Earnings Call Transcript - NOA Q2 2023

Operator, Operator

Good morning, ladies and gentlemen. Welcome to the North American Construction Group Earnings Call. At this time, all participants are in a 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 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 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 on SEDAR and EDGAR as well as the company's website at nacg.ca. I will now turn the conference over to Joe Lambert, President and CEO.

Joe Lambert, President and CEO

Thanks, Joanna. Good morning, everyone, and thanks for joining our call today. Today's call is clearly different from ones in the past, given the share repurchase agreement we signed yesterday, and we fully expect the majority of the discussion to involve the transformational acquisition of MacKellar Group. Therefore, we’ll do things a bit differently this morning. I have asked Jason to summarize our Q2 performance and then I'll jump right into the commentary and context on MacKellar. At the end of the prepared remarks, we are happy to address Q&A on either Q2 or MacKellar. With that, I will hand it over to Jason.

Jason Veenstra, CFO

Thanks, Joe. And good morning, everyone. As mentioned, the focus on MacKellar, the quarterly comments this morning will be brief. On Slide 3, as a standard practice here we start with our safety commitment to ensuring everyone gets home safe. Our trailing 12-month recordable rate is now at 0.27 and represents a significant improvement from last year, which ended above our company target. We are primarily focused on leading indicator initiatives with several outlined on the slide, but are encouraged by the lagging indicator trend. On Slide 4, you'll see two things. One, 61% was the highest utilization we've ever had in a second quarter; but two and probably more noticeably, the month of June was well below expectations. April and May benefited from the strong momentum carried from Q1, with an average of 70%, which was very encouraging. However, the surprisingly wet weather in June and a required mobilization of equipment into Fort Hills drove utilization in that month to below 50%, a level we haven't seen since mid-2020. High demand remains for our heavy equipment, and we expect this throughout 2023 and into 2024. We likewise expect our maintenance teams to continue their strong work and correlated improvements in the mechanical availability of our fleet. We remain on track with our utilization goals to be in the targeted range of 75% to 85% on an annual basis, with the trailing 12-month average now at 70% compared to the 65% we posted in 2022. Moving to the financials, on Slide 6, combined revenue of $277 million represented the highest level of revenue this company has ever had in a Q2 and correlated to the typical impacts that the spring season has on equipment utilization in the oil sands. Return on invested capital of 15.3% is the highest we've ever achieved and surpassed the company goal we had set at 15%, as trailing 12 EBIT of $143 million outpaced increases in invested capital, which now sits at $731 million. On Slide 7, on a combined basis, revenue was 21% ahead of Q2 2022. Reported revenue generated primarily by our core heavy equipment fleet was up 15% quarter-over-quarter, with the drivers of this increase being slightly improved utilization and the adjusted equipment and unit rates applied in Q3 2022. The ML Northern, acquired on October 1, provided another full quarter of operations with fuel and lube delivery, and as we approach the one-year anniversary of welcoming them to NACG, we are happy to consistently report the strong performance of that critically important support fleet. Our share of revenue generated by joint ventures and affiliates was $83 million compared to $60 million in Q2 2022, but notably up from Q1 2023 revenue of $78 million as their projects were not as significantly impacted by the spring season. The Nuna Group of Companies had another busy quarter of activity at the gold mine in Northern Ontario. A particular note though is the primary drivers of the increase in combined revenue included the continued growth of top-line revenue from rebuild ultra-class haul trucks and excavators now being owned by our joint venture with the Mikisew joint venture. And the increasingly important impact of the joint ventures dedicated to the Fargo-Moorhead flood diversion project. We had another full quarter of construction work at the Fargo project with the project passing the 10% completion mark and hitting its stride. Combined gross profit margin of 13.1% was a quarterly improvement from the 9.6% we posted last year, as our operations in the Fort McMurray region experienced the challenges of Q2 weather. Our joint ventures continued their trend of strong, consistent operating margins, benefiting from the ML Northern acquisition from lower internal costs as well as strong margins from services provided to external customers. The second-life rebuild program commissioned and sold another ultra-class haul truck during the quarter. Moving to Slide 8, adjusted EBITDA of $52 million is the best Q2 we've ever posted and reflective of the commentary thus far.

