SNC-Lavalin Group Inc.
SNC (TSX): C$24.48
Stock Rating: Outperform Target: C$42.00
June 10, 2022
Fireside chat notes - challenging parts are not getting worse while good parts are doing well
We had the opportunity to host a fireside chat at the annual Quebec Conference hosted by NBF yesterday.
Takeaway notes generally reinforce our recovery thesis on this name, over time (in attendance, CFO Jeff Bell and VP Investor Relations Denis
LSTK language reiterated and not getting worse. Management noted that the estimated losses for LSTK are tracking “well below” the $300 mln worst-case scenario number given to the market in the beginning of the year, even though the strike in Q2/22E and inflation continue to have an impact (we model losses in the $30 mln/quarter range going forward).
Most of the Ontario projects (Eglinton, Trillium) should be done by the end of this year, leaving us with an estimated $500 mln in backlog left in 2023 (there is a small part of REM in 2024 – see phasing chart in Figure 1 below).
OCF is still expected to be slightly positive for the full-year (2022) while FCF would be lower by around $200 mln due to capex ($100 mln) and operating leases ($100 mln). Conversion of net income to FCF appears to be unchanged (when anchoring to 2024).
Bidding costs back to normal post Q1/22. Increased bidding costs in Q1/22 were largely a matter of timing of some new projects that came up for bidding; the inflection point appears to be contained to Q1/22. Outlook on the backlog is therefore positive while management does not see any slippage or cancellations in its pipeline (government skew is of course helping overall).
SNCL Engineering margins still expected in 8-10% EBIT range. Inflation is generally a non-factor
as most of the contracts provide pass-through clauses.
Margins are expected to bounce back towards the higher end of the guided 8% - 10% in H2/22E (this is a seasonal pattern as H2 is always stronger than H1).
SNC continues on its efficiency drive (IT, real estate, process optimization, etc.); note that top performing industry peers generate 15%-16% EBITDA margins (vs. SNC in 13%-14% target range when converting revenue to net basis); over the longer term, management does not see a structural impediment to converging with industry’s leaders.
407 ETR – key asset for the medium term. Management continues to view 407 as an integral part of balance sheet enhancing strategy. Once SNC becomes a purely consulting entity, Board and management might revisit the need for outright hard asset ownership (of interest, please refer to Chicago Skyway could be sold for $4 bln - some 407-related thoughts if press articles are correct).
Linxon – similar to Engineering ROIC + positive industry backdrop.The segment’s negative contribution is not indicative of its trajectory going forward; disregarding the ABB equipment sales with zero margin flowing through the P&L, margins would be margins would be similar to the Engineering business, according to management.
Even though backlog of this business is lumpy, management sees it as an important electrification play benefiting from the Net Zero emission tailwinds. ROIC is comparable to Engineering business given segment’s low capital intensity and working capital benefits from being paid for projects upfront.
Nuclear organic growth remains robust and could be stronger if political will finds a way. Outlook remains solid given two primary tailwinds. Structurally, nuclear offers a powerful stepping-stone as many governments pursue a long- term Net Zero strategy. Secondly, the geopolitical situation in Ukraine has accelerated governments’ push for energy independence from Russian oil and gas, especially in Eastern Europe. Furthermore, there is an opportunity to add two CANDU reactors to the Romanian Nuclear Generating Station, as the civil infrastructure is already in place for four units.
For required disclosures, please refer to the end of the document.
2 | Page In the meantime, work continues on refurbishment at Bruce and Darlington in addition to Hinkley Point (engineering services work).
UK will likely see another new site approval, providing further opportunity for SNC’s nuclear business.
Bottom line – scraping the bottom of operational transition (on a consolidated basis). We often get questions regarding why investors are not rushing into buying SNC shares now while generally understanding that the bulk of challenging projects will be done in less than a year; hence, EV/EBITDA multiple of 6.5x on 2023 forecasts. When examining other situations where consulting peers veered off track via a construction overture that ultimately proved costly (AECOM, Tetra Tech and most recently, Stantec), stocks only started working AFTER the completion or sale of said challenging projects.
As a result, we are straddling a time value of money issue where in 15-18 months we have a high-quality consulting entity... but we still need to get there via a 6-7 quarter reporting schedule. NAV-wise, it’s a lot of upside, but it is geared towards those with extended time horizons. The sense we got from today’s fireside chat and some one-on-one meetings that the ring-fenced LSTK losses are a worst-case scenario exercise, and we appear to be tracking better than that; in addition, good parts of the business (Engineering, Nuclear, and 407) continue to perform (or recover). We rate SNC shares Outperform; $42.00 price target using a SOTP valuation where we assign 12.0x / 12.0x / 5.0x for EPDM / Nuclear / Infra Services on 2023E EBITDA while ascribing no value to Infra EPC and Resources EBITDA, plus $13.17 per share from 407 ($10.60) and other concessions ($2.57).