Acquisition Of Lendlease Will Expand Addressable Markets

Key Takeaways

• Strategic repositioning in Utilities and strong Telco agreements enhance future growth, boosting earnings and revenue stability.
  
• Acquisition of Lendlease Services diversifies offerings and markets, driving potential top-line growth and supporting financial sustainability.
  
• Continued challenges in the Utilities segment and risks from large-scale contracts and tendering efforts could threaten margins, earnings, and cash flow stability.

Catalysts

Engages in the design, construction, operation, and maintenance of infrastructure networks across the telecommunications, utilities, and transport sectors in Australia.

• The strategic repositioning of the Utilities segment and the successful renegotiation and exit from loss-making contracts are expected to continue enhancing margins, positively impacting earnings growth into FY '25.
  
• The Utilities division has secured multiple new operations and maintenance agreements, supporting revenue growth across all market sectors. This is likely to impact future revenue positively.
  
• Service Stream's acquisition of Lendlease Services has significantly diversified service offerings and expanded addressable markets, resulting in a 44% CAGR in revenue over three years, indicating potential for continued top-line growth.
  
• The Telco segment benefits from strong agreements and demand for connectivity, with 85% of FY '25 work already secured under contracts with potential for further growth, positively impacting revenue and earnings stability.
  
• Service Stream's improved cash flow conversion rate, alongside strengthened balance sheet metrics, supports future growth investments and financial stability, likely boosting earnings sustainability.

Service Stream Future Earnings and Revenue Growth

Assumptions

• Analysts are assuming Service Stream's revenue will grow by 5.6% annually over the next 3 years.
• Analysts assume that profit margins will increase from 1.4% today to 2.3% in 3 years time.
• Analysts expect earnings to reach A$61.8 million (and earnings per share of A$0.1) by about February 2028, up from A$32.3 million today. The analysts are largely in agreement about this estimate.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 20.0x on those 2028 earnings, down from 29.7x today. This future PE is greater than the current PE for the AU Construction industry at 17.5x.
• Analysts expect the number of shares outstanding to decline by 0.35% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 7.09%, as per the Simply Wall St company report.

Service Stream Future Earnings Per Share Growth

Risks

• Continued challenges in the Utilities segment, despite recent improvements, could affect margins and earnings if not fully resolved, particularly since it has historically been a drag on performance.
  
• Risks related to large-scale fixed-price contracts, especially in sectors where margins are slim, could negatively impact net margins if these projects face overruns or cost escalations.
  
• The reliance on achieving margin improvements and securing growth in new business opportunities could present execution risks that might not materialize, affecting revenue and earnings growth expectations.
  
• Potential overexposure to specific long-term contracts, such as the nbn UniFi agreement, which is currently up for renewal, presents a risk to earnings stability if not successfully renewed or extended.
  
• A significant investment in tendering, such as the defense contract bid, presents a risk if unsuccessful, as it could lead to sunk costs without corresponding revenue, negatively impacting net margins and cash flow.

Valuation

• The analysts have a consensus price target of A$1.657 for Service Stream based on their expectations of its future earnings growth, profit margins and other risk factors. However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of A$1.75, and the most bearish reporting a price target of just A$1.41.
  
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2028, revenues will be A$2.7 billion, earnings will come to A$61.8 million, and it would be trading on a PE ratio of 20.0x, assuming you use a discount rate of 7.1%.
  
• Given the current share price of A$1.56, the analyst price target of A$1.66 is 5.5% higher. The relatively low difference between the current share price and the analyst consensus price target indicates that they believe on average, the company is fairly priced.
  
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.