Stock in Focus | Service Stream Ltd (ASX: SSM)

By Robert Miller | Portfolio Manager at NAOS Asset Management

In this article we answer 8 questions about Service Stream Ltd (ASX: SSM).

SSM is a business providing a wide range of specialist services, principally the development and maintenance of telecommunications and utilities assets. They do this through their nationwide subcontractor base. SSM has a market capitalisation of approximately $670 million.

How long have you held the stock?

We have known the business for many years and the current management team for over two years. They have successfully turned around the business, following a recapitalisation in 2014. After gaining confidence in their track record of consistently delivering earnings growth and creating a safe balance sheet, we felt comfortable investing 12-18 months ago.

What do you like about it?

Firstly, we like the management team who are transparent and consistent with their strategy and results. With regard to transparency, SSM provide excellent market disclosure on their operations. On consistency, they have delivered EPS growth every half since 1HFY14. Secondly, we like the capital light business model that has seen SSM generate excellent cash flow, building a conservative balance sheet and high dividend pay-out levels to shareholders. Thirdly, we like that the business has scale and operates in markets that have strong growth prospects.

How is it better than its competitors?

SSM has nationwide reach with one of the largest field forces of subcontractors in the country who provide a large array of services to the telco and utilities markets. Given this, there are many different subsets of competitors. It is important to note that SSM is focused more on annuity type revenues generated from ‘maintenance type’ services, with high volumes of ‘small tickets of work’ providing an arguably lower risk profile to the typical large project ‘construction type’ contracting businesses.

SSM’s key advantages over competitors are twofold. The nationwide reach of their operations and subcontractors, particularly in the telecommunications space, means they can win work on national contracts rather than being only regionally focused. This becomes more cost effective and efficient for both SSM and the customer through aligned operating systems, project understanding, payment processing and service consistency. Secondly, SSM’s track record of delivery on previous contracts for mission critical assets means they are well-placed to win repeat business from those same customers. For example, SSM has been a key delivery partner for Telstra in terms of rolling out their 3G and 4G mobile networks. They know the technology and infrastructure well, hence we believe SSM are likely to be in a strong position to help deliver the 5G network when that rollout occurs.

What do you like about its management?

We believe SSM has a high-quality management team for the following reasons:

1. Track record of delivering consistent earnings growth
2. Track record of achieving and outperforming market guidance
3. Track record of capital management benefitting shareholders – they’ve previously undertaken buybacks and special dividends
4. Company strategy and communication is simple and consistent
5. Focus on balance sheet and cash generation
6. The internal systems are efficient and scalable
7. Shareholder alignment through long term incentive plans for management

What is your target price?

When valuing investments, we look for companies that we feel can achieve a total shareholder return over a three-year period of 20% per annum. After announcing a large and strategic acquisition, we currently feel SSM hits our hurdle for achieving this return profile.

At what point would you sell it?

If our valuation was achieved, if the risk/return profile didn’t stack up, or if there was a significant deviation from the initial investment thesis.

How much has it added (subtracted) to your overall portfolio over the last 12 months?

It has been a positive contributor to our mid cap LIC (ASX: NAC) and remains a core holding.

Where do you see the value?

SSM has announced the strategic acquisition of a utilities services business which will further diversify company earnings into a large and growing market. Client crossover and geographical expansion are two of the areas where we believe synergies of the combined business can generate further value. The organic SSM business should continue to benefit as a key rollout partner for the multiple 5G mobile networks to be built in the coming years. In addition, as a key provider of maintenance services to the NBN, this earnings stream should naturally grow as more people are connected to the NBN.

Important Information: This material has been prepared by NAOS Asset Management Limited (ABN 23 107 624 126, AFSL 273529 and is provided for general information purposes only and must not be construed as investment advice. It does not take into account the investment objectives, financial situation or needs of any particular investor. Before making an investment decision, investors should consider obtaining professional investment advice that is tailored to their specific circumstances.

Switzer Super Report: Published 06 December 2018