Emeco Holdings Limited (EHL) Earnings Call Transcript

Thank you for standing by, and welcome to the Emeco Holdings Limited FY '22 Full Year Results Briefing. [Operator Instructions] I would now like to hand the conference over to Mr. Ian Testrow, Managing Director and CEO. Please go ahead.

Thank you very much, and thank you to everyone for dialing in. Good morning, and welcome to Emeco's Full Year '22 Results Briefing. I'm joined today by our CFO, Thao Pham. Today's announcement of $250 million operating EBITDA, which we preannounced in June, is a solid result. We've delivered growth in each of our operating divisions, and our business performed well despite COVID disruptions, continued labor shortages, inflationary pressure and extreme East Coast weather in both halves of the year. I want to thank our 1,400 employees who worked tirelessly to deliver for our customers and navigate the many challenges we faced in FY '22. This hard work has set us up for a strong FY '23. Emeco prides itself on its people and culture, and the team has performed exceptionally well. Thao will take you through the financial performance of the business shortly, but if you turn to Slide 2, I'll take you through the group financial highlights. Revenue of $754 million, which was a 22% increase on FY '21. This is driven primarily by Pit N Portal, but we also saw a 7% growth in Rental and 11% growth in Force. Operating EBITDA grew by 5%. Operating NPAT grew by 22% to $69 million, reflecting the significant interest expense savings from the refinance of our U.S. dollar notes in July last year. We now have Aussie notes in place at 6.25% maturing in FY '27. We continue to deliver strong free cash flow with cash conversion of 96%. The Board has declared a second half capital management package of $13 million, including a final dividend of $0.0125 fully franked, equivalent to the interim dividend, and an on-market buyback of a further 1.5% of shares on issue. This takes total capital management for FY '22 to over $24 million, which is 35% of operating NPAT. We also opportunistically purchased an additional $7.6 million of stock during the second half. Our buyback program, together with our increased earnings and our reduced financing costs, increased EPS by more than 3x on FY '21. Our balance sheet is in good shape with leverage just below 1x. Our return on capital, which sits constantly above -- sorry, which sits comfortably above our cost of capital, has now stabilized at 16%. This will increase in FY '23 as we drive increased earnings from our existing asset base. Just turning to Slide 3. The safety of our workforce is and will always be our highest priority. TRIFR is 1.9, down from 2.1, and we remain LTI-free for 6 years. As I noted, operating EBITDA of $250 million reflected year-on-year growth in all 3 divisions. Rental has now returned to growth as we deployed assets from across the year in both regions, which is reflected in our Rental business gross utilization of 92%, up from 87% in FY '21. We also managed margins well given the inflationary environment, while Rental and Force held margins from FY '21 into FY '22 shows the resilience of the business. Our operating utilization was impacted by ongoing operator shortages and the weather events I described earlier. Our fleet is well placed to increase operating utilization and earnings in FY '23 as conditions normalize. Pit N Portal's base business of underground rental and underground and open cut services projects performed well. However, overall performance continues to be impacted by the profitability of a major project. We are currently renegotiating this contract to improve earnings and margins. FY '23 will see improved earnings and margins from the Pit N Portal business. Force continued to perform well and grow its external business and demonstrate the key strategic cost and quality advantages it creates for our business. Now on to outlook for FY '23 on Slide 4. We expect operating EBITDA growth in Rental, Pit N Portal and Force. These earnings will be generated from our existing asset base. Rental growth in FY '23 will be underpinned by improving operating utilization, our focus on cost control and continuous improvement initiatives, rise and fall mechanisms that help with inflation pressure and rate increases when extending contracts and placing equipment into new jobs. Pit N Portal will deliver increased earnings and margins as we address our underperforming major projects. We expect growth to be weighted to the second half. Force growth will be weighted towards internal works as we utilize this capability to manage inflation and extend the life of our equipment and components. Our sustaining capital budget for FY '23 will be $155 million to $160 million, and this includes our replacement asset program. We expect return on capital to increase as earnings grow from improved realization of the existing asset base. Our focus is working out fully harder to increase earnings, managing costs improving Pit N Portal returns and margins and maximizing free cash generation. Now turning to safety and sustainability. On Slide 6, we provided an overview on our safety. I'm very proud of our safety record. We've been lost time injury-free since February 2016, so for over 6 years now. And we've improved our TRIFR down to 1.9 from 2.1 last year. We've invested significant time and cost in updating our health and safety strategic plan to bring it in line with the additional size of our workforce, which is now 1,400 strong, and the additional services we perform. If we turn to Slide 7, a bit of work that we've done on our people and culture. As mentioned, we've increased the size of our workforce by 27% and now have approximately 1,400 employees. In FY '22, we worked hard to increase the number of females and apprentices in our workforce. More recently, we entered into a strategic framework with Kuuwa, an indigenous-owned business in Western Australia. I'm excited by this partnership as it helps us to better support indigenous businesses and communities while providing additional solutions to our customers. Project Align remains a centerpiece of our people and culture commitment. We achieved some great progress this year with the engagement of our workforce, development and implementation of our core values and building on our community engagement and sponsorships. Turning to Slide 8 on ESG. Significant work has gone into developing our ESG strategy during the year. You'll see on Slide 7 (sic) [ Slide 8 ], we present our ESG wheel with the 8 material things we identified as important to the Emeco Group. This was identified through stakeholder engagement and industry benchmarking. We're now rolling this out across the business with actions, metrics and targets identified. Now I'll hand it over to Thao to go through the financials in more detail.

