Service Stream Flowing Nicely Now

Service Stream sits in a very sweet spot. The government’s investment in the NBN will continue to drive opportunities for the fixed communications business, while in mobile communications, increasing demand for mobile data and advances in technology will continue to drive infrastructure development. In its newer business, energy and water, there are also plenty of opportunities.

Infrastructure provider Service Stream Limited (SSM) has had mixed fortunes with the National Broadband Network (NBN), and would have been cursing it not so long ago, but in reality, the two organisations were made for each other.

Service Stream, which listed on the Australian Securities Exchange (ASX) in 2004 as Total Communications Infrastructure Limited, is a specialist service provider to the utilities industry, particularly telecommunications. The company was established in 1995 as a specialist communications deployment business, with the specific purpose of integrating the communications industry with the construction industry.

At the time the core business was providing turnkey base station infrastructure to wireless communications providers. Service Stream has grown to become an infrastructure and network services provider to the electricity, water and gas sectors, too, with a service offering that covers site access, design, construction, installation, maintenance and ongoing services to support network operation.

The company is organised in three divisions, Fixed Communications, Mobile Communications and Energy and Water. In the recent FY16 result, Fixed Communications generated 44 per cent of revenue and 56 per cent of operating earnings, Mobile Communications accounted for 38 per cent of revenue and 45 per cent of operating earnings, and Energy and Water contributed 18 per cent of revenue and 14 per cent of operating earnings (eliminations, interest received and unallocated corporate services overheads mean these proportions do not sum perfectly.)

The announcement of the NBN in 2009 should have been a godsend for a business like Service Stream, and indeed it started out that way. Service Stream was among the first seven companies awarded contracts at the NBN’s first release sites in May 2010, and became a sub-contractor to Fujitsu in its greenfields rollouts soon after.

It also formed a joint venture with Lend Lease called Syntheo, which won $650 million worth of NBN rollout contracts, in conjunction with Transfield Services. In June 2012, NBN dropped Fujitsu following concerns about connection delays, but Service Stream stayed involved, splitting $183 million worth of contracts with Leighton subsidiary Visionstream.

That was the first brush with NBN disaster. Then, in February 2013, NBN blamed the Syntheo joint venture for a significant shortfall in the number of houses passed by the NBN. A month later, Syntheo announced that it would hand back all of its undone NBN work in the Northern Territory, and in August, it walked away from the NBN altogether. Lend Lease took over Syntheo’s remaining obligations, while Service Stream self-suspended its stock from trading for two months while it assessed losses stemming from the joint venture. Eventually, Service Stream booked an operating loss of $32 million as a result of the partnership, and took an $89.8 million writedown on the way to a net loss of $107.1 million in FY13.

That was a low point, but the fact remained that Service Stream was a telecommunications network specialist, and NBN was the biggest telecommunications infrastructure game in town. Service Stream swallowed its pride, refinanced its debt, froze salary and bonus rises, and got back on the horse, winning new NBN contracts.

Fast-forward three years, and Service Stream continues to work on the NBN rollout, has won the job to design and build Telstra’s wireless network, and has just signed a five-year $10 million contract with NBN to roll out infrastructure including fibre-to-the-node (FTTN), fibre-to-the-premises (FTTP) and fibre-to-the-building (FTTB). That takes to five its number of NBN contracts: in FY16, Service Stream’s NBN revenue rose by one-third, to $184.9 million.

In FY16 Service Stream lifted revenue by 6.7 per cent to $438.9 million, and net profit by 70 per cent, to $20 million. Operating cash flow rose 32 per cent to $62.3 million. On a pre-tax basis (and before significant items) earnings surged 66 per cent to $28.5 million. The second half of FY16 was the sixth consecutive half-year of operating earnings growth.

Each of the three businesses grew its revenue, fixed communications by 7 per cent, mobile communications by 8 per cent, and energy and water by 6 per cent. Operating earnings surged, up 51 per cent in fixed communications, by 21 per cent in mobile communications, and by 42 per cent in energy and water.

Earnings per share (EPS) soared 80 per cent to 5.1 cents, while the company’s return on assets (ROA) increased from 6.4 per cent to 10.2 per cent. Service Stream paid a capital return to shareholders of 5 cents a share on 10 June 2016, and lifted its full-year dividend by one cent, to 2.5 cents a share, fully franked. The balance sheet at the end of FY16 was very strong, with $41.1 million of cash on hand at year-end, up 56 per cent from FY15, and no borrowings.

The mobile communications division added new clients in the form of Nokia Networks, (work on Optus’ wireless network), the NSW Telco Authority, PIPE Networks (part of the TPG group) and Axicom (previously known as Crown Castle Australia). In energy and water, the company commenced a new contract with AGL Energy’s Active Stream, installing more than 40,000 electricity smart meters. The division also completed 2,445 residential and commercial solar PV installations (for Origin Energy) with aggregate capacity of 11.3 megawatts, and started a new meter reading and meter replacement contracts with Hunter Water in New South Wales.

These new contracts give Service Stream enhanced earnings diversification and a solid platform for growth, while the new NBN contracts give it a significant proportion of annuity-style revenue.

Contract loss is always a big risk for Service Stream, operating as it does in a limited number of market segments in which there are relatively few competitors, but the company says only a small number of contracts with key customers are due to expire during FY17, and it is confident that most of them will be either extended or renewed where there is ongoing work.

Analysts’ consensus sees Service Stream earning 7.9 cents a share in FY17 (up 56 per cent), and paying a fully franked dividend of 4 cents a share (up 60 per cent.) On those prospective numbers Service Stream trades at 13 times expected FY17 earnings, and a fully franked yield of 3.9 per cent.

At the height of Service Stream’s NBN problems in 2013, you could have bought the stock for 12 cents: even at the start of 2016, it was sitting at 43 cents. At $1.02 now, and capitalised at $372 million, Service Stream has been a great performer. On consensus analysts don’t see great potential for price growth from here, although it is worth pointing out that broker Ord Minnett has a price target of $1.13, which is 10.8 per cent above the current price. Service Stream is a very solid business that looks a prime candidate for patient capital growth. It has puts its NBN difficulties of three years ago behind it, and in fact, NBN has turned into a strength for Service Stream – and it no longer relies on it quite as much.