Joe Lambert, President and CEO

Thanks, Jason. As a company, NACG has always been very selective in how we use our capital. And when it comes to our M&A, we have been determined but patient in selecting the right businesses, people, geography, and markets to enter. That is why today I am extremely excited to announce our largest acquisition to date, the MacKellar Group. This transformative transaction is a culmination of thorough operational and cultural diligence over the course of multiple years and a deal that makes clear strategic sense. We believe this transaction is financially compelling and more accretive to our shareholders than any other use of capital. I hope at the end of this presentation, all participants will agree that this transaction fulfills our stated objectives and provides a meaningful step change in our project execution capabilities and growth profile. In this slide deck, I will present and discuss a high-level review of MacKellar and the financial highlights of this transaction, followed by a review of how this acquisition fits our corporate strategy for growth and diversification, and ending with a few slides on our next steps and outlook for 2023 and 2024, before taking any questions you may have. On Slide 4, founded in 1966 by Alastair MacKellar, a heavy equipment mechanic or fitter in Australian terminology, the MacKellar Group has grown to over 450 pieces of heavy equipment operating on more than 15 projects with more than 1,000 employees, of which over 375 are highly skilled maintenance personnel operating in a system focused on safety and innovative ways to lower equipment costs and extend asset lives. As a leading provider of heavy earthwork solutions to mining and civil sectors, MacKellar provides a meaningful entry into Australia at a time when every piece of equipment is in peak demand. Moving on to Slide 5, we highlight some of the key financial attributes of the transaction. Starting with a purchase price below the book value of assets and a favorable purchasing structure, our strong underlying business has allowed us to finance the acquisition with our own balance sheet, resulting in exceptional accretion. Our fully underwritten financing, supported by our lead lender, shows confidence in our business and the vendor-provided financing alliance management teams and mutually incentivizes exceeding performance targets. Although fully debt-financed using the strength of our combined balance sheets, the leverage is expected to be 1.8 times at year-end and below 1.5 times by the end of 2024. Last but certainly not least, MacKellar adds over $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 I am thrilled to be announcing it today. On Slide 6, we provide a bit of a timeline and the approach we took to the transaction, starting with an introduction through our team at DGI, who we acquired back in 2021. MacKellar is a longtime customer of DGI, and the founders of each company have had both a business relationship and personal friendship for several decades. Seeing the similarities between NACG’s and MacKellar’s operating philosophies and corporate culture, DGI facilitated the introductions. After several initial conversations, it was clear that our two companies shared common values and culture and would make a great combination. We likewise toured each other’s field operations to confirm that the words matched with what we saw in the business execution. Once the fit and potential combination had been mutually established, we progressed with the utmost diligence through continuous and transparent dialogue for over two years, resulting in agreement on both companies’ transaction criteria. This disciplined approach provides us, our board, and the MacKellar team with significant confidence in the ability to successfully integrate and execute our strategic plan moving forward. On Slide 7, we provide more detail into the transaction rationale. First and foremost, MacKellar shares our same core values of safety and focus on operational maintenance excellence to be the low-cost provider and contractor’s choice. In my opinion, this cultural fit cannot be overstated as it is key to integration success and a match that is so similar that I would expect anyone knowing NACG and speaking to a MacKellar employee to feel like the only difference was the accent. I will move on to other points as we will discuss this further on subsequent slides, but this cultural match is definitely a unique and favorable sign, providing confidence in our future together. Along with a transaction that has minimal integration and financing risk, we are acquiring a large, newer, and well-maintained fleet at below book value with significant room for growth and diversification in the varied commodities resource-rich areas of a mining-friendly country. With new equipment lead times ranging from one to two years, acquiring a fleet of this size provides immediate scale during peak demand. I would also note the relatively young age of this fleet, with just over 40% of the fleet being purchased in the last five years and just under 30% in the last two years, with these most recent purchases still having a couple of years before requiring any meaningful major components sustaining capital. With significant contract awards expected in NACG’s core business before year-end, we expect a combined backlog of greater than $4 billion, providing consistency that allows for planning efficiency of our workforce and our fleet. Moving on to Slide 8, both NACG and MacKellar are committed to the health and wellbeing of our employees and minimizing our environmental impacts through individual commitment and proactive participation at every level of the organization. Combined, we