Emeco Holdings Limited (EHL) Earnings Call Transcript

Ladies and gentlemen, thank you for standing by, and welcome to the Emeco Holdings Limited FY '20 Interim Results Briefing. [Operator Instructions] I must advise you that today's conference is being recorded. I would now like to hand the conference over to your first speaker today, Managing Director and CEO of Emeco, Ian Testrow. Thank you. Please go ahead.

Thank you very much, and thank you to everyone for dialing in to our FY '20 half year results presentation. Just to begin, our scoreboard there. Another solid half for Emeco, with EBITDA and EBIT getting some strong growth coming to the corresponding half by 16% and 13%, respectively. Once again, we see margins incrementally increasing, which it has been for the last few years, which shows that we're working harder, continually looking to improve rates and our continuous focus on improvement opportunities and cost focus in the business being reflected in rate increases period-on-period. Good to see the net leverage down on track to about a 1.5x target to the end of FY '20 at 1.77x and a strong return on capital, which is very representative of the way we run this business in regard to our capital management, a rebuilding of assets and management of components. The return on capital is very important to us. If we just go to Slide #3, we talk about the first half highlights. As I mentioned, continued strong performance compared to first half '19, with operating EBITDA being 16% up on first half '19 and within the guidance that we provided at our AGM. Operating EBITDA margins increased to 48.3%, which is up from 46% in the first half of '19. We look forward to the completion of the Pit N Portal acquisition in -- at the end of this month. We're excited about this opportunity. It -- we entered the hard-rock industry, we increased our gold coverage or gold exposure from 12% to 27%, with a strong pipeline of work for further increases in gold, copper and nickel, lead, et cetera. So we're very excited about that. I mentioned the leverage is very, very important to us, 1.77x, down from 2x as of 30th of June, 2019, on track to achieve our target FY '20 that we've been talking about for quite some time now of 1.5x. Our diversification. We're excited to see that iron ore has gone from 10% to 20%, doubled in the period on half-on-half. That's fantastic for us. We're seeing new gold project wins in gold and iron ore. So really getting some balancing in our commodity diversification. And as usual, we continue to target being the lowest cost, highest quality equipment provider in the industry. As mentioned on the previous slide, that return on capital of above 20%, and consistently sitting above 20%, is really important for us. We've absorbed the growth assets, and we're still above that 20%. It's really, really important for us and shows how well we manage the capital and sustainability of this business. Moving on to Slide #5. Safety continues and will always be the #1 priority of our business. As we expand our service offering into underground, we expand our employee base. It's really important that we invest further in our safety resources and our safety systems. Creating and maintaining a safe workplace for our employees is absolutely our #1 priority. The next slide, #6, and people. I mentioned acquisition of Pit N Portal, we go from 600 people to 900 people. This is the absolute strength of our business. We have a very high intention -- sorry, retention rate of our employees. We have a very, very talented group of dedicated people that work for us, and it's the heart and soul of the service we provide our customers. And it's one thing to have equipment, but having equipment that we can rebuild for our Force workshops and then using our Emeco and Matilda and now Pit N Portal brands and dedicated people to apply value to that equipment, to apply the technology to the equipment, the planning and everything that goes with it. That's the heart and soul of the business. So we -- the diversity of our workforce is really important to us as is the expansion of our Apprenticeship Program. That's our way of giving something back to the industry and investing in the sustainability of our workforce. We go on to the operating segments now. I'd like to hand to Thao Pham, our Chief Strategy Officer, to talk further this business unit.

