Desjardins maintain target at 37$Rating: Buy, Risk: Above-average, Target: C$37.00
Further details on SNC’s new strategic direction for the Resources business—
a significant step in its transformation
The Desjardins Takeaway: Positive
This morning, SNC announced the transformation of its Resources business to focus on engineering services and project management, thus concluding its strategic review of the business. As part of the transformation, SNC will focus solely on profitable segments of the services business, and sell or close non-core businesses (eg the divestiture of the Resources business in South Africa), including exiting multiple countries (to nine from 30). The Resources business will eventually be integrated within SNCL Engineering Services (we suspect once its profitability reaches at least breakeven and all Resources LSTK projects have been completed).
SNC is targeting the Resources services business to reach breakeven adjusted EBIT in 1H21 and to be profitable for the full year in 2021. Management did not indicate a long-term margin target for the business. The improvement in profitability will be driven by (1) headcount reduction to 8,000 employees from 15,000 by end 2020, and to 6,000 by end 2021; and (2) simplification of the business around core engineering services, with a focus on existing profitable relationships with longstanding customers. From a financial standpoint, SNC expects the Resources Services business to contribute ~10% of its consolidated revenue in 2021, in line with our forecast. Management expects negative segment adjusted EBIT in the range of C$15–25m in 2H20 as a result of the restructuring (excluding any potential losses related to LSTK projects).
Management also provided additional details on the performance of the Resources segment in 2Q20. Adjusted EBIT losses related to LSTK projects accounted for C$95m out of the total of C$122m, which included a C$70m client’s claim on one project. During the quarter, SNC completed one Resources LSTK project and is on track to complete the vast majority of the four remaining contracts by the end of 2020 —a key milestone in terms of derisking the business.
Bottom line, while we acknowledge that SNC’s 2Q20 results were below expectations, we note that the miss was related to LSTK projects which management is in the progress of exiting. While we had favoured a divestiture of the Resources services business, we suspect this would have been difficult in light of the COVID-19 pandemic, and we are encouraged that management is making the necessary decisions to improve the business. Finally, we are pleased with the performance of SNCL Engineering Services in spite of the pandemic and it remains the main driver of our long-term investment thesis on the name. We recommend that long-term investors buy the shares following their underperformance this morning.