Aecon Group Inc

TSX:ARE

Earnings Call Transcript 2023-Q1

[Operator]

Good morning. Thank you for attending today's Q1 2023 Aecon Group, Incorporated Earnings Call. My name is Bailey, and I will be your moderator for today's call. [Operator Instructions] It is now my pleasure to pass the conference over to our host, Adam Borgatti, Senior Vice President of Corporate Development and Investor Relations. Mr. Borgatti, please proceed.

[Adam Borgatti, executive]

Thank you, Bailey. Good morning, everyone, and thanks for participating in our first quarter results conference call. This is Adam Borgatti speaking. And presenting to you this morning are Jean-Louis Servranckx, President and CEO; and David Smales, Executive Vice President and CFO. Our earnings announcement was released yesterday evening, and we posted a slide presentation on the Investing section of our website, which we will refer to during this call. [Operator Instructions]As noted on slide two of the presentation, listeners are reminded that the information we're sharing with you today includes forward-looking statements. These statements are based on assumptions that are subject to significant risks and uncertainties. Although Aecon believes the expectations reflected in these statements are reasonable, we can give no assurance that these expectations will prove to be correct.With that, I'll now turn the call over to Dave.

[David Smales, executive]

Thanks, Adam, and good morning, everyone. I'll touch briefly on Aecon's consolidated results, review results by segment and then address Aecon's financial position before turning the call over to Jean-Louis. Turning to slide 3; revenue for the first quarter of CAD1.1 billion was CAD121 million or 12% higher compared to the same period last year. Adjusted EBITDA of CAD25 million, a margin of 2.2% compared to CAD21 million, a margin of 2.1% last year and operating profit of CAD6 million compared to an operating loss of CAD10 million. Diluted loss per share in the quarter of CAD0.15 compared to diluted loss per share of CAD0.29 in the same period last year.Reported backlog of CAD6 billion at the end of the quarter compared to backlog of CAD6.4 billion at the end of the first quarter of 2022. New contract awards of CAD812 million were booked in the quarter compared to CAD1.2 billion in the prior period. Now looking at results by segment; turning to slide 4; Construction revenue of CAD1.1 billion in the first quarter was CAD119 million or 12% higher than the same period last year. Revenue was higher in each sector, with the largest increase being in civil operations primarily from an increase in major projects in both Eastern and Western Canada.In Industrial Operations, higher revenue due to increased activity on mainline pipeline work and higher field construction work at mining and wastewater facilities in Western Canada, partially offset by a lower volume of field construction work at chemical facilities in Eastern Canada. Higher revenue in nuclear operations was driven by an increased volume of refurbishment work in Ontario and the U.S. In Utilities from an increased volume of telecommunications and electrical transmission work, partially offset by a lower volume of oil and gas distribution work and in Urban Transportation Solutions, driven primarily by higher volume of work related to rail electrification in Ontario.New contract awards of CAD795 million in the first quarter were CAD398 million lower than the prior period. Backlog at the end of the quarter of CAD5.9 billion compared to CAD6.3 billion at the same time last year. Adjusted EBITDA in the Construction segment were CAD22 million, a margin of 2% compared to CAD19 million, also a margin of 2% in Q1 last year. Adjusted EBITDA increased by CAD3 million, primarily from higher volume and gross profit margin in Industrial and Urban Transportation Solutions and from higher volume in Nuclear Operations. Turning to slide 6; Concessions revenue for the first quarter was CAD17 million compared to CAD14 million in the same period last year, primarily due to an increase in airport operations at the Bermuda International Airport.Bermuda continues to operate at a reduced volume compared to pre-pandemic levels but continue to recover in 2022 and the first quarter of 2023 from the more severe impacts experienced in 2020 and 2021. This recovery was evidenced in the first quarter of 2023 by the fact that traffic averaged 72% of at the pre-pandemic level in the first quarter of 2019 compared to average traffic in the first quarter of 2022 being just 43% of the pre-pandemic level. Adjusted EBITDA in the Concessions segment of CAD15 million compared to CAD14 million in Q1 2022, primarily due to results from the Bermuda Airport.Turning to slide 7; at the end of the first quarter, Aecon had a committed revolving credit facility of CAD600 million, of which CAD240 million was drawn and CAD10 million utilized for letters of credit. On December 31, 2023, convertible debentures with a face value of CAD184 million will mature and the company expects to repay these debentures at maturity or before.At this point, I'll turn the call over to Jean-Louis.

