Company Overview: Service Stream Limited (ASX: SSM) is engaged in the provision of essential network services, including access, design, building, installation and maintenance. The company’s principal services are divided into four operating segments, including Fixed Communications, providing a wide range of operations, maintenance, installation, design and construction services to the owners of fixed-line telecommunication networks in Australia, Network Construction, providing design, construction and associated services to the owners of fixed-line and wireless telecommunications networks, Energy & Water, providing specialist metering, new energy and inspection services to gas, water and electricity network owners and other customers, and Comdain Infrastructure, providing operations, maintenance, design and construction services to gas and water network owners and operators.


SSM Details

FY20 EBITDA to be Higher than FY19 Despite COVID-19 Related Challenges: Service Stream Limited (ASX: SSM) is engaged in the provision of essential network services, including access, design, building, installation and maintenance. In FY19, the company reported another year of growth across key profitability measures. Key highlight for the year was the acquisition of Comdain Infrastructure in January 2019 and the benefits derived out of the same during the second half. Group revenue for the period increased by 35%, driven by growth in the Telecommunications and Utilities segments, coupled with growth from the acquisition of Comdain Infrastructure. Total revenue from the telecommunications division came in at $587.81 million and that from the Utilities division came in at $273.42 million. EBITDA for the period improved by 33% on a year-on-year basis. Net profit after tax went up by 21% on the prior corresponding period, attributable to an improvement in EBIT, offset by higher net financing costs associated with an increase in the size and utilisation of the financing facilities of the Group from the acquisition of Comdain Infrastructure. The company declared a final dividend of 5.5 cents per share in FY19, with total dividend for the year amounting to 9 cents per share, as compared to 7.5 cents in the previous year.


Key Financials (Source: Company Reports, Thomson Reuters)
 
FY19 was marked by continued consistency of service delivery under Telecommunications’ various contracts with nbn co and the nbn Business Deployment on Demand (BDoD) contract secured during the year. Under the OMMA contract with nbn co, the company completed the activation of 727,000 new customers, as compared to 787,000 in the previous year. The Board noted the future prospects of the Wireless business in respect of 5G design and construction opportunities and those for the Comdain Infrastructure business and is aligning its activities with the strategic plan.

1HFY20 was another profitable period, with adjusted NPAT rising by 28% on Y-o-Y basis. The period was marked by a solid cashflow performance, with dividends for the six months amounting to 4.0 cents per share (fully-franked).

The Board expects that the demand for essential network services will continue to strengthen in the medium term. In such a scenario, the business seems well-positioned to capitalize on both organic and acquisitive growth opportunities and deliver value for shareholders. Dividend paid in FY19 was in line with the Group’s progressive dividend policy approach and the Board is continuously reviewing the Group’s capital management strategy to maximize returns to shareholders.

1HFY20 Performance Highlights: During the half year ended 31^st December 2019, revenue came in at $497.8 million, up 43% on pcp, and EBITDA from operations stood at $58.1 million, up 50% on pcp. The telecommunications division contributed $45.3 million of EBITDA, with a margin of 15.2% on revenue, driven by favourable impacts arising from the adoption of AASB 16 Leases, the profitable wind-up of nbn D&C operations and a favourable work mix. EBITDA from the Utilities division came in at $15.5 million, with a margin of 7.8%. EBITDA margin for the Utilities division was 2.8% lower than pcp due to the inclusion of lower margin revenue from Comdain Infrastructure and the impact of one-time bid and JV establishment costs in relation to the successful 10-year Sydney Water tender opportunity. NPAT for the period increased by 28% and came in at $32.3 million, with each of the business units performing in line with expectations. The company declared an interim dividend of 4 cents per share, paid on 19^th March 2020.


1HFY20 Financial Highlights (Source: Company Reports)
 
Financial Position: During the first half, the company generated operating cashflow before interest and tax amounting to $32.8 million, as compared to $26.4 million in pcp. Significant cashflows for the period included net financing costs, tax payments, net capital expenditure, dividends, lease liability payments, lease incentive receipts, etc. At the end of the period, the company had net debt amounting to $4 million, with borrowings, finance lease and cash-on-hand amounting to $60 million, $0.1 million, and $56.1 million, respectively.
 
COVID-19 Business Update: The company notified that despite the current economic environment, demand for its services has remained strong as it is classified as an essential service provider. However, there have been certain negative impacts in relation to increased costs to safely deliver field-based operations, disruptions to some work programs, and the delayed commencement of individual minor projects.
 