will continue our commitment to achieving industry-leading results and a relentless pursuit of zero harm and getting everyone home safe. You can likewise expect to see more details of an integrated ESG plan in our next annual Sustainability Report, which demonstrates further commitment to key items such as reducing our carbon footprint, expanding our indigenous relationships, increasing diversity in our workforce, and improving the communities we work in. On Slide 9, we highlight some of the key skills and characteristics of MacKellar and note how well they match ours. Whether it's an Indigenous customer or vendor partnership, MacKellar values them all and treats them with respect, honesty, and a genuine desire to be mutually beneficial. MacKellar has continued to innovate and build their skills through in-housing of equipment maintenance, component remanufacturing, and equipment rebuilds. They have successfully and continually demonstrated these skills through lowering costs and extending component and asset lives. The hands-on solution focus extends from the executive team to the frontline with demonstrated commitment to safety, ethics, communication, people, and performance. In our next section on diversification, I'll quickly go through these slides to show what we will achieve pro forma with this transaction and what the opportunities are to further grow and diversify the business going forward. On Slide 11, we show our geographic diversification into Australia and highlight all the key characteristics that make it such a great resource market. With its concentration of resources in Western Australia and Queensland, the country provides a great growth engine as we look to expand further into these mining-friendly regions. On Slide 12, we highlight our significant geographic diversification progress and fleet expansion since 2018 on the left and the tremendous resource richness of Australia on the right, including many transition metals, which we believe provide strong potential for further growth and diversification. Australia has some of the largest and most actively mined resources in the world and we're confident that the region presents a massive opportunity. Slide 13 shows the diversification progress since 2018 in EBIT and the expansion of customers from five to thirty-five. The pro forma business maintains a long history of working with quality blue-chip customers while reducing the contribution of our largest end market from 94% to 35%. We also have a strong history over that timeframe of not only achieving diversification targets but improving margins while achieving them, which is an accomplishment we are particularly proud of and which we expect to continue as we expand. Slide 14 and 15 illustrate the wide spectrum of MacKellar’s quality customers and longstanding relationships. MacKellar’s strong reputation has earned it various major projects and it now has operations on numerous sites, a few of which are highlighted here on Slide 15. In our closing section on Slide 17, we have provided a brief overview of the transaction timeline. After today’s announcement, we will be working towards a targeted closure date of Q4. Once completed, MacKellar will continue business as usual with an already established high-quality management team, but with the full support of NACG now behind it. We plan to share best practices and systems to continually drive down costs and improve operational performance. On Slide 18, we provide more detail on our focus over the next 12 to 18 months. One key area I would like to delve into is the focus of the small NAC transition team in the implementation of ERP systems and procedures. With MacKellar's strong growth and continued internal maintenance focus, their existing systems are beginning to get stretched and limiting management's ability to obtain good data. This is almost exactly the position we were in around five or so years ago, and our transition team and corporate support will be absolutely focused on helping to design and implement these systems and procedures at MacKellar using all of our past learnings to get the gains of what we did right without enduring the pains of what we got wrong. Although I consider both companies to have top-notch maintenance skills and innovation, the skills aren't identical and there's much to be gained by cross-training and sharing of best practices. We both have in-house maintenance work that was once being performed by vendors, and where the tasks are the same, we'll review each step in the process, compare, and pick what works best and combine to create an improved process. And where the in-house tasks are different, we'll evaluate the opportunities and see if that task can be brought in-house or not currently performed. Ultimately, we expect the sharing and systems improvements will support the company as a whole in continuing to lower costs, improve margins, and increase utilization while focusing on continued growth and diversification opportunities. Finishing on Slide 19, we are reaffirming our outlook for this year while increasing it for the combined impact of the fourth quarter pickup. We're providing a meaningful step change to our financial profile with increased ranges across the board. We expect to provide updated 2024 guidance later this year, but I would like to highlight the incremental impacts of MacKellar, as they are material. We anticipate a 2024 increased EBITDA and EPS of over 50%, enhanced by our backlog and see a clear path to de-leveraging to net debt of less than 1.5 times by the end of 2024. I've never been more bullish on NACG's future and I'm thrilled to welcome MacKellar to the NACG family. With that, I'll open up for any questions you may have.