[Jean-Louis Servranckx, executive]

Thank you, Dave. I would like to take a brief moment to address the four large fixed-price legacy projects laid out in our latest disclosure documents. As a reminder, these four projects entered into in 2018 or earlier by joint ventures in which Aecon is a participant are being negatively impacted due to additional costs, for which the joint ventures assert that the owners are contractually responsible, including four among other things and foreseeable site conditions, third-party delays, COVID-19, supply chain disruptions and inflation-related to labor and materials.In the first quarter, Aecon recognized an operating loss of CAD2.8 million related to these four projects, which comprise 25% of consolidated revenue in the quarter and represented CAD801 million or 13% of backlog at March 31, 2023. Aecon and our partners continue to work towards resolution of compensation for these impacts with the respective project owners, and we are focused on pursuing all avenues for adequate and timely compensation with the objective to reach fair and reasonable settlement agreements and to move towards project completion in each case.As I've said before, this will take some time, but we are on it and constantly. Turning to slide 9; demand for Aecon Services across Canada continues to be strong, particularly in smaller and medium-sized projects. While volatile global and Canadian economic conditions are impacting inflation, interest rates and overall supply chain efficiency these factors have stabilized to some extent and have largely been and will continue to be reflected in the pricing and commercial terms of our recent and prospective project awards and bids.Turning to slide 10; with backlog of CAD6.0 billion at March 31, 2023, and recurring revenue programs continuing to see robust demand, driven by the utility sectors and ongoing recovery in airport traffic in Bermuda, Aecon believes it is positioned to achieve further revenue growth over the next few years. As a reminder, the major scope of the GO Rail Expansion On-Corridor Works Project, the Scarborough Subway Extension Project and the Darlington New Nuclear Project will only be reflected in backlog at the successful conclusion of the [indiscernible] development phases. Aecon, including joint venture in which we are a participant is also prequalified on a number of project bids due to be awarded during the next 12 months, another considerable pipeline of opportunities to further add to backlog over time.Trailing 12 months recurring revenue of CAD895 million was up 24% versus the prior period and 69% versus two years ago, primarily from growth in utilities operations. Recurring revenue is expected to continue to grow, driven by demand in the utility sector and the Concessions segment is expected to see airport traffic in Bermuda continue its recovery in 2023 and '24. Turning to slide 11; Aecon continues to support the energy transition to build and operate sustainable infrastructure. In February 2023, Aecon announced that the Oneida Energy Storage L.P. executed an agreement for the Oneida Energy Storage Project to deliver 250 megawatt 1,000 megawatt hour energy storage facility in Ontario.Aecon Concessions will be an equity partner in the Oneida L.P. upon financial close and Aecon was also awarded an EPC contract by Oneida L.P. to construct the facility. Projects as Oneida Energy Storage, GO Expansion On-Corridor Works, Scarborough Subway Extension and the Darlington New Nuclear Project demonstrates the path Aecon is on to embrace the opportunities and the increasing focus on energy transition, decarbonization and sustainability present. This is very much the future direction for Aecon, and we are excited by the progress made to-date in establishing ourselves in this space.Turning to slide 12; Aecon released its fourth Sustainability Report building a sustainable future last week, outlining our progress and key accomplishments in responsible ESG practices. This report highlights Aecon initiatives to embed sustainable innovations and work towards Net Zero construction throughout its operations. Aecon is pleased to report continued progress towards its target to achieve a 30% reduction in direct CO2 emissions by 2030 with a 14% direct reduction already achieved to-date by the end of 2022 on an intensity basis.Sustainability is part of our DNA at Aecon and a key consideration in every decision we make as we continue to focus on building what matters to enable future generations to thrive and transition to a Net Zero economy. Turning to slide 13 with strong demand, growing recurring revenue programs and diverse backlog in hand, Aecon is focused on achieving solid execution on this project and selectively adding to backlog through a disciplined bidding approach that supports long-term margin improvement in the Construction segment.In the Concessions segment, in addition to expecting an ongoing recovery at the Bermuda Airport through 2023 there are a number of opportunities to add to the existing portfolio of Canadian and International Concessions in the next 12 to 24 months, including projects with private sector clients that support a collective focus on sustainability and the transition to a Net Zero economy. The GO Expansion On-Corridor Works project and the Oneida Energy Storage Project are example of the role Aecon Concessions segment is playing in developing, operating and maintaining assets related to this transition.As previously announced on March 1, Aecon announced that it has entered into a definitive purchase agreement with Green Infrastructure Partners, under which Aecon has agreed to sell its ATE Road Building Aggregates and Materials business in Ontario for CAD235 million in cash. In addition, on March 15, Aecon announced that it has entered into an agreement with CC&L Infrastructure to sell a 49.9% interest in the Bermuda International Airport Concessionaire for $128.5 million in cash. Closing of these sales transactions is expected in the second quarter of 2023. Upon closing, Aecon expects to use the net proceeds from the transactions to pay down debt on its revolving credit facility.Thank you. We will now turn the call over to analysts for questions.

