North American Construction Group Ltd. (NYSE:NOA) Q3 2023 Earnings Call Transcript

North American Construction Group Ltd. (NYSE:NOA) Q3 2023 Earnings Call Transcript November 4, 2023

Operator: Good morning, ladies and gentlemen. Welcome to the North American Construction Group Conference Call regarding the Third Quarter ended September 30, 2023. At this time, all participants are in listen-only mode. Following the management’s prepared remarks, there will be an opportunity for analysts, shareholders, and bondholders to ask questions. The media may monitor this call in 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 that participant’s permission. The company wishes to confirm that today’s comments contain forward-looking information and that actual results could differ materially from a conclusion, forecast or projection contained in that 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 in SEDAR and EDGAR as well as on the company’s Web site at nacg.ca. I will now turn the conference over to Joe Lambert, President and CEO. Please proceed.

Joe Lambert: Thanks, Joanna. Good morning, everyone, and thanks for joining our call today. I’m going to start with our Q3 2023 operational performance before handing it over to Jason for the financial overview. And then I’ll conclude with the operational priorities, bid pipeline, outlook for 2023 and our first look at 2024 before taking your questions. On Slide 3, our Q3 trailing 12 months total recordable rate of 0.30 is less than half of what it was at this time last year, and remains below our industry leading target frequency of 0.5. We will continue to focus our efforts on further advancing our training programs, communicating and promoting safe behaviors, fall health campaign on flu shots and audio metric testing and our winter hazard awareness programs as we enter our busy winter season and continue to add to our workforce.

A construction worker talking to two supervisors while standing on a scaffolding.

On Slide 4, we highlight some of the major achievements of Q3. I’ll discuss McKellar later, but wanted to highlight the ramp up of our Fargo-Moorhead flood diversion project, which had its most active earthworks summer that will be followed by its busiest winter as this major infrastructure project progresses into the core of its multiyear construction schedule. Our telematics programs are exceeding expectations and we continue to expand our capabilities and support to the operations and maintenance teams. Our Mikisew joint venture is progressing nicely and continues to add low cost second life rebuilds to its fleet of heavy haul trucks. We see strong long-term demand for the Mikisew fleet and are actively looking for additional core assets to rebuild and continue to grow the joint venture assets.

In Northern Ontario, we successfully completed our gold mine construction project joint venture with Nuna and have several active bids in the Ontario and Quebec regions. We also completed a major overburden fleet relocation in oil sands to support changes in customer demand and mine plans during the quarter. We believe the current fleet allocations will fit well with future overburdened demand and contract awards such as no meaningful fleet moves will be required over the winter. Moving on to Slide 5, you can see that the aforementioned Q3 fleet mobilizations negatively impacted our fleet utilizations. And although a better than average Q3, it was below expectation. However, we remain on trend and confident in our ability to hit our target range of 75% to 85% by the end of next year.

Moving on to Slide 6, we highlight some of the key attributes of the MacKellar transaction. First and foremost, we have cultural alignment, shared core values and maintain a focus on operational excellence, especially in the area of heavy equipment maintenance. We believe these common characteristics and a well planned transition, which is already underway, will make for a smooth integration into the overall business over the coming year. Financial highlights include a purchase price below book value of assets and a favorable purchasing structure. Additionally, our strong underlying business has allowed us to finance acquisition with debt rather than equity, resulting in the exceptional accretion. The vendor provided financing and earn-outs, align management teams and mutually incentivize performance.

Although fully debt financed, leverage is expected to be less than 1.4x by the end of 2024, which is about where we were immediately prior to the transaction closing. Last but certainly not least, MacKellar adds 2 billion in incremental backlog, providing predictability and sustainability for the business that allows for longer term investments for future efficiency and growth. Measured on all metrics, this deal was a rare opportunity and we’re eager to execute the transition plan and set up MacKellar for long-term sustainable success. Slide 7 lists both our currently wholly-owned operating entities as well as our strategic partnerships. These acquisitions and partnerships have all been formed over the last five years and are the main drivers of our success and growth, diversification, profitability, and lowering our costs.

These acquisitions and partnerships have made us stronger and more stable, and that means we change our business for the better. I think one of our major shareholders said it best while turning our assets and facilities when he stated this is not your father’s NOA. With that, I’ll hand it over to Jason for the Q3 financials.

Jason Veenstra: Thanks, Joe, and good morning, everyone. To start, I’ll provide brief context regarding the MacKellar transaction which closed effective October 1. As disclosed in the Q3 report, a final purchase price for the MacKellar Group will be based on audited financial statements as at September 30, 2023. And as such, we continue to disclose the estimated full consideration of $395 million. We look forward to providing full purchase price allocation details in the year-end financials and are encouraged to see strong operating results leading up to and continuing through the closed date. Similar to the other equipment-related transactions we’ve completed over the past few years, there was zero interruption to MacKellar’s operations upon close and we anticipate a strong fourth quarter from their fleet.