Operator, Operator

Thank you. Your first question comes from Aaron MacNeil with TD Cowen. Please go ahead.

Aaron MacNeil, Analyst

Hey, morning all. Thanks for taking my questions. As it relates to MacKellar, if you look across the 15 projects, can you give us a sense of what the remaining mine lives are? And if there's any history of re-contracting, I guess I'm trying to think about it in the same way that you talk about your oil sands contracts and maybe you could also differentiate between met coal and thermal coal, if that's possible?

Joe Lambert, President and CEO

Yes. I would say it's extremely similar, Aaron, that they're long live resources. So in Western Australia, it's predominantly gold and iron ore. Gold fluctuates highly in mine life, and iron ore generally has extremely long mine lives. Their major operations in Queensland are split between thermal and metallurgical coal, and those mines have already been around, similar to oil sands for about 50 years, but they all have extensive mine lives, estimated in the 10 to 40-year range.

Aaron MacNeil, Analyst

And in terms of re-contracting, they’ve been around since 1966. Have they had the same contracts that have been?

Joe Lambert, President and CEO

Yes. Many of their customers, especially in Queensland, have been customers continuously for multiple decades, and we can certainly highlight this a lot more in future decks.

Aaron MacNeil, Analyst

Yes. No, I understand. I think you've made it pretty clear that debt reduction will be the priority, at least in the near-term, but how are you thinking about capital allocation more holistically? Like will the focus be to reduce debt further? Does MacKellar open up opportunities to further consolidate in Australia, and that's something you are interested in? Like how does that rank against the NCIB and the dividend? And just maybe give us a sense of where your head's at with this acquisition and what capital allocation may look like?

Joe Lambert, President and CEO

Yes. I think, Aaron, we're always evaluating at any point in time with share price, M&A opportunities, debt repayment. I mean, debt certainly becomes more attractive as interest rates keep going up, and it certainly has the lowest risk of any. But we're always comparing and evaluating risk versus reward. Even after this deal, we have a significant amount of liquidity, and certainly by the end of 2024 at 1.5 times, we will have a significant liquidity to do other things if those opportunities present themselves.

Aaron MacNeil, Analyst

Got it. Thanks, guys. I'll turn it over.

Joe Lambert, President and CEO

Thanks, Aaron.

Operator, Operator

Your next question comes from Kevin Gainey with Thompson Davis. Please go ahead.

Kevin Gainey, Analyst

Hey guys, congrats on the quarter, and thanks for taking my questions. I think I have one for you first, Joe. You talked about it a little in the prepared remarks, the mechanical capabilities of MacKellar. Maybe if you could go into some of the similarities or differences?

Joe Lambert, President and CEO

Yes. I guess the biggest similarity is they're extremely focused on maintenance-efficient innovation, which is very much what we do. I'd say we do a lot of our component remanufacturing in-house or with partnerships. They do the same. When I talk about sharing of best practices, what I really mean is that there are a lot of those things we do and they do the same, but there are a lot of little differences. I'll use a dozer track frame as an example. We rebuild the track frame, which is kind of the middle piece of it, and they rebuild tracks, which is obviously what you think of as the rim of the wheel and the tire. But we don't do each other's activities, and we will be able to evaluate those remanufacturing options and see if we can bring them in-house at each other’s place and continue to drive those costs down. So they're very maintenance-focused. The founder was a mechanic, and they are a very maintenance-focused group as we are, and we understand, as they do, that the biggest driver of our cost is equipment, and as much as we can control and drive down that cost is going to increase our competitiveness and margins.