[Operator]

[Operator Instructions] Our first question today comes from the line of Michael Tupholme from TD Securities.

[Michael Tupholme, analyst]

For the GO Expansion On-Corridor Works Project and the Scarborough Subway Extension Project, I know neither of those is included in backlog. Two questions; I guess, first off, can you talk about how we should think about the expected revenue contribution from those two projects this year? And was there anything from those projects that contributed in Q1? And if so, can you quantify that for us?

[Jean-Louis Servranckx, executive]

Yes, I can give some elements of answers, I mean, to this question. We are in the middle of the development phases. For these two projects, it's been for GO transit, electrification and modernization and for Scarborough. Just to give you some color about it. I mean, on the GO Transit, there are, at the moment, more than 1,000 full-time employees working during this development phase. Scarborough, I would say, around 300 people working each time, Aecon represent between 25% and 50% of those people. In terms of revenue, although I mean this is what we are studying during the development phase, what was forecasted by the contracting authorities want to have construction work around CAD8 billion during a period of 8 years, more or less.And you will remember that we have a 28% participation in the operation during 25 years, which will make something like between CAD300 million and CAD400 million per year of operations of the network. All this will be confirmed at the end of the development phase that will probably take place for this big project at the end of 2024. For Scarborough, I would say it's too early. It was announced at a CapEx between CAD2 million and CAD3.5 billion by the owner. And we are just ramping up in the development phase. So we will know a little more later.

[Michael Tupholme, analyst]

Okay. That's helpful. Second question -- sorry, just a follow-up second question here regarding. Hello? Okay. Yeah, just a question about the recurring revenues within the company so you've seen strong growth in recurring revenues on a TTM basis for some time now. Just wondering how we should think about the growth potential in recurring revenues over the next couple of years, I guess, this year as we move through the year and then also into next year, if possible.

[Jean-Louis Servranckx, executive]

We basically are optimistic and those recurring revenue are driven first by our utility sector with constantly growing -- it's quite amazing to see. I mean, there's not one single month without brainstorming about new business lines, new activities, new initiatives, new innovation, I mean, in this utility sector. So this sector is growing. And for the rest by our airport operation as you have noticed, I mean, during the first quarter of 2023, we reached 72% of the activity pre-pandemic, and it's still growing, and we expect by the end of 2024 to have cut back pending level. So yes, we are expecting some growth. David, any addition to this.

[David Smales, executive]

The only thing I'd add is obviously the sale of half our interest in Bermuda will reduce the Bermuda piece, even though underlying traffic will continue to recover. But otherwise, as Jean-Louis said, the growth will really be driven by the Utilities business, which continues to be very strong and see good opportunities. A lot been built on the back of some of the small token acquisitions we've done over the last 5 or 6 years, where we're starting to see some sort of real traction in areas like electricity transmission and distribution as well as expanding our telecommunication work into the regions. So still lots of very positive tailwinds.

[Operator]

The next question today comes from the line of Chris Murray from ATB Capital Markets.

[Chris Murray, analyst]

So just following maybe on Mike's question a little bit, just thinking about revenue contribution from these things -- these projects not in backlog. Should -- is it fair to think in the development phase that it's going to be fairly de minimis revenue over the next little while or is somehow the work there getting some blended into the recurring revenue because a lot of it will be things like utility moves and things like that in advance.

[David Smales, executive]

Yeah. So it's not part of the recurring revenue, Chris on the basis that this isn't -- had a long-term Master Service Agreement-type arrangement like we have in utilities where these agreements go out for many years, and we do the same type of work year-in, year-out. This will all -- sort of won't go through recurring revenue. I mean it is relatively small compared to when we're getting to the execution phase of both those projects. They will still -- had some reasonable revenue in 2023 and 2024, just based on the recovery in terms of the people we have working on those projects, working through all the scoping and pricing and engineering, that's all being paid for and [ gross ] revenue, but it's, as you said, relatively small compared to where we gain to the execution phase. So more in the tens of millions than the hundreds of millions, let's put it out.

[Chris Murray, analyst]

Okay. That's helpful. And then just one quick kind of modeling follow-up question. On the divestitures that you guys have planned for Q2, I'm sure you've had a chance now to take a look at how you're going to do that on the financial structure. Dave, just tax, I'm assuming the airport, that's always been a lower zero tax jurisdiction. So am I right to think that there should be no tax impact on that one? And are there any -- do you have any tax deferrals or other pools that maybe you could draw from that we should be thinking about with the sale of ATE.