The senior secured equipment debt assumed that close along with the upsized credit facility, both transacted at levels disclosed in the July announcement, which gives us overall confidence in the estimate provided. Integrating and reporting on this transformative step change is front and center for a variety of our corporate groups and remains on track for full inclusion in our year-end reporting. Our teams have been in constant dialogue with their Australian counterparts, with weekly and monthly routines taking shape. Moving to the historical financials and some brief commentary. On Slide 5, you’ll see effective performance in the oil sands and progress on the Fargo-Moorhead project drove adjusted EBITDA of $59 million, which essentially matches the record setting Q3 we achieved last year.

Return on invested capital of 14.7% remains stable as the company goal we had set for ourselves of 15% as trailing 12 EBIT of $137 million was generated by the invested capital, which now sits at $735 million, just prior to the MacKellar acquisition, which will add, as mentioned, $395 million to invested capital. On a total combined basis, on Slide 10, revenue was slightly up from Q3 2022. Reported revenue increased from Ml Northern acquired on October 1, 2022 providing another full quarter of operations and a strong quarter from DGI trading. These increases were offset by lower equipment utilization achieved in the quarter as we moved equipment into Fort Hills, as mentioned by Joe. Our share of revenue generated in Q3 by joint ventures was $78 million, which was the same as Q3 2022.

The Fargo-Moorhead project had an excellent operational quarter and achieved the progress metrics and project milestones they were targeting. In addition, we had positive contributions from the continued growth of top line revenue from rebuilt ultra-class haul trucks and excavators directly owned by our joint venture with Mikisew. Offsetting these positives, the Nuna Group of Companies did not have the typical busy Q3 they are accustomed to. Permitting delays and the impacts of wildfires in northern Canada, and particularly the evacuation of Yellowknife, had significant impacts on Nuna’s ability to carry out their assigned scopes. Combined gross profit margin of 13.9% was a quarterly improvement from the 13.1% we posted last quarter, despite the challenges experienced by Nuna and again reflects the strength of a diversified business.

Margins benefited from the ML Northern acquisition from both lower internal costs as well as strong margins from services provided to external customers. Moving to Slide 11, adjusted EBITDA was consistent and reflective of the revenue commentary. Included in EBITDA is direct general and administrative expenses, which were $6.9 million in the quarter equivalent to 3.5% of revenue and remained under the 4% threshold we set for ourselves. Going from EBITDA to EBIT, we expensed depreciation equivalent to 12.8% of combined revenue, which reflected the depreciation rate of our entire business, including the very active equipment fleet at the Fargo-Moorhead project. When looking at just the wholly-owned entities and our heavy equipment, the depreciation percentage for the quarter was 14.7% of revenue and reflected the challenging utilization quarter.

Adjusted earnings per share for the quarter of $0.54 was $0.11 down from Q3 2022, as the impacts of higher depreciation and interest rates are factored in with EPS. The average interest rate for Q3 was 7.1%, as we’re up from the Q3 2022 effective rate of 5.8% from well known interest rate increases. Excluding the upcoming impact of the MacKellar acquisition on Q4 results, the gross interest expense of $8.1 million is expected to be the high watermark as free cash flow is generated in Q4 allowing for the pay down of debt with the expectation of stable rates moving forward. Moving to Slide 12, I’ll summarize our cash flow. Net cash provided by operations of $42 million was generated by the business reflecting EBITDA performance net of cash interest paid.

Free cash flow was $10 million and sustaining maintenance capital of $42 million was invested in the fleet. Moving to the final financial Slide 13, net debt levels remain stable at $395 million in the quarter as the $10 million of free cash flow was used for growth asset purchases, dividend payments, and trust purchases. The correlated net debt and senior debt leverage remained steady at 1.4x and 1.3x, respectively. And with that, I’ll pass the call back to Joe.

Joe Lambert: Thanks, Jason. Looking at Slide 15. This slide summarizes our priorities moving forward. MacKellar integration is obvious, and I’ll touch on that in the next slide or so. And I’ll rightfully start with safety. This area of focus being core to our culture and values is our ongoing efforts to ensure each and every one of our employees returns home safely at the end of every workday. As I’ve stated before, although we have an extensive health and safety management system and multiple initiatives for improvement, we continue to feel our growing workforce requiring increased new hires and an industry supply lowering in experience. Our focus on further developing our frontline supervision and expanding our green-hand training programs will be key as we expand.