Kevin Gainey, Analyst

That sounds good. And maybe for Jason, if you could talk about the seasonality of MacKellar from a revenue standpoint, and then also, from a modeling perspective, maybe the interest expense run rate that you're thinking post-transaction?

Jason Veenstra, CFO

Yes. Thankfully, MacKellar is actually very flat from a seasonal perspective. So, our midpoint for next year is around the $145 million EBITDA run rate. And when we look at that, even for how they're performing this year, it is very consistent quarter-over-quarter. They have a little bit of weather issues in December and January, but nothing like we experienced in the Canadian oil sands. So it should really help for quarter-over-quarter volatility in our results. Regarding a run rate, our $1.25 midpoint for EPS in our ranges assumes a 7.5% interest rate, which is a combination of the vendor take-back financing, the equipment leases we hope to have in place, as well as the revolver, which is currently tracking in the high 7s from an interest rate perspective. But 7.5% is a good base case, and we hope to beat that with primarily equipment financing, which is quite competitive.

Kevin Gainey, Analyst

Perfect. I'll hop back in the queue.

Joe Lambert, President and CEO

Thank you.

Operator, Operator

Your next question comes from Tim Monachello with ATB Capital Markets. Please go ahead.

Tim Monachello, Analyst

Hey, good morning, everyone.

Joe Lambert, President and CEO

Good morning, Tim.

Tim Monachello, Analyst

Just a few questions on the acquisition, starting with the Australian competitive landscape. I know, Joe, you've worked in Australia before. I'm wondering if you can maybe parallel the competitive advantages that MacKellar might have in the Australian market versus how you guys are positioned in the Canadian market. Obviously, you have a very strong competitive positioning in oil sands. I think the Australian market's a little bit more fragmented and perhaps more competitive, but it looks like MacKellar still has pretty strong profitability and margins. So, I'm just wondering if you can lay that out for me?

Joe Lambert, President and CEO

Yes. I'd say it's extremely similar to ours. I mean, the Australian contract mining in earthworks marketplace is big. It's much more prevalent for mine sites to contract than in North America. But with that, there are more competitors, both public and private. The focus there, similar to us, is the way to maintain consistency in that marketplace is to be the low-cost provider and focus on safety. Their in-housing of maintenance for component remanufacturing or second-life rebuilds of equipment, which they've likewise been doing for many years now, is very much where we focus because that’s the biggest driver of cost, and we will certainly look for other areas of operational efficiency, but that's what drives their competitiveness. And it's what we'll use, similar to what we've done in our core oil sands business to diversify and get into other areas. We'll look to do the same thing with MacKellar and using that low cost such that you can go out and diversify without losing margin.

Tim Monachello, Analyst

Is there evidence that MacKellar is the low-cost provider, at least one of the lowest-cost providers in the market in Australia?

Joe Lambert, President and CEO

I don't think we have as definitive evidence as we've had in oil sands, where we've had clear timeframes, such as during COVID, and when we were the only ones operating, and during some tenders that were done during reverse auctions. So we don't have that kind of clarity, I would say. But just looking at what they do and how they do it, and the cost savings versus external vendors, we certainly believe they're there or very close.

Tim Monachello, Analyst

And then I know that in future iterations of your presentation, you'll wrap in MacKellar, but there are a couple of things that I'm curious about. One is the bid pipeline that MacKellar might have in Australia. How does that look compared to the NACG bid book?

Joe Lambert, President and CEO

There's quite a few projects in there. I don't know how it compares historically. I guess really their biggest issue, Tim, is their fleet is almost fully utilized. So it's more about having the assets to do the work than having the work to bid on. There’s plenty of work in bid pipelines occurring, especially in Western Australia, with their Western Plant Hire Group. We’re going to look to see whether we can utilize some of our underutilized assets from oil sands to give them some support in the extremely strong demand environment that they’re in. So the bid pipeline is strong. I can't give you a comparator because I don't know it off the top of my head. But the limiting factor on that bidding is more the amount of equipment they have and the high demand they already have.

Tim Monachello, Analyst

Okay. Got it. That gets into my next question, so I was going to ask about that. Do you think that the smaller end of your fleet in the Canadian market is suitable for some of the demand profile in Australia?

