Industrial services company SRG Global Ltd (ASX:SRG) announced a largely positive report for the six months to December 2022.
SRG Global reported revenue of $380 million, up 28% on the prior corresponding period. Earnings Before Interest Tax Depreciation and Amortisation (EBITDA) was up 26% to $34 million. Net Profit After Tax (NPAT) was up 31% to $12.4 million. Free cash flow for the period was $28.5 million, measured by cash flow from operating activities of $44.5 million minus capital expenditures of $15.9 million. EBITDA to cash conversion for the period was 139%, which reflects well on SRG’s capital management.
Looking ahead there is a large pool of work available that SRG can bid for, which they estimate to be approximately $6 billion. Other industry tailwinds include increasing mining capital expenditure as supply struggles to keep up with demand for decarbonisation metals, and high levels of government infrastructure spending.
SRG Global provides industrial services to the mining, industrial and infrastructure sectors. These services cover the entire lifecycle of engineering, constructing, and sustaining assets. SRG has three operating segments; asset maintenance, mining services and engineering & construction.
Source: SRG Global FY 2023 H1 results presentation
The three segments contributed roughly the same amount to EBITDA. Engineering & Construction contributed $13.8 million on revenue of $186.4 million, Asset Maintenance contributed $14.3 million on revenue of $123.1m, and Mining Services contributed $14.2 million on revenues of $70.5 million.
The chart below shows that Australian capital expenditure for mining companies (left side) is recovering from the downturn in spending over recent years. Expenditure is expected to rise further with many mining companies looking to cash in on the decarbonisation theme, which should benefit the mining services division.
SRG Global had net cash of $38.1 million at December 31 2022, up 86% on the prior corresponding period. A fully franked dividend of 2 cents was declared, up 33% from 1.5c cents in 1HFY22.
Source: SRG Global FY 2023 H1 results presentation
Underpinning the rise in earnings has been a steady stream of contract wins. As of 31 December 2022 SRG had $1.5 billion of work in hand, which is contracts secured and work where it is highly probable by SRG’s calculations of a 70% or more chance of the contract rolling over. Of that, 64% is recurring earnings, which are term contracts in the Asset Maintenance and Mining Services sectors where SRG has been working successfully with the clients for some time and is therefore expecting the contracts to be continued in the future. This allows for more stable and predictable earnings, than if SRG were entirely non-recurring projects.The remaining work in the Engineering and Construction sector is individual projects.
SRG Global’s strategy of diversifying operations and creating recurring earnings, coupled with the award of new contracts, has shown up in its financial results. Revenue, profit and free cash flow have been in an upward trend since 2020, which is pleasing to see in a low margin business.
Source: SRG Global H1 reports, authors calculations
SRG Global Guidance Upgrade
FY23 Earnings Before Interest Tax and Depreciation (EBITDA) guidance was increased to $72m – $75m, a step up from FY22 EBITDA of $57.2 million.
Acquisition of ALS Asset Care
Since the release of its financial results, the only major development for SRG Global has been the announcement in February of its acquisition of the Asset Care Business from ALS Ltd (ASX:ALQ), for $80 million.
SRG paid what seems to be a reasonable 5.2 times FY23E EBITDA for the Asset Care Business. The business fits with SRG’s goal of targeting recurring revenues, as approximately 99% of ALS Asset Care revenue is maintenance related and a significant proportion is contracted.
The acquisition will be funded through a combination of $51.4 million in equity raised at $0.72 per share, via a $46.4 million institutional placement and upcoming share purchase plan for up to $5 million, plus $30 million drawn from a new secured term loan, and existing cash.
SRG Global continues to win contracts
SRG has announced several new contract wins in February. A specialist facades and structures contract with Multiplex Constructions in Perth valued at ~$120m. Multiple civil and remedial engineering contracts in the bridge, rail and marine sectors in Victoria and Queensland total of ~$40 million, plus two contracts with Northern Star Resources (ASX:NST) valued at ~$220 million.
Risks to SRG Global
Often when times are good, companies can take the opportunity to expand. We have seen this with the recent acquisition of ALS Asset Care by SRG for $80 million, which is a big step up from the previous two acquisitions last year when SRG acquired Queensland based Bartek, an engineered products business for $2.6m in December, and in March acquired WBHO Infrastructure’s WA business for $15.2 million.
If work slows this could be a problem as SRG borrowed $30 million to help fund the acquisition just as interest rates are starting to rise. If revenue should be lower and borrowing costs remain elevated this could put pressure on earnings
Also if there is a decrease in commodities prices this would likely mean less expenditure on mining services, and less profit from mining companies means a decreasing government tax take, which could affect the amount they have to spend on infrastructure projects.
The outlook for SRG Global
A bullish commodities cycle and a strong pipeline of work may see SRG’s earnings and dividends increase in coming years. SRG has exposure to and is targeting growth in civil infrastructure construction & remediation. Historically, governments have increased spending on infrastructure projects in economic downturns, which many economists are predicting may happen as a result of the attempt to control inflation. On the flipside, a downturn could see private sector work dry up.
The company is capital light and scalable as its business is people servicing assets. But this means SRG will need more employees to service an increase in contracts – finding workers may be tough at present thanks to a skilled labour shortage and rapidly rising wage growth. Obviously, taking on more employees brings its own risk, because if demand does wane, those employee expenses will remain, and could see profits drop precipitously.
Despite recent share price appreciation the company still trades on a relatively undemanding P/E ratio of 15 and trailing dividend yield of 3.7%.
As someone with a small position in the company I am happy with the results and outlook over the coming years, and will be keeping a close eye on how the recent acquisition pans out.
Disclosure: the author of this article owns shares in SRG and will not these trade shares for at least 2 days following the publication of this article. The editor does not own shares in SRG. This article is not intended to form the basis of an investment decision and is not an official recommendation. Any statements that are advice under the law are general advice only. The author has not considered your investment objectives or personal situation. Any advice is authorised by Claude Walker (AR 1297632), Authorised Representative of Equity Story Pty Ltd (ABN 94 127 714 998) (AFSL 343937).
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