North American Construction Group Ltd. (NYSE:NOA) Q1 2024 Earnings Call Transcript

North American Construction Group Ltd. (NYSE:NOA) Q1 2024 Earnings Call Transcript May 4, 2024

North American Construction Group Ltd.  isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Good morning ladies and gentlemen. Welcome to the North American Construction Group Conference Call regarding the First Quarter ended March 31, 2024. At this time, all participants are in a listen-only mode. Following management’s prepared remarks, there will be an opportunity for analysts, shareholders and bondholders to ask questions. The media may monitor this call in a listen-only mode. They are free to quote any member of management but they are asked not to quote remarks from any other participant without the participant’s permission. The company wishes to confirm that today’s comments contain forward-looking information and that actual results could differ materially from conclusions, forecasts or projections contained in the forward-looking information.

Certain material factors or assumptions were applied in drawing conclusions or in making forecasts or projections that are reflected in the forward-looking information. Additional information about those material factors is contained in the company’s most recent management’s discussion and analysis which is available on SEDAR and EDGAR as well as on the company’s website at nacg.ca. I will now turn the conference over to Joe Lambert, President and CEO.

Joe Lambert: Thanks, Enrico. Good morning, everyone and thank you for joining our call today. I’m going to start with a few slides showing our Q1 operational performance before handing it over to Jason for the financial overview and then I will conclude with our 2024 operational priorities, bid pipeline, backlog, outlook for 2024 and finish up with our capital allocation plans before taking your questions. On Slide 3, our Q1 safety performance remains well below our industry-leading target frequency of 0.5 and we have reduced our lifesaving rules violations by 50% from Q1 last year. These statistics now include our Australian incidents and work hours. We currently are focusing our safety efforts on frontline leadership training, improving our peer-to-peer recognition program and increasing leadership visibility in the field.

On Slide 4, we highlight some of the major achievements of Q1. Our recently acquired Australian business continues to deliver strong and consistent results even after some heavy rain impacted summer months and the backlog down under increased significantly with the award of a $500 million 5-year contract extension with our long-term metallurgical coal producing client. With our integration team now resident and our Australian bid pipeline showing continued strong demand, we remain confident that the Australian market will play a dominant role in maximizing our fleet utilization and return on assets. The first equipment transfers to Australia have reached their store and we’re excited about the long-term opportunities we see in the Australian market.

Our Fargo-Moorhead flood diversion project smoothly ramped up in Q1 in advance of its first big summer construction season and we remain confident in our overall project plan. Our telematics system continues to provide maintenance savings, achieving a record quarterly saving of almost $2 million in Q1 and we’re evaluating some Australian assets for an initial rollout of telematics in Q3. And last but not least, we were awarded a 3-year contract in oil sands which generated about $225 million in 2024 backlog. On Slide 5, we show fleet utilization by region. Australian utilization remains strong with Q1 ending on a March high note after a few high rainfall impacted summer months. In Canada, our utilization suffered from mobilization fleets between oil sand sites in February and lower volumes of winter reclamation work.

We remain on trend and confident in our ability to hit our Canadian target range of over 75% by the end of this year and we’ll also be looking to similarly increase our Australian fleet to over 85% during the same period. I’m sure some may believe our Canadian utilization targets are stretched after coming off that February low. However, if you consider the units we expect to transfer and some sales of smaller assets, combined with improving mechanical availability and no further anticipated fleet mobilizations, our math still suggests we are capable of exceeding our target before year-end. With that, I’ll hand over to Jason for the Q1 financials.

Jason Veenstra: Thanks, Joe. Good morning, everyone. Getting right into it and starting on Slide 7. The headline EBITDA number of $93 million and a correlated 27% margin were driven by a successful second quarter from Australia since the change of control on October 1, 2023. Our margin in particular, along with the combined gross profit margin of 18% illustrates a strong operational quarter. All business units contributed to this margin with the exception of Nuna which posted EBITDA margin of less than 10% in the quarter when factoring out the onetime costs that were incurred as part of the restructuring during the quarter. The EBITDA margin illustrates project execution risk in the joint venture and is a metric indicative of why a change was needed.

