Durny, Don't forget that there are seasonal aspects to the...

Durny,

Don't forget that there are seasonal aspects to the business, so the DH is normally weaker than the June half due to the Christmas period, and it was more pronounced in the past half year due to the fact that because Christmas day fell on the Tuesday, most of SKE's clients stopped work on the prior Friday, so they lost a few billing days compared to other years.

The seasonality is evident in the ratio of Employee Expenses to Revenue over half years, where the DH ratio is around 1% higher than that of the JH:
JH09: 84.1%
DH09: 86.5%
JH10: 86.2%
DH10: 87.9%
JH11: 87.8%
DH11: 88.3%
JH12: 88.7%
DH12: 89.5%

As you can see, in the last half Employee Expenses as a % of Revenue is 80 basis points higher than June half of 2012.

Now you might be tempted to say, “well that’s negligible, surely?”.

Well, no, not really: when you consider that half-yearly revenues are of the order of magnitude of almost a billion dollars, it becomes evident that 80bp translates into $7m or $8m swings at the EBITDA line.

So to have held financial performance in the December half on par with the June half given this natural seasonality, as well as considering the dramatic slowdown in the resources sector in the December half, I think reflects a very credible and impressive result.

I’ll wager few people will be aware that, after adjusting for the $1.4m in restructuring costs that were taken above the line, this is a record half-year NPAT result.

That, I think, speaks volumes about both the underlying strength of the franchise as well as the way the business is being run.

Naively, many people (lazily) dismiss SKE as a price-taking, low-margin, mining services contractor, but I’ve always held the view that these guys are for more the architects of their own financial destiny than they get credited.


The one niggle I had when I looked at the financial statements was the significant ($40m) investment in creditors, which resulted in no Operating Cash Flow coming out of the business in the half.

However, just listening to the result presentation confirms that this was purely a timing issue (related – again – the day on which Christmas fell, and the fact that most clients closed off their books on the prior Friday, yet employees still had to be paid).

The company has confirmed that payments of $30m were received in early January.

Slide 8 in the presentation pack shows the trend in average NIBD, which is probably a better measure of the trends in the condition of the balance sheet given the OCF seasonality.

By my modelling, at the current dividend payout ratio of around 60%, SKE will be debt-free in 18 months’ time.
Which, of course, won’t happen, because the payout ratio will obviously continue to flex upwards, as it has done over the past two years since the re-instatement of dividends.

Given the cash surplus capital generating abilities of the business, SKE can afford 90% dividend payout ratios and the balance sheet will still remain on a even keel.

The 4% revenue uplift in the half vs DH11, and the 2% rise vs JH12, against the backdrop of a very tough business environment speaks to me about market share gains.

And, most importantly, this clearly hasn’t come about via aggressive price discounting given that the EBIT margin in the half reaching an all-time high, exceeding even the levels of the pre-GFC boom period.

I note that consensus EBITDA forecasts are around $96m for FY13 (in other words, a LOWER June half EBITDA, which certainly isn’t going to happen), and around $102m for FY14.

With further market share gains highly likely, and with additional ($5m) cost reductions to be delivered in the coming twelve months, my view is that consensus view for FY13 EBITDA will need to be revised to around $100m, and for FY14 closer to the $107m/$108m mark.

That will place the stock on the following undemanding valuation metrics:

P/E = 11.3x
EV/EBITDA = 7.2x
DY = 6.7% (assuming the POR continues rising to 75%)
FCF yield on EV of 8%

I think SKE will continue to increase in intrinsic value for some time to come, with the attendant wealth creation for its owners.

It will remain one of my largest holdings.

With a management team that understands the paths to, the mechanisms for, and the determinants of, SHAREHOLDER VALUE CREATION, I can sleep really easy at night being a shareholder in Skilled Group.

Skilled by name, and skillful by nature, I reckon!


Cam