Under valued, page-6

I’ve spent some time going through the SKE numbers and listening to the results presentation and thought I’d share what I found and what I thought of what I found.
Right up front I want to advise you that I am just a humble investor and nothing here is meant as investment advice. And yes I am a SKE shareholder.

Div first half FY14: 7.5c Div second half FY14: 9.5c Total FY14: 17.0c (FY13: 16.0c)
POR of 72% based on FY14 Underlying earnings.
Price prior to FY14 ann: $2.50 Div yield based on FY14: 6.80%ff
Price at close on Friday: $2.68 Div yield based on FY14: 6.34%ff
PE based on FY14 Underlying earnings: 11.36 at Friday’s close.


The “headline” figures in the FY14 report can be misleading if you don’t dig a little deeper.
The headline figures read like this:
FY13 FY14
Reported NPAT: $56.2m $44.2m
Net debt: $44.8m $170.1m
Reported EPS: 24.1c 18.9c
Not a great look. However just a tiny bit of digging gives a different view of where SKE is at.

FY13 FY14
Underlying NPAT: $58.4m $55.3m
Underlying NPAT margin: 5.1% 5.1%
Underlying EPS: 25.0c 23.6c

How did they get from “Underlying” to “Reported” ?

Underlying NPAT $55.3m
Minus $3.0m = Redundancy and branch closure. Costs incurred to realise $15m cost saving in FY14.
Minus $4.0m = Acquisition and integration costs. Thomas & Coffey acq costs and Broadsword integration costs.
Minus $6.2m = Amortisation of acquired intangibles (non-cash). Non-cash amortisation of customer contracts in relation to Broadsword acquisition and increase in OMSA investment.
Minus $1.3m = Notional interest on deferred consideration (non-cash). Non-cash notional interest expense on Broadsword deferred consideration recognised at NPV on acquisition.
Plus $3.4m = Tax on reconciling items. Tax expense on above items, where relevant.
Reported NPAT $44.2m

When you look through that list it isn’t difficult to work out that a lot of the cost will be at very least, much reduced in FY15. In FY13 Underlying NPAT was $58.4m with redundancy & branch closure costs of $2.5m, Acquisition costs of only $0.614m and amortization of intangibles of just $0.63m resulting in a reported NPAT of $56.2m.


The following are take aways from the FY14 profit announcement:

….with second half revenue 6.7% higher than the first half. Underlying EBITDA margin was maintained at 5.1%.
The strategy to invest in more attractive, higher growth sectors… The strong run-rate achieved in the second half is expected to continue into FY15.
…..implementing system and process efficiencies, contributing to a further $15 million sustainable cost reduction.
Engineering and Marine Services:
Activity levels in ATIVO improved in the second half
Thomas & Coffey, acquired in February 2014, is performing well..
Mobilisation of the Saipem contract commenced in the fourth quarter, with the majority of activity scheduled to occur in FY15
Broadsword Marine Services contributed $16.6 million EBITDA, in line with expectations. The business experienced a high level of vessel utilisation in the second half and has a strong pipeline of work, including mining and infrastructure related projects.
Overall, the strong second half run-rate achieved in Engineering and Marine Services is expected to continue into FY15. There is a strong pipeline of opportunities, including recent contract wins.
Workforce Services:
Underlying activity levels stabilised in the second half…
Volumes in Workforce Services continued to benefit from supplier consolidation in mining and FMCG sectors.
The pipeline of infrastructure projects and re-setting of NBN activity is expected to support future growth.
Technical Professionals:
Swan revenue and contractor numbers declined significantly across the year, affected by reduced engineering project activity. However, contractor numbers appear to have stabilised towards the end of the second half.
The cost base in this segment was lowered significantly during FY14 in response to the ongoing difficult market conditions.
Strategy:
Capability to recruit and mobilise large scale projects: The provision of manning services to the pipe-laying phase of the Ichthys LNG (Saipem) project is progressing well, with the first vessel already mobilised and the second vessel scheduled to be mobilised in 1H15. Approximately 1,000 construction and marine personnel are expected to be placed through SKILLED’s involvement in the project.
A reduction in indirect costs of $15 million (with $3.0 million in associated restructuring costs) was achieved this year, delivering $41 million in sustainable cost reductions over the past three years. It is expected that a further reduction of approximately $10 million will be delivered in FY15.
SKILLED Engineering, …. It has significant exposure to the mining & resources segment, with activity aligned to production volumes rather than commodity prices.
Outlook
The stronger second half FY14 trends are expected to continue into FY15, despite external market challenges:
• Engineering & Marine Services: the contribution from the Saipem project will offset reduced activity from the OMSA JV. A full year contribution from Thomas & Coffey and growth in Broadsword will support FY15 earnings. Growth is also expected from increased activity levels, new contract wins and a visible pipeline of opportunities.
• Workforce Services: overall activity levels appear to have stabilised, with wins in FMCG, mining & resources and transport & logistics, however margin pressure is expected to continue.