Restructuring efforts were completed during the quarter and the projects in Northern BC and the Northwest territories were finalized. Restructuring expenses incurred and added back for adjusted earnings purposes related to severance costs and onetime expenses required to complete legacy projects. Moving to Slide 8 and our combined revenue and gross profit. As we will have for 2 more quarters, MacKellar provided a step change in the quarter-over-quarter variance. On a total basis, we were up $53 million quarter-over-quarter. MacKellar and DGI which we combine in Australia in our results were up $128 million, almost identical to the Q4 variance which could have been higher if the rainfall in January and February have been less severe. This rainfall impact can be seen in Australia’s equipment utilization which got back to 80% in March after being in the mid-70s for the first 2 months of the year.

This positive variance was offset by the lower equipment utilization in the oil sands region. Our share of revenue generated in the quarter by joint ventures was a net $29 million lower than Q1 2023. The Fargo-Moorhead project had a steady operational quarter, was up $10 million and achieved project metrics and milestones required of the project schedule. More than offsetting this positive though, was the variance impact of the completion of the construction project at the gold mine in Northern Ontario in Q3 2023 which led to lower quarter-over-quarter revenues within the Nuna Group of companies. Combined gross profit margin of 18% despite another challenging quarter posted by Nuna reflects the strength of a diversified business. Gross profit margins benefited both from the operations in Australia which were higher than 20% in the quarter and is normal course.

And from Northern whose fleet lowers our internal costs as well as generate strong margins from services provided to external customers. Moving to Slide 9. Record Q1 adjusted EBITDA was consistent with and reflective of the revenue commentary. The 27% margin we achieved reflects an effective operating quarter and with the positive 2023 trend from the Q4 and Q3 margins of 25% and 22%, respectively, is indicative of where we see our business trending and operating adds. Included in EBITDA, General and administrative expenses were $11.1 million in the quarter, equivalent to 3.8% of revenue which remained under the 4% threshold we’ve set for ourselves. Going from EBITDA to EBIT, we expensed depreciation equivalent to 14% of combined revenue which reflected the depreciation rate of our entire business, including the equipment fleet at the Fargo-Moorhead project.

When looking at just the wholly owned entities and our heavy equipment in Canada and Australia, the depreciation percentage for the quarter was 14.8% of revenue and reflected the addition of the Australian fleet as well as first quarter operations in the oil sands which require higher idle time due to the cold weather. Adjusted earnings per share for the quarter of $0.78 was $0.18 down from Q1 2023 as the impacts of higher interest are factored in. The average interest rate for Q1 was over 9% in the quarter, the highest rate we’ve paid in a long time and remains a compelling indicator for us as we look to pay down debt in the back half of 2024. Moving to Slide 10. I Net cash provided by operations prior to working capital was $74 million and generated by the business, reflecting EBITDA performance net of cash interest paid.

Free cash flow usage of $36 million was driven by the $62 million draw on working capital accounts and $60 million spent on our front-loaded sustaining capital maintenance and replacement programs. Moving to Slide 11. Our PPE of $1.2 billion is up $470 million from the pre-MacKellar September 30, 2023 balance on the $430 million worth of assets we purchased in 2023 and $20 million of gross assets purchased this quarter in Queensland and Western Australia. Net debt levels ended the quarter at $781 million, an increase of $58 million in the quarter due to the $36 million of free cash flow usage as well as the investment in growth assets. Net debt and senior secured debt leverage ended at 2.0x and 1.6x, respectively and are considered reasonable levels 6 months after a transformative fully debt funded acquisition.

With that, I’ll pass the call back to Joe.

Joe Lambert: Thanks, Jason. Looking at Slide 13. This slide summarizes our priorities for the year. This slide is unchanged, so I’ll just hit the high points. The MacKellar integration continues to progress smoothly. As I mentioned in my letter to shareholders, we are thrilled with the Australian market in general and see great opportunities for growth and continued efficiency improvements with our stronger systems and processes in place. Under the second point, we highlight our ongoing efforts to win strategic projects for our business. As we look to sustain and grow our infrastructure business, we will need to win the infrastructure work and with a strong potential U.S. infrastructure in the bid pipeline, we have initiated a partnership with a known international construction company and set this year’s priority to qualify on one major infrastructure project.