Thanks, Ian. On Slide 10, operating profit and loss. The key message here is that we have delivered solid financial performance in what was a challenging operating and inflationary environment. Revenue is up $134 million on FY '21 being 22% growth. Pit N Portal represents $108 million of this increase, and pleasingly, Rental revenue also grew 7% on FY '21. Operating EBITDA growth of 5% to $250 million reflects growth across all operating segments in FY '22 and as previously announced, is at the lower end of our guidance range due to the impact of COVID, tight labor markets and extreme weather events all impacting operating utilization. As is well understood throughout the industry, we also experienced cost inflation, particularly with costs and labor. Group EBITDA margin of 33% is down on FY '21, as you can see, although these margins held flat half-on-half throughout FY '22. Essentially, Rental and Force margins have held over the year. And whilst Pit N Portal margins are naturally lower than Rental given the higher proportion of capital-light services, there is also a drag because of the underperforming projects that Ian referred to. Operating EBIT is up modestly on FY '21 and operating NPAT is up 22% to $69 million, driven by the significantly lower interest expense from the note refi we did earlier in the year. A reconciliation between our statutory and operating numbers are on Slide 23 in the appendix. Turning to Slide 11 and cash flow. The key call-out here is that we generated $67 million of free cash flow before any gross capital. There was strong cash conversion at 96% after adjusting for the $11 million working capital build. Cash collection and data management is strong. Working capital was largely built in the first half to support Pit N Portal growth. We also increased inventory levels to mitigate against supply chain risks created by COVID. You can see the annual interest savings following the note refi bringing down our annual interest cost to $20 million. And sustaining capital expenditure was as per our preannouncement in June. $25 million of this was spent on replacement assets, and there was a 6% increase in capitalized rebuilds largely due to inflation. We spent $17 million on growth capital, of which $5.6 million was spent in the second half to opportunistically acquire a fleet of midlife asset cores. And you can read up more on the midlife asset cores in our presentation, which was released a couple of months ago in mid-June. With the remaining free cash of $48 million, almost $30 million of this was used to fund capital management initiatives during the year. This equated to a payout of 35% of operating impact for dividends and buybacks, at the top end of the Board's stated policy of 25% to 40%. And then an additional $7.6 million was spent on share repurchases on top of this. Turning to Slide 12, our balance sheet. Leverage remains at our long-term target of 1x whilst still funding sustaining replacement and growth capital as well as capital management. We have good liquidity with $60 million on this balance sheet and our undrawn revolving credit facility of $97 million. As mentioned, we refinanced our U.S. notes with Aussie dollar notes at the beginning of the financial year at a fixed rate of 6.25%. This is a 5-year note, which matures in FY '27, so we still have 4 years of tenure remaining, and we'll continue to look at ways to improve our capital structure. Back to you, Ian, for the divisional overview.