[David Smales, executive]

Yeah. So for both the tax implications are relatively minor compared to the overall proceeds, as you mentioned, well, virtually all of Bermuda will have no tax impact. And then on ATE, yes, in terms of how that's structured, there will be tax, but it won't be a huge number.

[Operator]

The next question today comes from the line of Gabriel Moreau from IA Capital Markets.

[Gabriel Moreau, analyst]

You state in your MD&A that you will be using the proceeds from the asset sale to reduce the leverage and repay the convertible debt. But can you comment on your other capital allocation priorities?

[David Smales, executive]

Yes. So in addition to that, we continue to be focused on the opportunity to add to the business in terms of smaller [indiscernible] acquisitions. We've been particularly active on that in the utility space. And I think we're seeing the benefit of that in terms of -- the numbers we talked earlier about recurring revenue and I referenced the fact that we're starting to see some real synergy from those, tuck-in acquisitions now. And I think we see lots more opportunities in that space. So that will continue to be a focus as well as maintaining the dividend policy, which is being a feature for us over the last decade or so. So that remains important. So those plus reducing leverage would be the main considerations.

[Gabriel Moreau, analyst]

Okay. So you could potentially use the proceeds for other short-term priorities.

[David Smales, executive]

Well, I'm not saying the short-term priorities. The growth of the business in areas like utilities through tuck-in M&A is part of our long-term strategy as is the dividend policy. So I think they're all part of the theme of where we see the business going and the huge opportunities we see in the market ahead of us.

[Operator]

[Operator Instructions] Our next question today comes from the line of Jonathan Lamers from Laurentian Bank.

[Jonathan Lamers, analyst]

Good morning. Following the sale of the minority interest in the Bermuda Airport, could you comment on the types of new infrastructure opportunities you plan to pursue in terms of which end markets are of interest or geographies?

[Jean-Louis Servranckx, executive]

Yes. Mainly speaking, as we have announced, we are extremely interested with the energy condition. It represents, I mean, different end segments, but the opportunities are huge, I mean, just take an example, for Ontario, as per the last ISO report, it's becoming clear that decarbonizing the grid by, let's say, 2050 required a system capacity of [ 8,000 ] megawatts. I just remind you that at the moment, Ontario at something like 40,000 megawatt. So the CapEx associated to this is about CAD400 billion so it will take time. But it's underway. I mean, just in nuclear, where Aecon is extremely strong it's 18,000 megawatts additional that has to be built during the next 25 years.So we are speaking about refurbishing. I mean, evidently, you probably have noticed that the refurbishment program where Aecon is working and going quite well. The second unit [indiscernible] being connected to the grid during the summer earlier and forecasted perfectly in the budget, the one [indiscernible] before the end of the year. So there is now a little more knowledge about what could be done at between and the decision will be taken during the year 2023. But it's also about new build. You know about the SMR contract, I mean on which we are engaged on alliance model with OPG, GE Hitachi and SNC, but also new large reactors.There's a lot to do. There's a lot to do to come back to Ontario on what we call the new northern hydro project. There's a lot to do in storage. It may be pump storage, it may be battery storage, I mean Aecon is very active in the field, construction and concession. It's also about hydrogen. So this is really where Aecon wants to be, and it's one of the main reasons for our divestiture of ATE. We just think that we can develop much better competitive advantage, I mean, in this energy transition, and we are working on this.

[Operator]

The next question today is a follow-up question from Michael Tupholme from TD Securities.

[Michael Tupholme, analyst]

I wanted to ask you about the margin profile of the backlog. Wondering if we exclude the four legacy fixed-price projects that have been negatively impacted by additional costs and we look at the remainder of the backlog. Can you just talk about what the margin profile of that remainder of the backlog looks like versus what it looked like about a year ago?

[David Smales, executive]

Yeah, we obviously don't give detailed margin guidance. But in terms of the overall profile, it's positive versus a year ago. If you kind of look at the areas where we're growing and the kind of projects we've been adding to backlog over the last year or so they tend to be in areas where there's a bit more predictability. So we've seen kind of fixed price level of backlog come down fairly significantly over the last 12 months. So that gives us a good view as to where we expect margins to be over the next little while. And we certainly expect them to be stronger over the next 12 to 24 months than they were over the previous 12 months.

[Michael Tupholme, analyst]

Okay. Perfect. And then one additional question. When we look at the backlog expected to be executed over the next 12 months currently sits around CAD3.1 billion, which I think is up slightly on a sequential basis. Is it possible to break that figure down between how much of that work is coming from the four fixed-price legacy projects versus all of the other work that would fall outside of those in terms of the composition of that CAD3.1 billion of next 12 months backlog.