Item three describes our prioritizing winning bids continue to build our backlog, which provides consistency and stability in our operations and financial projections and continue to drive our diversification into commodities and geographies that reduce our risk profile, while improving return on assets or lowering capital intensity. The final area prioritizes continued expansion of our operational maintenance expertise. We will prioritize new technologies, such as our telematics system, and continue to in-house [ph] and vertically integrate our maintenance services and supply, including a 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 costs and improve equipment utilization, resulting in increased competitiveness and likelihood of winning the tenders mentioned in the previous item.

Slide 16 shows some key milestones in our MacKellar integration plans, much of which I have discussed previously. What I would like to highlight is just like any project in North American, we know a project well planned that starts strong tends to run smoothly. As such, we have had our transition ERP teams, including our internal systems experts, experts consultants, which we have had prior experience and success, and MacKellar executives and senior management, developing our execution plan far before this deal closed. Within the first week after close, we had MacKellar executives in Canada reviewing and providing input on those plans. And before the end of October, we have boots on the ground in Australia executing the plan as we speak. We believe strongly that the system stability and increased management information that our transition here between [ph] teams can bring to support the MacKellar team will provide a robust, well tested foundation for the future growth and increased profitability of the business.

Slide 17 highlights a net increase of around 1.5 billion to our already strong bid pipeline with large increases, that is the big blue dots on the top line, from long-term non-oil sands contract tenders. One change of note to the bid pipeline has been our regional oil sands tender. Unlike the original submission, which was for a five-year term with committed overburden volumes for all five years, the client has told us they’re pivoting to a three-year term with committed overburdened volumes for one year. The change to a master services type agreement with annual commitments isn’t new and is a return to the same structure of agreement we operated for many years prior to this current agreement. Although no formal reason was provided for the change in term and commitment, we believe the client is looking to optimize their longer term mining plans and focus on operational opportunities as communicated by their leadership team.

We believe oil sands demand for heavy equipment, especially for the larger ultra-class size equipment, will remain strong for the foreseeable future, and our fleet will be fully engaged for 2024 and beyond. The shorter term commitment has some positives as pricing is only firm for one year, and we have low risk for cost inflation that it can occur outside of contract escalation indices, such as we had in the last couple of years. Lastly, although we truly believe our oil sands demand will remain strong for many years to come, we also see those big blue diversified dots and continued strong heavy equipment demand in Australia as opportunities to further diversify and reduce consolidation risks. Lastly, on backlog, in Q3, we were awarded winter projects in oil sands totaling about 30 million and Nuna was awarded a $30 million mine remediation project.

On Slide 18, our pro forma backlog sits at a record 2.8 billion, with our additional MacKellar adding about 2 billion and our expectations for year-end are to have backlog in excess of 3 billion with the award of the regional oil sands tender offset by our normal quarterly drawdown from executed work. On Slide 19, we have provided a revised outlook for 2023. With MacKellar closed, Q3 in the books and a focus on a safe and efficient close to the year, we’ve been able to increase the midpoint and tighten the range for EBITDA with an encouraging uplift for EPS as well. Sustaining capital increase due to some remanufactured component quality issues which we have isolated and resolved and a slight increase from MacKellar, free cash flow is also reduced due to the previously mentioned sustaining capital increase, combined with joint venture distributions deferred into the new year and slightly offset by the increased EBITDA projections.

On Slide 20, we have provided our initial outlook for what is projected to be a record setting year. This is a slide I’ve been eager to get to. Outpacing our 50% accretive acquisition, adjusted EBITDA and EPS midpoints are more than 80% increases over any previous year-end result. Free cash flow is more than double any previous year-end result. And if directed to debt repayment, our net debt leverage at the end of next year will be less than 1.4x, which is a level lower than any previous year end. This slide more than any other shows what this business and this team can produce, and I’m so excited to close out this year strong and achieve these 2024 targets while continuing to challenge our team to advance this business beyond expectations for years to come.

In my 15-year tenure within NOA, these are by far the strongest projections we have issued. Lastly, regarding capital allocation, as always, we continue to assess our options in light of market and other macro conditions outside of our control, and we’ll provide our expected allocation in more detail on our next call. With that, I’ll open it up for any questions you may have.

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Q&A Session

Operator: Thank you. [Operator Instructions]. Your first question comes from Yuri Lynk of Canaccord Genuity. Your line is already open.

Yuri Lynk: Good morning, guys.

Joe Lambert: Good morning, Yuri.

Yuri Lynk: Joe, just wondering how your 2024 expectations for MacKellar have evolved since you announced the deal back in July.

Joe Lambert: I think we probably have a bit more information and that we’re probably a bit more optimistic on what we put out as the annual contributions. It’s probably slightly more than what we had in that July 27 deck. So we brought them up, and I think we have more confidence in those numbers.