Thanks, Thao. Thanks. Now turning to Slide 14 and our Rental division overview. I'm pleased to report that our Rental business has achieved revenue growth of 7% and EBITDA growth of 5%. This has been achieved for the deployment of assets throughout Australia, driving gross utilization to 92%, up from 87%. Operating utilization has remained subdued at 60% despite strong demand due to COVID-related disruptions, operator shortages in the West and extreme weather in the East. While this has been frustrating, our fleet is now placed into projects where we're confident operating utilization and earnings will increase as conditions normalize. Margins were held pretty close to flat during the year for our disciplined cost management and extensive use of force to rebuild our equipment and components. This is a solid outcome given the inflationary cost pressures and shows the resilience of the business model we've created. We secured fully maintained projects in both East and the West, in line with our strategy and made good progress in rolling out EOS to new and existing projects. Going into FY '23, we expect further growth as operating conditions normalize. The fleet has plenty of capacity for increased earnings, as shown in the graph on the left-hand side of Slide 13, which compares current earnings and operating utilization to pre-COVID levels. We'll maintain our usual disciplined approach to cost and business improvement initiatives to manage inflation. This is where Force comes into its own as a key part of our strategy. With cost advantage in maintenance and rebuilds for our in-house capability, we use this capability to outperform our competitors and to deliver value to our customers. We're confident we'll get rate increases where we extend and sign new contracts. In existing contracts, we also have the protection of rise and fall mechanisms that help us with cost increases. We anticipate margins in Rental to remain steady in FY '23, which shows the resilience of our business model given the inflationary cost pressure. Turning to Slide 15. Eastern regions worked hard to place equipment into new projects in FY '22. Gross utilization has increased from 86% in FY '21 to 92% in FY '22. Momentum created in the first half of FY '22 carried through to the second half as the team kicked off new projects in coal and copper. Whilst operating utilization has increased from 59% to 62%, there remains significant capacity to work the Eastern region fleet harder to reach the pre-COVID high of 72% operating utilization. We're well set up in the East with most of our high-value assets now work in the right customers and the right projects will drive operating hours higher. With our continued discipline on cost and pricing, we see good growth in FY '23. Slide 16 shows the performance of the Western region. The Western region achieved another strong year of growth, reflecting the successful deployment of assets transferred from the East, driving up gross utilization to 91% from 89%. However, operating utilization remains 59% compared to 58% in FY '21, reflecting work harder. Once the operator shortage improves and COVID disruptions dissipate, we expect a lift in earnings as operating utilization builds, particularly as we get assets to work in double shift projects. The Western region team will be focused on increasing service levels and expanding our EOS offering in FY '23, areas where we feel we are clearly differentiated from our competitors and provide our customers the most [indiscernible]. We're very excited about the new EOS module that helps customers track and manage their carbon optimization projects. I want to reiterate that over the longer term, we see the Western region margins increasing in line with those achieved in the East as we increase the proportion of fleet deployed into double shift projects. Turning to Pit N Portal on Slide 17. We acquired Pit N Portal as part of our diversification strategy into services and to broaden our commodity exposure and customer value proposition. Since we acquired the business in March 2020, just in time for COVID, Pit N Portal has more than doubled in revenue. This is a significant achievement, particularly given COVID, hard borders, and extremely tight labor market. The growth in Pit N Portal has been achieved through new project wins in underground rental and services and successful expansion in the open cut projects utilizing the Western region rental fleet. The base PNP business is performing well, having won and executed well on the majority of its projects and delivering financial results according to plan. As noted earlier, we continue to experience disappointing results and a major project, which is impacting overall returns and margins of the Pit N Portal business. We've invested significant management time to address these issues and will advance in a renegotiation of the contract. Our objective is to agree on the revised terms and rates to create value and certainty for both parties. This will enable Pit N Portal to achieve growth and earnings in margins -- growth in earnings and in margins in FY '23. Looking at Slide 18 and the Force workshops. Force is an integral part of our strategy with the highest quality and lowest cost provider of open cut open cut and underground mining equipment. Force activity increased 12% as both retail and internal rebuild works grew during the year. Retail revenue grew by 17% as Force continues to provide customers excellent value and earnings grew by 11%. Force did an exceptional job to hold margins steady in an inflationary environment. You may recall, we acquired a line boring business, Borex, at the beginning of FY '22. Borex provides force in Emeco internal savings as well as retail earnings and exposure to new customers. The integration of Borex has gone really well. This has been an effective vertical integration acquisition that has improved our core capability and provided the group with cost benefits. As utilization increases in FY '23, we expect more internal activity as we are forced to provide Emeco and Pit N Portal a cost and quality strategic advantage and manage inflationary costs. We expect retail work to continue to grow, and we anticipate margins to remain broadly flat. Turning to Slide 20 and our strategy. You're all familiar with the slide and our strategy, so I won't spend too much time on it. But the key point I want to make is that all the work we've undertaken in the past several years to rebuild our balance sheet, widen our value proposition, diversify our commodity and customer mix and drive hard to become the highest quality and lowest cost provider of open cut and underground mining equipment, now place us in a strong position to deliver earnings growth to drive shareholder returns. Our EPS growth of 3x compared to FY '21 demonstrates this work is paying off. We have our rental fleet placed in the right projects to achieve increased utilization and earnings. We're managing the inflationary environment for the use of force, disciplined cost management and continuous improvement projects. We're pushing rate rises where possible. We're nearing a resolution at our underperforming major project that will see Pit N Portal deliver the sort of returns we have planned when we acquired the business. Our cash flow generation and balance sheet strength gives the ability to reinvest in our fleet, to take advantage of growth opportunities and to fund capital management. We're excited about our prospects in FY '23 and beyond. With that, I'll hand over to questions.