Joe Lambert, President and CEO

Absolutely, especially in the Western Australia rental market. So, our 100 to 150-ton trucks that are underutilized in oil sands, we've been moving into other regions and bidding into other regions, are highly utilized in the Western Australia rental market.

Tim Monachello, Analyst

Okay. Do you think that there's a high likelihood that you're going to have to grow the fleet organically as well in Australia?

Joe Lambert, President and CEO

I don't know that offhand. I think there'll be an opportunity, and I think we’ll evaluate that kind of growth capital, like we do for the rest of our capital allocation, as far as what's the risk and reward and opportunity within it. I think that the Western Australian Rental Market will be able to feed from an underutilized fleet, but there are certainly some big gear and long-term mining contracts that would require growth assets. We will evaluate those opportunities just like we do anywhere else in our capital allocation.

Tim Monachello, Analyst

Okay. And then last one for me. Is there anything in the MacKellar contract book that's coming up for renewal over the next maybe two years that is meaningful that you'll have to replace?

Joe Lambert, President and CEO

Not significantly. I think you can see by that backlog number that they're booked for several years. There are different contracts, of course, but they certainly have long-term contracts with good escalation clauses and coverage for inflation. Even on the rental side, they’re long-term rentals. So I don't see there will be significant churn in the next two years, but it will be a small portion of the overall work.

Tim Monachello, Analyst

Okay. That's really helpful. Thanks a lot, guys, and congrats on the deal.

Joe Lambert, President and CEO

Alright, thanks, Tim.

Operator, Operator

Your next question comes from Maxim Sytchev with National Bank. Please go ahead.

Maxim Sytchev, Analyst

Hi, good morning, gentlemen.

Joe Lambert, President and CEO

Good morning, Max.

Maxim Sytchev, Analyst

Joe, two questions for me, if I may. The first one, I was wondering if you don't mind maybe commenting about sort of eventual infrastructure spending opportunities, as I believe Australia right now is going through a pretty significant investment cycle. Yes, maybe that’s the first one if you can provide me color there? Thanks.

Joe Lambert, President and CEO

Yes. I do think, first of all, MacKellar isn't involved in any major infrastructure works; it's all mining contracts and rentals. I absolutely see great opportunity there. In particular, our partner in Fargo-Moorhead, the company we partner with there, is also, I believe, either the number one or number two contractor in infrastructure in Australia. We certainly think there’s an opportunity with Australian infrastructure projects that have significant earthworks, where we'd be invited in, especially from our partners in Fargo, to bid on those works. So I think that's an expansion and diversification opportunity that we’ll have for MacKellar in the future.

Maxim Sytchev, Analyst

Okay. Excellent. Thank you. And my follow-up is for Jason, if I may. Caution to think about the free cash flow conversion given the slightly younger age of equipment; yes, any color there would be helpful? Thank you.

Jason Veenstra, CFO

Yes. It's a direct correlation to a higher conversion ratio. So we've been in that 30% range, trying to inch up to 35%. MacKellar's nicely in the 40% free cash flow conversion range, even with pretty heavy interest next year. So, as Joe mentioned in his prepared remarks, the sustaining capital range we gave for MacKellar next year is a pretty wide range. As we get to know their equipment, we'll fine-tune that. We think there's a little bit of upside there to get even north of 40% conversion ratio, so definitely some good free cash flow potential over the next couple of years with this newer fleet.

Maxim Sytchev, Analyst

Okay. Excellent. That’s it for me, gentlemen. Thank you so much, and congrats on the deal.

Joe Lambert, President and CEO

Thanks.

Jason Veenstra, CFO

Thanks, Max.

Operator, Operator

This concludes the Q&A Section of the call. And I will pass the call over to Joe Lambert, President and CEO for closing comments.

Joe Lambert, President and CEO

Thanks, and thanks everyone for joining us today. We look forward to providing the next update either upon the closing of this transaction or our Q3 results.

Operator, Operator

Ladies and gentlemen, this concludes your conference call for today. We thank you for participating and ask that you please disconnect your lines.