The second part of this priority is when a meaningful project that uses our smaller mining assets that are currently underutilized in our oil sands business. We have several active tenders that would utilize these smaller assets and we expect to win one of these projects this year. Item 3 prioritizes continued expansion of our operational and maintenance expertise. We will prioritize new technologies such as our telematics system and continued in-house and vertically integrate our maintenance services and supply, including near-term focus on identifying and sharing best practices between our Canadian and Australian businesses. We believe this prioritization and focus will continue to lower cost and improve equipment utilization, resulting in increased competitiveness and likelihood of winning the tenders mentioned in the previous item 2.

The final area prioritizes returning Nuna backed operational excellence and setting it up for growth and consistent performance. This work commenced earlier this year and I’m confident the changes made that Nuna will be back on its feet in time for their big summer projects and growing off a much stronger and stable foundation before the end of the year. Moving on to Slide 14. Our bid pipeline has grown significantly with over $500 million in additional projects under tender. While we anticipate strong demand in oil sands to continue for many years, the diversified opportunities in Australia and the strong demand for heavy equipment also present avenues for further diversification and improved return on assets. There’s a handful of these bids that are integral to our business.

2 projects in oil sands consisting of — one consisting of typical summer civil works that should be awarded imminently and a big stream diversion project which we expect to submit in Q2 with award in late Q3, are important projects for improving near-term utilization on our smaller mining assets. Longer-term opportunities to fully utilize these smaller mining assets have been tendered in multiyear projects in the Quebec iron ore mine and a South Australian magnetite mine. Our larger mining assets which remain in high demand and utilization but are in general uncommitted beyond 2024 have been tendered into opportunities for 5-year commitments in New South Wales and Queensland coal operations. We are excited about these opportunities and a couple of wins would provide meaningful insight and stability into our projections for 2024 and beyond.

On Slide 15, our backlog stands at $3 billion. This includes the recent award of a major metallurgical coal mine in Queensland and the regional oil sands contract balanced by our typical quarterly drawdown from executed work. This backlog enhances our confidence and predictability, particularly in our Australian operations. Slide 16 reiterates our outlook for 2024 and is unchanged from our last presentation in March. Lastly, Slide 17 focuses on capital allocation. We continued our interest rate. We expect to use our projected free cash flow of $160 million to $185 million for deleveraging while maintaining an open mind for more favorable risk return opportunities that may arise. We continually analyze all options to ensure that our capital allocation decisions are both opportunistic and aligned with our long-term strategic goals.

With that, I’ll open up for any questions you may have.

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Q&A Session

Operator: Thank you. question. [Operator Instructions] Your first question comes from the line of Tim Monachello from ATB Capital Markets.

Tim Monachello: I just wanted to touch on the commentary on transferring assets and potentially selling some of the underutilized ones. Can you say how many assets you would view as structurally underutilized in the Canadian market that might be up for transfer or sale?

Joe Lambert: We’d be looking about 100 of them, Tim. Some of them that aren’t committed into next year and some of them that aren’t being used right now. So there’s some smaller ones we expect to get engaged in this summer work, like I mentioned and we see opportunities next year in a few different areas. So those kind of 5 major projects that are under tender now we think would get the utilization of that fleet if we want a couple of those into the high ranges we expect to be in. But it’s about 100 units. I’d say, more weighted towards the smaller end of the fleet. So there’s — it’s disproportionate to where the smaller units are a bigger chunk of that $100.

Tim Monachello: Okay. And would that — that wouldn’t include the 20 that you already transferred or are currently transferring?

Joe Lambert: Yes, that would be part of it.

Tim Monachello: Are additional units that you’re looking at?

Joe Lambert: Yes, we expect the ones we sent we’ll actually get some utilization in late Q3.

Tim Monachello: Yes. Great. I was encouraged to see that those were going to work with contract — are those going — are those going to existing sites or new sites in Australia.

Joe Lambert: They’re pretty much supporting existing sites. There were just opportunities. They’re not all going one spot. There are 3 here 4 there, where there was opportunities where we didn’t have fleet either Western Plan or MacKellar.