Thanks, Ian. Emeco continues to operate under the 2 segments of Rental and Workshops. On Page 8, we have an overview of the Rental segment, which contributes 85% to the group revenue. The Rental segment continues to be a strong performer for Emeco and continues to deliver growth, with operating EBITDA up 14% and operating EBIT up 13%. This is largely driven by strong demand in met coal and also the Western Region improvements as we redeploy assets coming out of our historical low-margin projects into new higher-margin projects. In addition to all of that, obviously, we've got the contribution of the growth assets coming in, in this half as well. Gross utilization continues to be strong at 91%, with operating utilization continuing to tick up from 62% a year ago to now at 65%. Operating EBITDA margin also continue to increase, up 4.5 percentage points now to 61.7%. This is expected to continue to increase as we deploy our assets into higher margin projects, especially in the new gold and iron ore projects in the Western Region and also additional met coal projects. This supports continued growth in the second half of '20. Just going to a little bit more detail of the Eastern and the Western Region. So in the Eastern Region, as mentioned, met coal continues to be strong for us. And in addition to that, we have the contribution from the growth assets driving both utilization and earnings increases, with earnings up 22% on an operating EBITDA basis. Margins continue to increase, up 8.4 percentage points to 69.2%. This is largely due to the high-margin met projects and also the growth assets, also a very high-margin project for us. Thermal coal remains a steady contributor to the Eastern Region business. The outlook continues to be strong, especially in met coal, and particularly, we're continuing to see customers remain disciplined with their capital allocation in a market where stripping ratios remain high and equipment supply continues to be tight. Moving on to Slide 10 on the Western Region. I mean we've talked about calendar '19 being a transitional year for the Western Region for quite some time now. And basically, we're seeing these assets that were previously in low-margin historical legacy projects completing and then being redeployed into new iron ore and gold projects at higher margins. So in the first half of '20, we've seen this ramp up and with these higher-margin projects, it's translated into higher operating EBITDA, up 10% on the last half, and margins as well, going from 40.8% to 42%. In the second half, we expect the growth in earnings, margin and utilization in the Western Region to continue to increase, setting us up for a strong calendar year '20. Moving on to the Force workshops on Slide 11. The workshops contribute about 15% to the group revenue. The throughput continues to grow in the workshops and contributes earnings as well as savings to the group. Activity has significantly increased, up 91% on the first half of '19. This was driven largely by an increase in internal activity as the workshop supported the preparation and redeployment of assets into the new projects in the Western Region and then rebuilding critical components for the rest of our rental fleet. The internal portion of the workshops activity for this half was 56%, up from 42% in the first half of '19. So the workshops continue to provide the Emeco Group with value. I mean from an internal perspective, it provides us security of supply for our own rental fleet, allows us to minimize downtime, to maximize utilization as well as provide us with cost savings. From a retail perspective, obviously, there's the end benefit of retail EBIT of $2.6 million for the half, providing us that noncapital-intensive earnings. I mean I think the workshops has been great for Emeco, and I think there's real value there in rebuilding our fleet internally, saving us on both time and cost. And because we're allowed -- we can do it cost effectively, there's also that reduction in capital invested, which helps drive our return on capital and keeping it at high levels. And this was really proven with the recent growth asset purchase, where we successfully acquired low-cost mid-life assets, rebuilt them through the Force workshops and now generates us strong returns in the rental projects, which meets internal hurdles. Operating EBIT margin for the workshops has slightly decreased from 9% to 7%, largely as a result of the increased capacity we took on since the first half of '19 but also because of the increase in the internal works because the retail EBIT number absorbs all of the overheads associated with the workshops. But if you look from -- compared to the second half of '19, margins have gone up from 6% to 7%. Lastly, we think there's strong synergy potential between the workshops and also with the Pit N Portal workshops business that we're picking up at the end of the month. We're really excited to utilize the East Coast workshops to grow the Pit N Portal services capability and then also rebuild more underground equipment. Justine, I'll throw it to you for the financials.