[Operator Instructions] Your first question is from the line of Nicholas Rawlinson from Jefferies.

So you delivered growth in all operating divisions this year, and you've given an outlook statement [ to that effect ]. Any comment on how FY '23 growth will compare to FY '22? Because it feels like everything is a bit more positive this time around.

Yes, Nicholas, thanks for dialing in. Yes, I agree with you. I believe that FY '23 growth will outpace FY '22 growth.

Okay. Just a couple of follow-ups. One of your key competitors on both the East and West Coast is still seeing a bit of a rental squeeze with available fleet dropping massively in the last few months. Has that changed conversations with customers around minimum hours or rates?

Yes. Well, look, Nicholas, I agree with those sentiments. We're seeing the same thing. We're seeing supply/demand tighten. And I mentioned in our presentation that we're confident of achieving rate increases as we extend projects and as we take on new projects. So I agree with the sentiment you're expressing there.

Okay. Great. And on operating utilization in the Western region, what do you think is achievable there? You touched on what was your previous high in the Eastern region, but just wondering what you think for the Western region.

Yes. So Western region, about 58% now. Look, I think that the Western region is on a journey, is on a journey of creating more double shift projects, creating more EOS projects. And the growth in the West has been quite -- obviously aided by us transferring equipment over from the East to get commodity diversification, but the growth has been excellent. The team is doing a great job. I expect the West operating utilization to build into the mid-60s. I'm not sure if we'll get there next year. There's obviously a lot of variables with COVID and labor shortages in the West, which are holding us back a bit, but ultimately, I can see the West pushing out towards the high 60s ultimately long term and pushing their margins up into the 50s and higher to be more aligned with the Eastern region business.