Tim Monachello: Okay. And could you — I mean, put some bookends around like what the net asset value of those definitely would be like the stuff that you view as underutilized.

Joe Lambert: I don’t have that off hand,. I can probably get that for you later. Yes. We’re looking at the number of your — the net asset value just depends on which units we pick and it can vary dramatically between 2 different units of the same fleet based on what value is left in the component life of those assets. So 200-ton trucks can vary by — can differ by twice as much on what the net asset value is based on what components are in it.

Tim Monachello: Right. Okay. That makes sense. And then in Canada, obviously some weak utilization in Q1 but some optimism around growing utilization through the rest of the year. Curious if you could comment on how utilization for the Canadian fleet exited Q1 and is trending in Q2?

Joe Lambert: Well, it was definitely at a low in February when we’re moving fleet around and then started picking up in March. And yes, we expect that to continue through Q2 and we expect to achieve that 75% by the end of the year.

Tim Monachello: Okay. And then big working capital build in the quarter, Jason, curious, can you talk a little bit about what the drivers of that were and how you see that playing over the rest of the year should that unwind?

Jason Veenstra: Yes. We do expect it to unwind. It was primarily in Canada with a really busy March. We booked some pretty sizable accounts receivable in the month and collected that in April. So we expect that to work itself out. MacKellar had the same thing, although not as big a working — or an accounts receivable build in March but they had a bigger March than January and February and billed accounts receivable as well. So yes, expect it to unwind and hope for 2023, working capital full year was kind of neutral and we kind of expect that for 2024 as well. It won’t all unwind in Q2 but expect it to unwind over the 9 months.

Operator: Your next question comes from the line of Aaron MacNeil of TD Cowen.

Aaron MacNeil: Joe, I know you mentioned the bid opportunities for smaller mining assets but it looks like some of the bigger bid opportunities in your pipeline don’t occur until 2025? I know it’s early but as we think about 2025, what do you see as the big puts and takes year-over-year? Like does it look a lot like ’24 with maybe the benefit of some fleet reallocation? Or are there other major factors that we should be thinking about?

Joe Lambert: I think those opportunities in fleet allocations are not just improve utilization but — and it’s just inherent that you get more opportunities to put more hours on equipment in Australia just because of the weather and the way the projects are set up. So we do think there’s upside in not just getting park assets moving but getting long-term commitments for stuff that was uncommitted in 2025 that may be highly utilized now. I have looked at what the net impact of that would be top line. I think we’ve always expected kind of a 5% annual kind of improvement rate. I have embedded that with these actual numbers. There are some big projects. The coal ones I was talking about in Australia, we’re in the magnetite, they’re $300 million, $400 million jobs.

And we would look at those, say, 30 or so of our 100 assets going to any one of those projects for opportunities where we can that use under equipment to work. I mean it won’t be the entire fleet and there’ll probably be some ads in here and there for growth capital for matching shovels or things like that. But we see it as a great opportunity to meet that growth curve.

Aaron MacNeil: So the 30% you just mentioned, would that be incremental over and above the $20 million that you’ve already sent over there?

Joe Lambert: Yes.

Aaron MacNeil: Got it. And then for the balance, I guess, $20 million plus $30 million, minus 150 remainder, like where do you think the most likely end markets for those sort of remaining $50 you had to guess?

Joe Lambert: I would say we place half of them into summer works in oil sands this year and possibly into iron ore or Australian magnetite next year. And I think the remaining, say, 20-odd units are likely ones that we would look at selling as is or rebuilding and selling. I do think there’s some opportunities for our maintenance team to value-add to those and rebuild and we’re evaluating those markets right now. It wouldn’t be a huge dollar amount. I’d say — I think I said something like $20 million.

Operator: Your next question comes from the line of Jacob Bout of CIBC.

Jacob Bout: Joe and Jason, this is a problem on for Jason. So looking at Slide 5 targets of fleet utilization of about 85% in Australia and 75% in Canada. So you touched a bit about this in the prepared remarks but what would you say are the biggest factors that would help you base those targets?