** Having listened to the results presentation and the associated question time I came away with the following observations:

With the acquisition of Broadsword and Thomas & Coffey they have gone from a $10m-$12m Capex per year company to a $15m-$20m Capex per year company. (Note FY14 Capex was $51m which included $38m spent on new vessels – I think it is fair to assume that FY15 Capex will be back within the $15m-$20m range).

On the matter of those vessels; Vessel utilization was strong in the second half – particularly in the LAST QUARTER. Also worth noting, a number of new vessels have only come on line late in FY14. A quote from the results on Broadsword; “FY15 earnings likely higher than FY14”.
The company confidently expect to deliver $10ml cost out in FY15.

When pushed on the matter of acquisitions: Never say never, but there is nothing imminent. However they are discussing how they grow the International business.

What I’ve taken away from all of this;
I’m very impressed with managements ability to not only find “good” acquisitions (high margin, synergies and a reasonable fit) but even more so the ability to intergrate them. I’m also pleased that they were proactive very early on when the ‘old’ business looked like it was headed for trouble. Post the GFC it would have been easy to sit back and not want to increase debt.
On working capital – It is to peak mid FY15 in line with Saipem project and reduce toward the end of FY15.

I don’t for a minute shy away from the fact that in Workforce Services & Technical Professionals that revenues have been sliding away along with margins. Even in the second half things got worse. I’m heartened by cost savings and talk of a stabilisation in the situation. There is also the undeniable fact that a number of smaller competitors have “fallen away” recently. I think it’s best to assume that things will get worse before they get better.

To offset this situation, Engineering and Marine Services revenue was up very strongly. Particularly in the second half. And in this higher margin group – margins were up and particularly strong in the second half. It is to be remembered that Thomas and Coffey has only contributed since February and that a number of the new vessels came on line late in FY14. Also worth remembering that in a strong half for this arm of the business that the last quarter was particularly strong.

Probably the most alarming thing to come out of the announcements was that chief executive Michael McMahon has announced he’ll step down after the 2015 AGM. I’m personally glad he’ll be around for another 14 months to guide the company. I don’t mind saying that I think he’s done a commendable job during his time with Skilled Group. Particularly given what he was handed when he arrived.

In conclusion: I think it is a company where one arm of the business is really gaining traction and other very important arms are hopefully nearing the bottom of a difficult cycle. It has a very good management team and a good cash flow – allowing it to pay a fully franked div yield of well over 6%. I’m very happy to hold. And the markets will decide what they are willing to pay. I believe there is still reason for the share price to move closer to $3.

As an aside. This from the Fin Rev on the 1st of Aug. Two thirds of stocks in the ASX200 index attracted additional shorting over the past week. Flight Centre, SKILLED GROUP, Kathmandu, Arrium, Kingsgate and Fortescue Metals were amongst the most popular stocks to short sell. SKE share price during that period $2.45 to $2.55.

Very keen to hear what others think of SKE.