Thanks very much, Thao. So moving on to Slide 13 of the pack. Emeco generated $246.5 million in operating revenue for the first half '20. This is underpinned by the increase in average operating utilization of the fleet to 65% on a larger asset base, with the growth assets to deploy its contract, continued strong demand from customers and improvements in rates. The pleasing thing, as Ian mentioned before, was the business commodity diversification, which improved with iron ore now representing 20% of group revenue, up from 10% in FY '19, and thermal coal reducing to 20% from 23% last year. This was part of our strategy to diversify our commodity exposure and grow our Western Region business to service increased demand. Operating EBITDA of $119 million, with operating EBITDA margins of 48.3%, was achieved as low-margin contracts completed, and we relocated the equipment into new projects with higher margins, as Thao outlined earlier. This strong performance translated into an operating EBIT of $67.5 million. After taking into consideration interest costs, we achieved an operating NPAT result of $42.1 million, up 33% from PCP. We also remain very disciplined in our allocation of capital, as both Ian and Thao outlined, with our key metric, return on capital, remaining strong at 20.6%. Moving to the cash flow slide. Emeco achieved an operating cash flow of $75.3 million in first half '20, up $63.2 million in first half '19. However, working capital was impacted by the final installment of strategic growth assets, growth in the business, ramp-up of the Western Region and timing of debtor payments due to Christmas closures, which were similar to the prior period as well. Cash and working capital will improve in the second half. The level of net sustaining capital expenditure has grown to $49.1 million, reflecting the larger fleet size, increased utilizations and current market conditions. This figure really consists of the sustained business capital expenditure associated with component rebuilds, which has been offset by the disposal of noncore and end-of-life assets as we continue to evaluate and optimize our fleet. From a cash tax perspective, Emeco still has $257 million in unutilized tax losses, of which $68 million has not been recognized, and we're not expecting to pay cash tax for the next couple of years. The business continues to remain focused on maximizing the conversion of EBITDA into cash and deleveraging, so that the company can refinance its debt on more attractive terms. Moving to Slide 15 on the balance sheet. Emeco's reduced its net debt to operating EBITDA ratio to a 1.77x from 2x at 30 June 2019, demonstrating our continued focus on generating cash and deleveraging. In January 2020, we successfully upsized our revolving credit facility from $65 million to $100 million on the same tenor and terms, with a 2-year extension option until September 2023. This is currently undrawn and supports the business' ability to manage -- to reduce its gross debt. In terms of our notes, our 3-year noncall period is coming up on the 1st of April 2020, and we continue to assess our options for refinancing Emeco's capital structure to obtain better terms. That, in turn, provides optionality for capital management in the future. Supported by the recent upgrades we achieved from Moody's and S&P, our financial position today highlights the progress that we have made in building a sustainable business, strengthening the balance sheet and achieving a leverage of 1.77x, which puts us in a strong position to refinance that debt on materially better terms. I'll now hand back to Ian to go through the FY '20 focus and outlook.