Okay. Great. Just 1 last 1 for me. How many months of underperformance of that Pit N Portal contract did you have in FY '22?

12.

The whole time? Okay.

Yes.

The next question is from the line of Mitchell Sonogan from Macquarie.

Yes. Just following on just quickly on Mincor there, also the project that -- just in terms of the broader labor environment. It's obviously pretty tough out there for all operators, particularly in WA, but yes, just looking out. And I guess the projects that you're working on or tendering for, does it sort of change how you think about which projects you're chasing, whether you're sort of switching more from looking at contract mining more back into rental? Can you maybe just touch on how you're thinking about the growth prospects in the business over the next 12 months given the environment?

Good question, Mitch. Again, the Mincor project has been difficult for us. I just want to make clear that Pit N Portal guys did this thing back in 2019. It was delayed for quite a while because of COVID and ramped up quickly. Pit N Portal have done a magnificent job, I believe. I've been proud of them in the way their performance worked that made the way they have chucked resources harder. And to be perfectly honest, I think Mincor have been helpful for us as well. There's been some allowances to help us out with inflationary labor. But structurally, the project needs to be reconstruction. From a risk reward and a rate perspective, it's not stacking up. So I'm very, very grateful that Mincor have allowed us the opportunity in this first quarter of FY '23 to renegotiate this project and have that renegotiation verified by an independent source. So very grateful for Mincor and supportive, although we've really sort of ground this out together over the last couple of years and I appreciate the opportunity to address this. As far as how we select projects moving forward, it is wise. I mean Pit N Portal really ramped up, I mean like doubling their revenue. I said that we bought them just in time for COVID, best time for them to more than double in that area. It shows that they've got growth capability and they can win work. And I think they've done a fantastic job building their workforce in this very, very tight labor market. Steve Versteegen is an excellent operator. The project he's taken on since Mincor have been quite selective, which is paid more to our skill set or providing value in smaller type development jobs and a really good job with that. And also where we can increase our underground rental, we will as well. But also, I'd like to grow this Pit N Portal business. We do have some East Coast underground operations at the moment. I would like to grow it further on in the Eastern region. Yes, I think that's been very sensible in the projects that I've selected and we'll continue to be so moving forward.

Yes. Maybe just jumping on to the East Coast there. And you mentioned some East Coast underground projects for Pit N Portal. Can you maybe just touch on the upcoming potential projects and what you're looking at in particular states or commodities? And also just a final 1 there on the East Coast side. Can you maybe just touch on the broader demand environment from the coal customers in Queensland and New South Wales? Obviously, price has been quite strong for some time, but weather has been impacting, obviously, the actual operations there. But can you maybe just touch on how you're seeing that broad sector?

Yes, Mitch, a couple of questions there. Firstly, I'll address the Pit N Portal on the East Coast. Steve's been spending a bit of time over in [indiscernible]. There's opportunities for rental there and services, more sort of higher services roles than contracting, but we see good opportunity there. As far as how we see the East Coast, look, I think we're in a really good position with coal. I mean we've diversified our coal exposure over time, but we feel good about it going forward and we're certainly not shy to put some gear to work into coal. I mean the environment of coal with ESG concerns, particularly around financing and raising debt, I think creates opportunity for us. And I think the change in coal market with some Tier 1s exiting coal, and some more sort of private companies -- private equity companies coming into coal, creates an opportunity for us where we can deliver the equipment, we can deliver a maintenance solution and take a lot of risk out of these projects, not from just a financing but an execution perspective for these customers. So yes, look, I'm really excited about the East Coast and coal moving forward. I think it really suits our business model.