PORTFOLIO POINT: Given its exposure to 10 years or more of capital expenditure through the NBN, Service Stream is an attractive small cap for those looking to diversify outside the resources sector.
There are several ASX-listed companies exposed to the federal government’s $43 billion National Broadband Network rollout. Some of these include corporate heavyweights such as Leighton Holdings (market capitalisation $7,900 million), Downer EDI ($1,566 million) and Transfield Services ($1,252 million). Standing out among these is the relative market minnow, Service Stream (ASX: SSM) ($106 million), which has been winning more than its fair share of the rollout program alongside its Syntheo joint venture partner, Lend Lease ($4,168 million).
This places Service Stream in a somewhat unique position as an ASX-listed small cap industrial stock that is exposed to 10-plus years of significant capital expenditure. Moreover, that expenditure is more or less unrelated to the booming resources sector. As such, Service Stream is one of the few small-cap companies in the second tier of the so-called “two-speed economy” that can look out over the next few years with a high degree of confidence in its revenue base.
So what exactly does this company do? At its core, Service Stream is a critical link between large telco and utility companies and their millions of end users Australia-wide. By way of example, Service Stream provides its customers with the following types of services:
· NBN Co - Syntheo. The 50:50 JV has major contracts for the design and construction of the fibre network rollout, including in WA (worth $174 million over two years, plus extensions) and NT/SA (worth $141 million over two years, plus extensions)
· NBN Co - Standalone. Fibre network rollout including new-estate build services and potentially multi-dwelling unit services.
· Telstra. The Access and Associated Services contract provides a range of outsource services to the domestic telephony behemoth. Service Stream recently lost a slice of the installation and maintenance contract to a competitor. We expect further contract extensions/renewals within the ongoing Telstra remit to go some way towards filling the revenue gap this partial contract loss caused.
· Vodafone Hutchison, Telstra, Optus. Turnkey and project management services for the site design, acquisition and construction of wireless telecommunications infrastructure.
· Various gas/water/electricity utilities. Meter reading, installation (including a major smart meter installation programme), and disconnection/reconnection services.
· Origin Energy. Supply and installation contract for residential solar systems.
Service Stream was another one of those companies that endured a dramatic fall from grace during the GFC, predominantly due to a combination of too much debt from an ill-timed business acquisition and poor contract management. With a new board and management team at the helm and solid earnings visibility, the team at OC believes Service Stream is well worth revisiting from an investment perspective.
Analysts have forecast the company to be earning around 6 cents per share (cps) in FY12 and more than 7cps in FY13. At current share price levels of $0.40c, the stock is on an undemanding PE multiple of 6.6x FY12 (5.7x FY13). With a burgeoning “blue chip” order book, strong cash flows and comfortable levels of gearing, Service Stream has even resumed dividend payments, a reflection of the board’s high degree of confidence in the business moving forward.
Catalysts to look out for in the short term include further contract wins and/or renewals, particularly in the NBN arena (whether through the Syntheo JV or stand alone new estates/multi-dwelling units work), clarification of its relationship with Telstra, and any further guidance around full-year earnings and its order book going into 2013.
Robert Calnon is portfolio manager at OC Funds Management.