Thank you, Justine. Okay. So our FY '20 focus and outlook for the remainder of FY '20. We need to dedicate some resources, and we'll dedicate some resources into our HSE systems and our processes and our people. As I mentioned, we've been expanding workforce. We need to absolutely ensure we have a safe workplace. Integrate the Pit N Portal business is to be a key focus as well, taking control of that business at the end of this month. Justine, as announced a couple of weeks ago, will be moving into a Chief Integration Officer role. Justine's done a fantastic job integrating the previous businesses that we acquired, and we look forward to her doing the same with Pit N Portal and also with ongoing continuous improvement projects. So congratulations on that role, Justine. And we look forward to welcoming Neil Siford into the business at the end of March. FY '20 will also see us growing our met coal, our earnings and utilization in the Eastern Region that will see us grow iron ore and gold through earnings and utilization in the West. Overall, the business' operational utilization will increase. Rental margins again will increase through FY '20. And the growth assets will achieve the stated $25 million operating EBITDA in FY '20, slightly skewed to the second half. Moving forward, beyond FY '20, we're excited about the Pit N Portal business. We think that, that will be a really strong growth engine for us. Excited to be working with Steve Versteegen. He's got -- certainly got a strong pipeline of works that he's bidding on in front of him, and we look forward to supporting the Pit N Portal business. Continued strong workshop activity. Thao spoke about how important the workshop to -- is to us and both internally and supporting our customers for retail works. We are very excited about how Pit N Portal and their underground capability and underground relationships will add to our Force business. We're looking forward to providing further services to our customers to rebuild their equipment. And as Thao mentioned, it's very valuable for us, I mean, the Force workshop, to rebuild our components, rebuild our equipment and, as we bring equipment in, to rebuild it cost effectively and put it out to work. We have a very large workforce now, 900 people, as I mentioned, after Pit N Portal, a very skilled workforce, very high retention rate of that workforce. It's a real differentiator in this market where it's tight for skilled people. We look forward to applying more and more services with our skilled people. I think there's a real strong appetite for our customers, for us to widen our value proposition to create more value on sites, which results in greater tenure of our projects. So that's a challenge in front of us, and we look forward to it. Pit N Portal has certainly shown us the way forward, the way that they've increased and built from having equipment on their projects and into extending services. We do our best work, and we've got our people on the site, ensuring the performance of our equipment and looking after our customers' equipment. So we look to build on that moving forward. EOS is our technology that we're very excited about, we have been for quite some time now. We look forward to putting EOS into a new customer in gold in the remainder of FY '20. We're very excited about that. We think it's a great opportunity for us and the customer. And we're looking forward to evolving EOS to work in an underground application as well and to support some new project wins by Pit N Portal forward. But both involved -- our reason here is that we continue to be disciplined. We continue to work to ensure that our leverage is down to 1.5x. Our cash flow will increase significantly in the second half. We'll get down to that 1.5x for FY '20 and 1x for FY '21. We're looking forward to refinancing Emeco's existing notes to lower financing costs and to achieve more flexible terms. We have a window of opportunity to do that with the noncall period going away in our existing notes. And we look forward to pursuing refinancing options to place the company on more cost-effective terms moving forward. And once we -- within our target leverage range, we look forward to rewarding our loyal shareholders the payment of the dividend. Just moving on to Slide #18. This is the Pit N Portal business, just an update on that. We tuck the keys at the end of February. It's straightaway our commodity diversification changes. Gold goes from 12% to 27%. That will continue to increase as Pit N Portal grows. I'm really excited about, as I said, the maintenance capability, the cultural alignment of Pit N Portal, the embracement of technology and the customer focus, providing customer solutions. We think we can build on that. We share a customer base, particularly in gold projects and those types of metals projects where customers quite often will have an open cut pit and then build a portal from there. And we look forward to following customers both from the underground operations and their open cut operations as well. It's really important for us. We admire the way that Pit N Portal have evolved from being an equipment provider to a rental equipment provider and services provider. We think that's a great model for Emeco to find. And we feel that there's operational synergies in the workshops that underground capability will be beneficial for us for our Force workshops to increase that retail component. And just on Page 19 there to finish up. This is a very busy slide. I'm not going to read through it word for word. It will take for a long time. But I think the -- I just wanted to -- before moving forward in this business, we're more than just a rental company. I keep talking about these 900 people, the services they provide, the value we create for our customers, the increased tenure that we're getting with our projects. And I just really want to touch on probably just the secret sauce in this business. I was at our Kalgoorlie workshop the other day. And there was a piece of equipment in from Pit N Portal. It was a truck, an underground truck. And I think Steve Versteegen had picked it up for [ $120,000 ]. It was scrap truck and our workforce and -- in Kalgoorlie, our Force team rebuilt that truck, and it looked absolutely brand-new. And so the total value into that truck after we rebuilt was about $1 million. That truck would cost you $2 million to buy. This was a brand-new looking piece of machinery, was put out to work like a brand-new piece of machinery. That's absolutely the secret sauce here. We're a company that's developing our people, our systems, our technology. We build out our services, but at the end of the day, it's underpinned by our ability to put out low-cost, high-quality equipment. And in a market where there is a supply-demand imbalance of equipment, where customers are absolutely focused on reducing their capital intensity, where we shared taking risk from customers around that CapEx, around that equipment and providing our services on top of that, I think, that's really, really important. And I think this is absolutely the key for greater tenure and generating greater value for our customers, but also for great and strong returns for our shareholders moving forward. Our ability to procure equipment, like Steve has, with that underground equipment, like we did with the equipment that we bought in for growth assets, ability to project manage and put them through the Force workshops, cost effectively rebuild them, and all of a sudden, straightaway have a cost advantage against our competitors; to ensure the quality of that equipment once it's out there for our planning, our engineering, our analysis, the use of technology to monitor the components; and then the people, they're absolutely key, the people that we have, to support our customers, to have [ input ] for our customers, to create solutions for them and to provide that service safely on-site and reliably is critically important; and then top it off with the EOS technology to ensure that our customers get absolute maximum productivity from our equipment. And we measured and managed and shown them how they can use it better. I just think that's something that really excites me about this business and what we're creating. So we are disciplined, we are focused on our leverage targets, but we're also creating something great moving forward. And I really do feel that we're evolving or have evolved into a business that would create value in a sustainable way moving forward. Over to questions, Tom.