As an essential service provider, the company remained safe on the demand front and continued to witness increased demand for its services. The current uncertain environment has hit every business and the resilient players have continued to operate with minimum disruptions. Service Stream Limited has a strong financial position and seems well-positioned to deal with such a crisis. A robust demand scenario and strong financial position will help the company capture the market with its excellent capabilities.
 
Top 10 Shareholders: The top 10 shareholders have been highlighted in the table, which together form around 29.18% of the total shareholding.


Top 10 Shareholders (Source: Refinitiv, Thomson Reuters)
 
A Quick Look at Key Ratios: In 1HFY20, the company had a gross margin of 94.1%, higher than the industry median of 15.1% and 2HFY19 gross margin of 93.8%. EBITDA margin for the half stood at 11.6%, as compared to the industry median and 2HFY19 margin of 8.3% and 10.8%, respectively. Net margin for the half also improved slightly in comparison to the previous half and stood at 5.5%. Net margin was also higher than the industry median of 2.7%, implying decent profitability in comparison to the broader industry. Current ratio for the half stood at 1.35x, as compared to the industry median of 1.08x, depicting a decent liquidity position. Debt/Equity ratio came in at 0.30x, implying low levels of debt and financial strength of the business.


Key Metrics (Source: Refinitiv, Thomson Reuters)
 
Decent Dividend History: Over the period covering FY15 – FY19, the company has reported a CAGR of 56.5% in dividends paid, with FY15 and FY19 dividend amounting to 1.5 cents and 9.0 cents, respectively. Payout ratio based on adjusted EPS over the 4 years period has increased from 49.5% in FY15 to 59.4% in FY19. In 1HFY20, the company declared a dividend amounting to 4 cents per share, up 14% on the prior corresponding half. Over the previous 10 halves, starting from 1HFY15, the company has demonstrated a decent dividend trajectory as shown in the below image. Service Stream Limited’s business strategies seem well aligned with its progressive dividend policy approach and will support continued shareholder returns in the future.


Dividend History (Source: Company Reports)
 
Key Risks: The business is exposed to a number of risks that may hinder the fulfillment of its objectives in the near term. The group’s exposure to a small number of key customers and infrastructure programs can impact the revenue and profitability due to delays or disruption on the client’s front. As a result, the company is focused on building a diversified revenue stream and reducing customer concentration, through acquisitions, such as Comdain Infrastructure. Another risk relates to the lack of volume commitment in its customer contracts, which causes uncertainty in determining the revenue forecast. Although the company has been successful in renewing and extending majority of its customer contracts, the uncertainty regarding renewal of contracts remains a key risk for the business.

Outlook & Guidance: For FY20, the company expects EBITDA from operations to be ~$108 million, depicting low double-digit growth on FY19 EBITDA. The company has been working closely with its clients throughout the current crisis to support their critical network infrastructure. Although some clients have temporarily delayed work programs, the company remains in a strong position with a healthy contracted pipeline of ongoing work across a blue-chip client base. While the company expects COVID-19 to impact the business at least till early FY21, it anticipates that demand for its services will continue to strengthen and will support business growth once the COVID-19 dust settles.


Key Valuation Metrics (Source: Refinitiv, Thomson Reuters)

Valuation Methodology: EV/EBITDA Multiple Based Relative Valuation (Illustrative) 

EV/EBITDA Multiple Based Relative Valuation (Source: Refinitiv, Thomson Reuters)

Note: All the forecasted figures are taken from Thomson Reuters, NTM: Next Twelve Months

Stock Recommendation: Over the past six months, the company’s stock has corrected by 26.32% and is inclined towards its 52-weeks low price of $1.535, offering a decent opportunity for accumulation. During 1HFY20, the company delivered a robust financial performance. The company has a strong liquidity position to weather the impacts of COVID-19 and is supported by a strong demand for its services. It is continuously engaged in identifying expansion opportunities and aims to diversify its revenue stream through acquisitions. We have valued the stock using EV/EBITDA multiple based illustrative relative valuation method and have arrived at a target price with low double-digit upside (in % terms). Considering the 1HFY20 performance, strong balance sheet position, decent EBITDA guidance, work pipeline, and current trading levels, we give a “Buy” recommendation on the stock at the current market price of $1.865, down by 4.847% on 25 June 2020. 


SSM Daily Technical Chart (Source: Refinitiv, Thomson Reuters)

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