Yuri Lynk: Okay. And does that imply the legacy business is kind of flat to modestly up on EBITDA in 2024?

Joe Lambert: I think it’s fairly significant. I think we’re up probably 10% or 15% on a year-on-year basis. I’ll have to ask Jason to do the math for me, but —

Jason Veenstra: Yes, that’s correct. We’re expecting a really strong year from Fargo, and then strong, probably 10% up on the legacy business from an EBITDA perspective.

Yuri Lynk: Okay. And Jason, just while I have you, on the guidance, a pretty significant increase at the low end of EPS guidance for 2024 based from what I was expecting anyway. Was there anything in D&A or interest expense that played into EPS beyond what the EBITDA would have implied?

Jason Veenstra: No. It’s all in the EBITDA rate. Depreciation taxes and interest all are at run rates that would have been in previous guidance. So yes, the uptick you’re seeing would be stronger than expected. Run rate at MacKellar, as Joe alluded to, clarity with Fargo, and then strong utilization from oil sands assets.

Yuri Lynk: Okay. That’s it for me, guys. Thanks.

Joe Lambert: Thank you.

Operator: Your next question comes from Aaron MacNeil of TD Cowen. Your line is already open.

Aaron MacNeil: Hi. Good morning, and thanks for taking my questions. I think I’ll stick with the guidance as well. If I look at the midpoint of the revised 2023 guidance, I think sustaining capital shakes out to about 12.8% of revenue. Next year, that bumps up to 14.5%. And I’m just asking the question, because you highlight the relatively new or fleet of MacKellar. All other things being equal, you expect that introducing newer equipment in the fleet would bring that ratio down. And so I’m just wondering, is that increase a function of your conservatism or are there other factors at play that we should be thinking about?

Joe Lambert: There is some conservatism in that because we haven’t done the detail of the component scheduling at MacKellar that we do here. We’re in the process of doing that. So there’s more of an assumption of sustaining capital being at the depreciation levels. So yes, our expectation would be that we could actually improve upon that with the MacKellar site. But there’s always risks too, right.

Aaron MacNeil: Got it. So in terms of the legacy business, there’s no major changes. Is that the right way to think about the sustaining capital?

Jason Veenstra: Yes, I think that’s fair. Jason here from the financial side. I think, as Joe alluded to, the component issues in 2023 here have — would be a factor in that percentage as well. And we’ll just take a look as we go through 2024.

Aaron MacNeil: Makes sense. I know you already spoke to this a bit, but can you walk us through next steps with that regional oil sands contract that you’re chasing? And specifically, I’m wondering how much of that contract is extending existing work scopes versus new work scopes? How might things work if your contract expires, but you haven’t signed a new one yet? And just kind of like what you expect the timeline to be?

Joe Lambert: We expect it to be finalized before the end of this month. We’re in communication with them practically every day or every couple of days. We were going through some terms and conditions with them yesterday. These kinds of changes aren’t new, Aaron. I think you’ve probably been around with us. Last time when we — the last oil sands contract we renewed, I think we announced it in March of 2022, that contract was actually — we were told we were going to be awarded in September of the previous year. And the contract expired on December 31. And we had to have a bridging contract between December 31 and March 17 when we finally signed off on it. So when you have these big complex contracts, they can take some time.

And it’s not unusual for the execution of them to take a little bit of time. So we fully expect this to be done by the end of November. We believe we will receive a level commensurate with what we’re doing this year to fully utilize our fleet. We believe the demand is there. I think more than anything else, I know there’s probably some anxiety because we said we’re going to get this contract last year, and then it got deferred to this year. And now we’re saying it’s October 31. And now it’s going to be the end of November. And yes, it’s frustrating. But that’s not unusual with this size of a contract and the fact that our client went through a significant change at their senior leadership level. But our budgeting and our forecasting is based on first principles here.

We just look at where we are, what we expect? It’s supply, demand, competition and price. And we fully expect to be awarded work that’s going to keep our oil sands fleet busy for the next year and into the future. The change in structure just goes back to an old format. And we believe that’s being driven because of needs to have flexibility with their plans to adjust operations. So I don’t see this as anything tremendously unusual, and it’s frustrating, but we don’t expect it to have any significant impact on our business.

Aaron MacNeil: The bridging contract, it was exactly what I was trying to get at. So let’s say this gets delayed further, contract doesn’t get signed until the spring. In your — expect that you’d have a similar type of arrangement.

Joe Lambert: We would have some amendment with the existing contract that bridges it through to whenever they were — that’s what we did with the last one.

Aaron MacNeil: Yes.

Joe Lambert: Just amendment that extended the term of the previous agreement until we had all the terms and conditions signed out on the previous one.