Service Stream’s Positive Defence Surprise

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Service stream shares jump as analysts anticipate rising margins on the back of a new contract win with the Australian government.

-Service Stream wins larger-than-anticipated Defence contract
-Analysts positive on margin upside and diversification
-Company has long been perceived as a telecommunication infrastructure services provider
-Shares trade on a relative premium, with multiple catalysts for further upside

By Mark Woodruff

Winning new contracts and improving margins are key drivers of shareholder value for pure-play infrastructure services company Service Stream ((SSM)).

Last week’s announcement of a material Property and Asset Services contract win with the Australian Government’s Department of Defence boosted the share price back to levels not seen since December 2020.

Ord Minnett highlights Defence as a large and expanding segment, representing the final major utilities maintenance market Service Stream had yet to enter. Positively, earnings will now be diversified away from a traditional skew to Telecommunications.

The company operates through three divisions aligned with major infrastructure markets, Telecommunications, Utilities, and Transport.

As has occurred for contracts within other verticals, Macquarie expects Service Stream to improve margins over the life of this new Defence contract.

Already, shares trade at a premium valuation to peers such as Downer EDI ((DOW)) and Ventia Services ((VNT)), yet Citi sees multiple near- to medium-term catalysts supporting further upside and sustained earnings growth.

When reviewing Service Stream’s largely in-line FY25 results in mid-August, Ord Minnett highlighted Utilities was set to be the key growth driver in FY26, forecasting around 12% revenue growth, supported by recent contract wins with Urban Utilities and Sydney Water.

Further, with long-term National Broadband Network (NBN) agreements renewed, the broker expected the Telecommunications segment would deliver steady revenue and earnings through FY26.

Service Stream’s debt-free balance sheet left it well placed to fund both organic expansion and acquisitions, suggested the analysts.

At the time, investors were awaiting outcomes from multi-year Defence tender processes.

That wait concluded last week when management announced the securing of (an initial) $1.6bn long-term Base Services Contract with the Department of Defence.

Appointed the provider of Property and Asset Services for South Australia and the Northern Territory (encompassing 113 Defence sites and training facilities, including eight major bases), Service Stream will perform and support estate upkeep, land management, aerodrome operations, along with training area and range management services.

The contract will operate for an initial six-year term, with two extension options of between one-to-three years, to extend to a maximum term of 10-years at Defence’s discretion.

Management is anticipating minimal earnings contribution in FY26 as operations don’t commence until February 2026 and the required ramping mobilisation program, involving 350 new employees and a range of specialist contractors.

Macquarie considers this is a very positive contract win (larger than the market was anticipating), which opens a new vertical in facilities and land management services for government, diversifying Service Stream’s portfolio beyond traditional utilities and telecom work.

The expanding Service Stream business

Originally focused on telecommunications network services, Service Stream has grown through acquisitions to diversify into other sectors.

After listing on the ASX in 2024 as Total Communications Infrastructure (TCI), and renaming in early 2007 to its current monniker, the company expanded its telecommunications capabilities, and in 2008 entered the utilities field by acquiring AMRS, a meter reading and exchange business.

The company’s utilities footprint was further bolstered by the 2018 acquisition of Comdain Infrastructure, which added significant expertise in gas pipeline and water network projects.

A transformative milestone came in November 2021 when Service Stream acquired Lendlease Group’s ((LLC)) Services division for -$310m. This deal dramatically broadened Service Stream’s scope, adding around 2,200 staff and new capabilities in power, transport infrastructure, and industrial asset maintenance.

The company’s Telecommunications division provides network design, construction, equipment installation and ongoing maintenance for fixed-line and wireless networks. It has played a key role in Australia’s telecom rollout, including building, and maintaining parts of the National Broadband Network (NBN) and mobile systems. Major clients include NBN Co, Telstra Group ((TLS)) and Optus.

Delivering services across gas, water and electricity networks, the Utilities division’s capabilities span engineering and design, pipeline construction, meter replacement and 24/7 operations. Key clients include Sydney Water, South East Water, APA Group ((APA)), and Australian Gas Infrastructure Group.

The Transport division supports long-term maintenance of road and transport infrastructure, including intelligent transport systems and control room operations. Clients include Transport for NSW, Main Roads WA, VicRoads, and the South Australian Department for Infrastructure & Transport.

Cash flows and capital management

Underscoring the defensive quality of Service Stream’s asset-light services business, much of its revenue comes from recurring operations and maintenance contracts on critical networks (water, power, communications, roads) which tend to be less cyclical than construction and have high renewal rates.

This provides a stable base of cash flows. Indeed, over 95% of Service Stream’s backlog consists of term contracts with built-in escalation, and a majority of its clients are government or blue-chip entities.

At the time of FY25 results, Macquarie noted a strong balance sheet underpins optionality for strategic M&A or capital management initiatives.

A final, fully franked dividend of 3 cents took the full-year payout for FY25 to 5.5 cents, an increase of 22% on FY24.

Margins

Once mobilisation of staff is complete, the company should also be well positioned to win additional work, such as minor capital projects, providing incremental revenue beyond the initial $1.6bn contract value, thereby improving margins over the life of the contract, Macquarie explains.

Service Stream’s earnings margins have been modest (historically mid-single-digit) due to the lower-margin nature of utility construction and maintenance work, but management has been focused on margin improvement through cost synergies and selective bidding for contracts.

Citi forecasts no earnings margin contribution in FY26, but expects Service Stream to ramp quickly, leveraging complementary capabilities to reach around 5% by FY27.

While there is no change to this broker’s FY26 earnings forecast of $160m, the FY27 earnings forecast has been raised by 7% to $179m with Defence margin reaching 4.8%.

Beyond FY26, the analysts forecast the Defence margin will run at 5% in FY27 which takes Citi’s FY27 earnings estimate for the group to $186m, 8% higher than previously forecast.

Providers are expected to have fully transitioned and be mobilised in the five-month period to 1 July 2026 to be able to immediately meet annualised run-rates at that time, highlights Canaccord Genuity.

This broker’s Defence margin forecast aligns with management’s expectation of a mid-single digit percentage.

Outlook

Even after the greater-than-expected size of the Defence contract win, Citi sees further upside for Service Stream. It’s thought Utilities margins will continue to outperform, the balance sheet is strong, and Telco volumes may surprise, given Service Stream’s position as one of only two field services providers to NBN.

Citi rates the shares Buy alongside a price target of $2.65 (up from $2.45).

Ord Minnett has raised its target to $2.57 from $2.35 and upgraded to Buy from Accumulate.

Macquarie sits on Outperform (Buy equivalent) with an upgraded price target of $2.70, from $2.42 before the contract win.

This means there are three daily covered Buy-rated (or equivalent) brokers in the FNArena database with an average target of $2.64, implying nearly 11% upside to the $2.38 share price at the close of trade on September 15..

Outside of daily coverage, Canaccord Genuity has lifted its target to $2.60 from $2.30 and also retained a Buy rating.

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