[Operator Instructions] Your first question comes from Michael Aspinall from Jefferies.

Currently, operating utilization is at 72% in the East Coast and 50% on the West Coast, but you're moving assets from east to west. Can you just talk through the dynamic there?

Hand it to you, Sam?

Yes. Sam Byford here. So Michael, the East Coast, I guess, is 2 separate businesses. We've got New South Wales operations and the Queensland operations. So the growth in the operating utilization is predominantly in the Queensland operations in the met coal space. That's been offset a little bit in the New South Wales business with thermal coal. So those assets transferring or out of that New South Wales business, which is probably a bit sort of flatter in terms of utilization. So I guess, on balance, that sort of comes to your 72% that you mentioned.

Okay. And so are you expecting overall for the East Coast operating utilization to fall from here?

Not at all. Yes, we expect it to increase in the second half.

Okay. And just one more for me. Can you quantify the utilization or financial impact of moving those assets during the half?

Quantify in what terms?

The utilization, the impact on the West Coast or, in financial terms, sort of the costs for moving those assets across as if you had them operating full time.

So the cost is marginal. In terms of earnings, it's probably a few million dollars at the EBITDA line over the first half. I guess the difference between second half run rate last year, plus the growth assets, that delta there is probably the impact of the transfer of assets. So we'll recover that in the second half and have an exit rate into the second half, more in line with that run rate, plus growth assets, plus additional growth in the West.

Okay. And then just last one for me. On the East Coast, you mentioned stripping ratio is continuing to increase. That's still in met coal, is it?

It's across the business, met coal and thermal coal. We're also seeing it in the gold space in the open pit areas. So it's a general trend across the business or across the industry.

Okay. And do you have any kind of expectation for how long that will continue in the current environment?

We did say that that's been on an ongoing basis.

Ongoing?

Yes, we provided -- yes, we have some data we've provided in other packs, Wood Mackenzie forecast indicating that, that trend is continuing for 4 years, 5 years.

Your next question comes from Alex Karpos from Goldman Sachs.

A couple of quick ones from me. Just focusing on the West a little bit. Obviously, the utilization color is helpful. But we keep hearing about iron ore project delays from some of the other construction companies. Has that impacted the result here at all? Or how much visibility do you have here into the second half and beyond?

Do you want me to get that?

So we spoke consistently to the market that 2019 calendar was a transitional period for the West as we took out some -- completed some legacy projects for some previous M&A activity and put them into new works. We took a quite conservative view when those projects would start up. The first half of '20 very much for us has been around project management and relocating equipment from the legacy projects into the new projects, and that's played out according to our plan. I feel like we set the business well up for the second half. Do you agree, Sam?

Yes, 100%. So the key iron ore projects we're working on, Alex, have all commenced working as we had expected. Perhaps not as the clients had expected, but there's no impact to our business.

Got it. And just staying on the West, obviously, this is more of a longer-term question, but is there anything structural to prevent Western margins from reaching the Eastern levels, assuming some level of utilization? This is obviously a longer-term question, but could you see a similar high 60% margin for the Western business if utilization ramped significantly?

Yes. The one thing that the West has traditionally had is more services, Alex, in terms of the fully maintained side. So that naturally dampens your margin a touch, but it increases your revenue on the back of it. So that's probably what's impacting it currently. But going forward, we see a pretty strong rate and improvement in that margin.

We'll see margin improvement in the West in the second half.

Your next question comes from Mitch Sonogan from Macquarie.