Small Caps | 10:30 AM
New research on SRG Global highlights a strong history of earnings growth and potential upside from management's conservative acquisition strategy.
-80% of SRG Global's earnings are recurring
-Potential extra boost from management's acquisition strategy
-Buoyant outlook for infrastructure and construction spend in Australia
By Mark Woodruff
Australian diversified infrastructure services provider SRG Global ((SRG)) has demonstrated a strong and consistent track record of earnings growth, with a material portion driven organically.
Inaugural research by Morgans last week suggests positive momentum is set to continue, underpinned by growing customer preference for specialist maintenance providers over generalists and a notable increase in production volumes from key gold mining clients.
Founded in 1961 and headquartered in Subiaco, Western Australia, SRG provides maintenance, industrial services, and engineering and construction services across 20 industries including mining, water, energy, infrastructure and utilities.
The business consists of two broad reporting segments: Maintenance & Industrial Services (Maintenance) and Engineering & Construction (E&C).
The E&C division delivers specialist services for dams, bridges, facades, and concrete structures, targeting both private and government projects.
Asset maintenance is the largest earner, benefiting from an expanding infrastructure base, ageing assets, and increasing demand for outsourced maintenance, noted Bell Potter upon initiating coverage in May last year.
This broker highlighted the acquisition of Asset Care in February 2023 enhanced SRG's front-end diagnostics and inspection capabilities, enabling end-to-end asset lifecycle servicing and cross-selling opportunities.
Positively, around 80% of the company's earnings are recurring/annuity style, explains Morgans, and the business is relatively evenly split across the East Coast (50%) and West Coast (45%) of Australia, with New Zealand making up the balance.
Key risks include fixed-price contract exposure, project mis-pricing, labour availability, and commodity price sensitivity, but the broker believes SRG's strong client base, execution record, and diversified revenue streams mitigate these concerns.
Not factored into the share price, believes the analyst, is an ongoing prudent acquisition strategy by management to supplement organic growth.
Over the past three years, the broker views SRG's acquisitions as both successful and disciplined, with each transaction followed by a return to a net cash position before pursuing the next opportunity.
True to form, February's interim results showed a shift to a net cash position of $9.1m, recovering from pro forma net debt of $38.2m after the August 2024 acquisition of Diona, a specialist in water security and energy transition infrastructure.
SRG's visible cash generation, with an aggregate conversion rate of 100% from FY21-24, is considered a key indicator of earnings quality and acquisition performance.
Valuation
A year ago, Bell Potter presciently identified SRG as materially undervalued relative to its Industrial Services peers, noting it compared favourably to close peer Monadelphous Group ((MND)), with stronger margins and superior free cash flow (FCF) yields.
The analysts anticipated this valuation gap would narrow as SRG advanced its transition toward a more resilient, recurring revenue model and increased its presence in the expanding outsourced maintenance market.
All up, the SRG share price rallied circa 95% over the 12 months leading into its first half results for FY25 in mid-February.
Commenting again post results, this broker noted the valuation gap with the Industrial Services peer group has indeed closed, but still argued the stock should trade at a premium given its above sector-average EPS growth outlook.
Effective prior to the open of trading on March 24 this year, SRG Global was added to the ASX300 Index.
Most recent results
Outcomes were broadly in line with Ord Minnett's expectations, but management upgraded FY25 guidance by around 1% at the mid-point, driven by the Diona acquisition.
In support of the acquisition, management highlighted Diona's strong position in program and asset management services for utilities and government agencies.
Earnings for the first half slightly beat Ord Minnett's forecast driven by a stronger-than-expected margin outcome in the Maintenance & Industrial Services segment.
Maintenance & Industrial Services saw revenue increase by 19.4% to $388m on the prior year, while Engineering & Construction revenue jumped by 24.8% to $231.7m.
At the time, Ord Minnett felt momentum remained strong with the company's work-in-hand rising to $3.4bn, a 13% increase against FY24.
With an opportunity pipeline of circa $8.5bn, Shaw and Partners also remained confident in higher earnings over time.
The forward outlook was also supported by a high-quality management team, noted Ord Minnett.
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