turned down for a number of reasons. And whether it's valuation or whether it's the management or whether it's the fit into the portfolio commercially, operationally, we, in the past, done a number of things. And however, over the past, I would say, 6 months, our portfolio of opportunity set has never been more active. In fact Target's entire portfolio, commercial and otherwise, has never been more active. So we've got a commercial pipeline into the billions of dollars that we're looking at. We have a continual pipeline of transactions that we're looking at. I think 2024 is a breakout year in terms of how we think about transaction activity. I'll pause saying much more than that other than to say that I think we've honed in on the value chain piece pretty tightly. We're being shown a lot of things. And so I think our message has certainly resonated with some of the buy community -- I'm sorry, the sell community and in that market. And so we are looking forward to seeing what we can execute there through the year.

Is there -- is -- you mentioned this year, it's picked up the opportunities. Is that just because you've realized the opportunities to add to your business based on where you are today? Or is it something happen in the industry that's...

Yes, it's 2 things. So one, it's we have honed in much more clearly on the contract value where we think we can really add tremendous value to the government. And the government is looking for solutions, right? They're not trying to find more parties to do less work. They're trying to find more parties that hopefully can put them in the spot that the bases the burden on the contracting office. And so when you look at a company like Target, we can come in and really do things that I think take a handful of parties to do that we can do with one call. So within that, we see this white space in the government. Okay, so that's point one. Point 2 is we're getting many, many more inbounds than we were receiving even a couple of years ago. And the reason is because they're seeing our portfolio, and they're seeing the competitive pressure. We are showing up against a number of companies over and over and over again. And some of those companies look to monetize or look to make structural changes in their business, Target is receiving the call. And that's actually a great spot to be in, right? That tells you that your business plan, not only is it working financially, it's also working from a structural perspective when other counterparties are seeing that. And so you want to take advantage of that opportunity, and we are.

Are the counterparties private-equity backed? Or is it just mom-and-pop? Is there something about a need to exit that?

Yes, I think it's a little bit of both. I think it's a function of -- some of these companies are perhaps reach scale where they can't take it to the next level, perhaps. And again, we're dealing -- we're talking about companies that are not modular solutions oriented that have a capital spending profile that has historically been different than ours, right? I mean, we've spent $500 million of capital in the past 5 years, 6 years building out this entire portfolio. Their capital profile looks different. But even for them to continue with the growth it's heavy, right? And for us, it's very different. We would say, yes, it's very doable, right? We'll facilitate your growth profile. For them it's a heavy ask. And I think for any entrepreneur, you ask yourself if you're getting that natural question, okay, how much longer can I functionally do this with this organization I have intact or is it time there for me to scale up? And that's really hard to do at certain levels, sometimes it's a lot easier just to sell.

So I didn't ask you -- your debt has come down so much. I didn't ask you this, but how do you think about what the right capital structure is. Clearly, you have room to buy things just -- but what does your capital structure look like in terms of leverage? And how are you thinking about that?

Yes, it's a good question. I mean we -- yes, the leverage going to come down so much. We really asked the question more about how you view long-term debt profile of the business and the credit quality of the business. Look, the reality is right now, we are in a bit of an over-equitized position. However, that being said, we -- and you know this is from our years together, we are not of a mindset of overleveraging the business. Our view has been and it continues to be commercially and operationally as well as financially is ultimate flexibility. You cannot react to near-term opportunities if you don't have the balance sheet structure in place. And -- what that doesn't mean is overlevering to them, this is -- a common corporate approach is over levering, then you bring it back down and you go back to your 4x, you come back down to 2.5 and then you go through the 2-year process. We're not doing that because during that 2-year process, you lose all your flexibility. What we're looking at is coming in from under capitalized situation -- under -- over equitized, right, effectively undercapitalize the business to then have immediate opportunity sets to continue to get to, what would be kind of 2 to 3x, and that would be it. And that's it. But here's the reality. With our cash profile, we have the ability to do a couple of hundred million dollars of deals on balance sheet and keep leverage flat. And so that is a very unique spot to be in. And so when we look at -- I don't think our acquisition engine will likely be able to keep up with our cash profile. And that's the other thing that's geometric, right, is your cash profile then builds even faster. And so I think from a balance sheet perspective, just by definition of our capital base and by definition of our margin profile, I expect us to be kind of a perpetually underlevered situation.

I mean why not -- and I mentioned I love hearing that. Obviously, you understand the value of having a clean balance sheet. But why not add -- I think you said, why not add more leverage and more value to shareholders.

Well, you could, you could. But also at the same time, what happens is it also gets paid down very quick, right? So you actually could do that, right? I mean we likely would do something on balance sheet. I'm not suggesting we're using equity here at all. That will depend on the size of course. But everything we're looking at, we would likely do on balance sheet. But inside of a year or so, it's -- you're back to neutral, which is a good spot to be.

And you said the target is 2 to 3x or I think you used that number, I feel like your less...

Yes. No, we're 0.3 now, we're effectively going to be net zero by the end of the year. But I think if we were to look out over time, say, what's kind of Target's kind of peak leverage profile, 2.5 to 3 would probably be peak for us.

So you'd go there to acquire, but you bring back that down.

It'll come down fast. Yes.

With a few minutes left. Are there any questions from the crowd? I guess I'll ask my final question. Is there anything we did not ask you that you think would be a great thing to highlight, especially for those that are on this webcast.

Well, look, I -- that's a good question. Thank you for that. Look, I think the critical takeaway from this is a couple of things. One, we are, in many ways, kind of -- I still think someone in the early innings of the growth engine in some ways, that's my point #1 and then point #2 is continue to remember who our census population is, right? Women and children critically important to think in terms of Target. Just to get comfort in terms of the population mix and the durability, we oftentimes get caught up in terms of the immigration discussion, right, and how temporal that is. And we see the emerging crisis, et cetera. And it is and it has been. And a lot of that was brought on because of COVID. And that concept, when you understand that, and that this isn't so much a policy decision that it is a function of what's happening in the southern border and it's not Mexico. It's entirely of Central America. But you're seeing similar things happen in Europe, right? You're seeing similar things happening in Italy. You're seeing similar things happening -- previously happened in Germany. And so you're seeing this happen all over the world. And say, why is this happening? Well, it's happening because there has been -- I think COVID was so impactful to certain economies and certain countries in the world that the citizens they just frankly, could no longer tolerate the incivility of it. And so there's been a trend from a tremendous global migration to Western communities. I think our policy work that we've had done, our consultancy work suggests that, that is not going to stop. And the critical thing that you take that one extension is to say, okay, about Target, their population is children. So even if there were policy adjustments that the adult level has nothing to do with the children in our population. And so I think when you marry that and understand all that and then couple that with the way the government has approached the funding and the multiyear underwriting on this, it probably frames the story a bit different. And I think just helps illustrate and give the marketplace a much greater sense of confidence as to how this looks over the next several years.

That was a great way to wrap it up. And so a round of applause for Eric, we really appreciate you making the trip here. Thanks, Eric.