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Despite the recent rally in Service Stream, is it still cheap?

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Despite the recent rally in Service Stream, is it still cheap?

In 2019, the Service Stream (ASX: SSM) share price has risen by 24 per cent to around $2.17, and for the half-year to December 2018, the Company has reported an excellent set of numbers.

Over the past 8.5 years, Service Stream has consistently grown its revenue by an average annual 15 per cent from $197 million to $348 million and its EBITDA by an average annual 38 per cent from $10.7 million to $38.7 million.

Service Stream grew up servicing the telecommunications industry. Mobile network owners and operators increasingly outsourced the management of towers and digital broadcast sites (Network Construction Division), while the owners of fixed telecommunications networks made up of copper wire and fibre-optic cables have also become increasingly reliant on the likes of Service Stream for design, construction, maintenance and management (Fixed Communications Division).

Over time, Service Stream has slowly broadened its business model to also focus on utility customers (Energy and Water Division). Services include installation of in-home displays, smart metres, solar PV systems and managing service faults (electricity); the maintenance and management of user connections to their gas networks (gas); and providing a variety of water-related services including metre installation and reading and local emergency repairs to residents and businesses (water).

Telecommunications accounted for around 85 per cent of group revenue, however the recently consummated Comdain Infrastructure acquisition for $162 million (40.2 million shares X $1.692 per share and $94 million of cash) will add $320 million to the revenue line and $22 million to EBITDA. The acquisition enhances Service Stream’s capabilities in the East Coast Utilities market, given Comdain Infrastructure has grown its business by an annual average 20 per cent over the past five years, has a blue-chip client base and there is no duplication of services or contractual agreements across common clients.

Service Stream’s annualised revenue should exceed $1 billion revenue in 2019 and this will be split Telecommunications 57 per cent and Utilities 43 per cent, while annualised EBITDA is expected to approach $100 million.

Post the acquisition, Service Stream will have around $30 million of net debt, and with 401.4 million shares on issue, the enterprise value (at $2.17 per share) is $900 million. The vendors of Comdain Infrastructure own 10 per cent of Service Stream, and their Chairman, Tom Coen, has joined the Board of Directors. Shareholders’ Funds approximate $290 million, and a forecast normalised Net Profit after Tax of $63 million (for calendar 2019) implies a Return on Equity of 21.7 per cent.

With an estimated earnings per share of 15.7 cents, Service Stream is selling on a prospective PE of 13.8X and, despite the recent share price rally, this seems a little cheap to me given both businesses’ excellent track record, the greater diversification in earnings (including reduced reliance on the NBN), the increased annuity style revenue and the negligible indebtedness. The only question mark which will be answered with time is the cultural fit of the two organisations.

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Chief Executive Officer of Montgomery Investment Management, David has over 30 years of industry experience. David is a deeply knowledgeable and highly experienced financial services executive. Prior to joining Montgomery in 2012, David was CEO and Executive Director of Hunter Hall for 11 years, as well as a Director at JP Morgan in Sydney and London for eight years.

This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.

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2 Comments

  1. Hi David
    Thanks for the article. I noticed last Friday that 3 of the directors including the MD and Chairman each sold a substantial number of their shares in the company recently. If it was just one director I wouldnt be so concerned but all 3 at the same time is a little alarming.
    Would you see this as something to be concerned about for the company’s future prospects or more the directors taking advantage of the share price rally and rewarding themselves for their hard work to date?
    Thanks
    Sam

    • Thanks Sam. Yes, Directors Brett Gallagher, Leigh Mackender and Peter Dempsey sold a combined 4.07m shares or 44% of their holding, taking it down to a combined 5.2m shares, or 1.3% of the Company’s issued capital, post the Comdain Infrastructure acquisition. The market has generally been nervous about the momentum of the demand profile from the NBN over the medium-term, and hence the reason for the greater diversification into Energy and Water. NBN claims it will add 1.9m “activations” this year and 2.0m next year and any delay should keep the demand going into 2021. Margins may come down with time, and so the directors probably thought the recent solid share price rally presented an opportunity to “bank some cash”.

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