Service Stream: Thriving in the infrastructure slipstream

Service Stream (SSM) has jumped today on results that showed it has maintained a strong track record of execution in delivering its 11th consecutive half of EBITDA and NPAT growth. 

Key areas for the business going forward include the successful integration of Comdain Infrastructure, increasing annuity-style revenue, and capitalising on advances in technology within telecommunications and utilities.  

Following the 1H 2019 result announcement, we share our views on why Service Stream is well placed to thrive in the infrastructure slipstream despite already being up +16% in 2019.

Turning to the 1H2019 result, SSM comfortably exceeded consensus expectations of revenue, EBITDA, NPAT and EPS with positive earnings revisions expected to follow from consensus estimates.

Reported revenue, EBITDA and NPAT growth of +18%, 19% and 21% respectively on 1H2018 was stronger than anticipated, and the balance sheet finished with $69.5m of net cash prior to the completion of the Comdain acquisition in January 2019. Following 7 consecutive halves of exceptional cash flow conversion, cash flow has begun to normalise as previously flagged by management due to the unwinding of NBN prepayments.

As a reminder of their three key business divisions, SSM provides ongoing customer, maintenance and installation services to much of Australia’s booming infrastructure sector, including:

• Fixed Communications – Telecommunications network operations and maintenance
• Network Construction – Telecommunications network engineering, design and construction
• Energy and Water – Utility network design, construction, installation and maintenance

Service Stream's six growth engines

Looking ahead, the following areas of activity are expected to fuel future growth in the business:

• Comdain Infrastructure: the strategic acquisition of critical utility infrastructure service provider, Comdain Infrastructure, enhances Service Stream’s capabilities in the growing utilities market across the East Coast of Australia. Comdain has successfully capitalised on this growing market by delivering compound annual organic revenue growth of approximately 20% over the past 5 years. Importantly, Comdain diversifies and increases annuity style revenues for the group. Telecommunications and utilities revenue share will account for approximately 55% and 45% of total group revenue respectively going forward, down from an over 80% share in FY18, further diversifying revenue streams. We believe over time, with successful execution, the share price deserves an earnings multiple rerate given it currently trades at a discount to the ASX Small Industrials.

• Increasing annuity style revenue: In addition to increased utility maintenance revenue, the telecommunications assurance and remediation (maintenance) revenue within the Fixed Communications division should continue to grow as more Australians are connected to the NBN. This should improve the sustainability and, therefore, quality of group revenues.  

• New technologies: the roll out of 5G technology (and future subsequent technologies) is a significant opportunity for the wireless business, within Network Constructions, to capture the increasing demand for mobile data and advances in technologies. SSM has a track record of service delivery and execution for clients so they should be well positioned to capitalise on these future opportunities.

• Management: management have demonstrated a track record of consistently under-promising and over-delivering on earnings expectations, they provide transparent financial information to the market along with a well-articulated business strategy. Further strategic acquisitions which provide revenue diversity in adjacent markets provide further opportunities for growth.

• Broker coverage: limited research coverage provides investors opportunities to uncover companies before they become market darlings or crowded trades. SSM is rapidly graduating in market capitalisation, currently $823 million, with only two small cap brokers with research coverage.

• Regulatory: Should a Federal Labor government be successfully elected, there has been speculation the NBN could roll out additional Fibre to the curb (FTTC) which would be an additional opportunity for Service Stream.

Management have proven to be a ‘safe pair of hands’, well-equipped to execute on growing telecommunications and utilities infrastructure activity.

An undemanding valuation

Based on this, we believe the current valuation is undemanding for a capital light, cash flow generative business trading on less than 13x forecast PE for FY20, a discount to the S&P/ASX Small Industrials index PE of around 20%.

We believe SSM warrants a narrower discount to the Small Industrials Index PE, largely because of:

• consistent delivery of top-line growth and maintenance of stable margins over the last 2 years,
• greater diversification of earnings with the Comdain acquisition which reduces the company’s reliance on the NBN,
• cyclically independent earnings streams,
• multiple growth drivers including 5G infrastructure rollouts,
• a strong balance sheet with conservative gearing, and
• dominant market share.

If SSM’s multiple was to approach that of the Small Industrials index, a valuation closer to $2.75 could be justified.

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