[Jean-Louis Servranckx, executive]

Okay. Maybe I can add some elements for this. I mean to come back to your previous question it has to be clear that for Aecon, the topline is not an issue. I mean we have a strong backlog of CAD6 billion. I've always said that we are comfortable at this level of backlog plus our three progressive jobs, which are under development phases that will add something similar to CAD6 billion. So we are focused and your question was about margin in the backlog. We are absolutely focused on the quality of our backlog.It means the bottom line to increase the predictability of this bottom line. So this is our work every day. When we come back to these four legacy project, as announced, we still have something like CAD800 million in backlog for those projects -- of the total indicated of CAD6,000 million, it's something like 13%. On the most probable backlog after addition of the progressive job, I mean, it's around 6%. Three of those four projects are expected to be substantially completed before the end of 2023 or in the first quarter of 2024 with one remaining up to mid-2025. So this gives you more or less an idea of what is the share of revenue that will come from those projects.

[Operator]

The next question today comes from the line of Frederic Bastien from Raymond James.

[Frederic Bastien, analyst]

Good morning. Guys, there is growing momentum for the development of a high-speed rail network between Quebec City and Toronto. And that feels to me like the related work would be right in your wheelhouse. Can you comment on how realistic this idea is given that we don't really have the same population density as some European countries? And secondly, whether this is indeed something that you'd be interested in bidding for and participating in?

[Jean-Louis Servranckx, executive]

Okay, interesting question. I mean -- so first of all, you have noticed that the announcement, it's about high frequency or high speed. Second, there's still a lot to do from what we understand the request for qualification as probably -- is probably just in. So we will know very quickly who has been prequalified. And the RFP should be over within one year from now so that we will have -- the winner in terms of development. I remind you that at this stage, the organizer has excluded from the process rolling stock or equipment manufacturers and contractors. We say that we are not yet there, but we are -- of course, we are extremely interested with this project. So what do I see? I mean you know I'm coming from Europe, high speed train absolutely changed our country in Europe.And it's evident that for me that the aim is to get a safe and reliable less than two hour trip between Toronto and Montreal. Other way, I mean it's probably not worth -- and this depends on what -- I mean, it depends on clear dedicated line where the freight is -- not a priority for all of the high speed or high frequency rail. And most of the issue to reduce time are the entry and exit to cities. So there's a lot of infrastructure coming, I mean, in these cases. And I think it's going to be a very interesting project. And there's no reason, I mean, when you see this corridor between Quebec, Montreal, Ottawa, Toronto, there's no reason that high-speed or high-frequency train cannot be perfectly efficient.

[Operator]

The next question today comes from the line of Maxim Sytchev from National Bank Financial.

[Maxim Sytchev, analyst]

David, maybe just a financial question for you. When we're thinking about free cash flow generation and kind of the lack of it for the last couple of years, what needs to happen for this metric to turn into a positive territory? And specifically around the pacing of working capital drag? Maybe just any color for the next 12 to 18 months, please?

[David Smales, executive]

Yes. Certainly, it's heavily tied to resolution on the four legacy projects. As you know, we have outstanding negotiations going on in each of those projects and an arbitration scheduled on [ CTL ]. So a lot of that working capital build is tied to those four projects. And as we reach resolution on those that will certainly generate cash and reduce some of that working capital. So that's the primary focus. If we look at working capital, excluding those four projects, overall, it continues to be kind of -- can make sure with the growth in the business. Obviously, we've seen pretty significant top line growth over the last couple of years, which obviously requires some working capital along with that. But it's the four legacy projects that really dampened the cash flow profile over the last 18, 24 months.

[Maxim Sytchev, analyst]

But I guess -- I mean, if you settle like half of them this year, do you think positive free cash flow generation is possible in 2023 or just difficult to forecast given all the moving parts?

[David Smales, executive]

Well, if we were to sell to them this year, then yeah, I'm fairly confident that we would have positive free cash flow this year. So that's -- as Jean-Louis said earlier, that's the goal, and that's what we're working on. But it is dependent on the timing of those resolutions.

[Operator]

There are no additional questions meeting at this time. I would like to pass the conference back over to Adam Borgatti for any closing remarks. Please go ahead.

[Adam Borgatti, executive]

Very well, thanks very much, Bailey, and thanks all for your participation today. As always, if you have any more questions, feel free to follow up with us, and have a great rest of the day. Thank you.

[Operator]

This concludes today's conference call. Thank you all for your participation. You may now disconnect your lines.