Earnings Call: Q2 2021

Jul 23, 2021

Morning, everyone. This is André Löfgren, Head of Investor Relations at Skanska speaking. I would like to welcome you to the presentation of Skanska's six-month report for 2021. The presentation will be held by Anders Danielsson, who is our CFO, and also Magnus Persson, our CFO. After the presentation, you will all be able to ask questions. With that, I hand over to you, Anders. Thank you, André. Before we go into the figures, I want you to look at this picture. It's the new Moynihan Train Hall in New York City, U.S. It's recently inaugurated and very good for the city and the transport system there. Let's go into the 6 months report. Overall, we have a strategy that pays off. We can see Construction steadily improving the profitability quarter by quarter and also this quarter. Residential Development volumes and profitability on a high level, and Commercial Property Development divestments gains on attractive level. We'll go into that soon. The operating margin in Construction is 3.6% the first 6 months, compared to 1.9% last year. Return on Capital Employed in Project Development well above our 10% target at 12.4% on a rolling 12. Return on Equity 26.7% and very strong financial position for the whole company. We also managed to reduce carbon emissions with 43% compared to the baseline 2015, and that includes the Scope 1 and 2. We start with the different stream and Construction, the revenue was SEK 61.7 billion. We had order booking, strong order bookings, SEK 84.7 billion for the first six months. Strong order bookings in U.S. We can see that the market is picking up, projects are coming out in the market and clients, they are starting new projects. Overall, a book-to-bill of 120% on a rolling 12, so that's on a high level. The order backlog is slightly above SEK 200 billion, also historically on a high level. Operating income, SEK 2.2 billion, which corresponds to operating margin of 3.6%. We can see the profitability improving in all business units. We also have a one-off in the quarter. Magnus will go into that later on here, divestment of Infrastructure Services operation in the U.K. impacting the quarter positively. If you go into the Residential Development, revenue SEK 8.7 billion, very high increase on revenue. We can see also increase as a home sold, 2,500. The started home increased a lot to close to 2,000 units. The operating income SEK 1.2 billion compared to SEK 588 million last year, and very high operating margin. We have a 10% target, as you know, 14.3%. The Return on Capital Employed 16.6% rolling 12. A very high activity and strong profitability. We have a solid land bank, but we can see that zoning process is slow in several of our markets. The challenge for us is to work long-term on this. We have been successful because we have been able to increase the start of projects during the period. On the other hand, we have a shortage on homes in all markets, and that together with a low interest rate is mitigate that in a positive way. We can go into the Commercial Property Development. Operating income, SEK 1.5 billion. Smaller quarter than comparable period, but strong margins, attractive margins. We have a gain on sale of SEK 1.7 billion for this period. Return on Capital Employed above our target of 10%, 10.6%. Today we have 34 ongoing projects corresponding to close to SEK 23 billion in investment upon completion. We also have a reasonable alignment with the occupancy rate and the completion rate, 35% versus 39%. We started 11 new projects in the first six months. In the second quarter, we started the largest ever, The Eight in Seattle, outside Seattle in Bellevue, the largest ever, SEK 4 billion. That's very promising. It's in an area where vacancy rates are very low, around 1%, and we have very large world company in that area. I'm confident, and we can start it. Leasing, however, was a bit slow in the quarter. We leased 94,000 sq m the first six months. Divestment at very attractive level during the quarter. To conclude the commercial development, slow leasing market, but activity is picking up, and that's important. We can clearly see now in the second quarter that activity is picking up, more potential tenants are looking for offices. We can see that the visits have more views on our projects for potential tenants, and that's encouraging. I believe that will continue in the future. The property investor market is solid. We have very high interest amongst investors for our projects. Going to the construction again with the order bookings. Book-to-bill 120%, we have a strong order intake in the quarter. Again, order backlog above SEK 200 billion. That's encouraging for the future. If we go into each market and look at the order bookings, we can see that all areas, all regions have above 100% book-to-bill. You can see Sweden is slightly below 100%, but we do have a healthy backlog there, and we also had a strong quarter in Sweden when it comes to order bookings. With that, I leave it to Magnus to go further into the details. Thank you, Anders. We go into the Construction income statement. We had revenues for the first six months here. As you can see, we're down 14% if you compare it to the same period last year. If we look at Q1, it was down 18%. Q2 was down 10%. We're sort of slowly catching up here a bit with revenue development. With the good bookings we've had now, we think that's a good sign, of course, also. In terms of profitability, we can see that the measures we have taken continue to positively impact profitability levels. We had a gross margin in the first six months of 8.1%, which, of course, is super strong. We need to adjust to get to the underlying margin here for the gain on sale of the divestment we made in the U.K. business. If you take out the gain on sale, you will end up at a gross margin of 7.5% for the first six months. S&A costs falling nominally both year-to-date and in the second quarter. S&A over revenue is going up somewhat, but that's not really a concern for us. We're working with the cost structure in a good way here. EBIT margin 3.6% year-to-date and a whopping 4.7% for the second quarter, but that is a lot impacted by the divestment in U.K. If you strip the gain on sale out of the isolated quarter, you will end up with operating margin of 3.5%, which is still a very good performance. If we look at the different geographies, then we can say all geographies and all business units improved the margin year-to-date and also in the second quarter. The strong result we have is not sort of a consequence of any single event or so, but it's really a consequence of improving operations across the line, which makes this sort of a quality result, if you will. Sweden is improving. As you can see, 3.1% versus the 2.6% last year. Here we have in the second quarter last year, we commented on weaknesses in the Stockholm residential construction and also in the industrials business. These are not impacting negatively to that extent now. That's, of course, very good. Europe, 6.1% margin. This is where you will find the divestment gain. That's on the U.K., which is included in the Europe geography as we report there. If you adjust the 6.1% for the gain on sale, you will end up with 2.5%. That a significant step up compared to the same period last year. In the U.S., 2.7%. Here we have a very strong result in margin in US Building, and we continue to improve the profitability in US Civil as well. We continue to see a stable project portfolio here, which is, of course, exactly what we have been working with for quite some time. We go into Residential Development. We increased revenues by SEK 3.9 billion, compared to the same period last year, of which SEK 2.8 billion of that increase was in the second quarter isolated. Of course, it is so that the comparison period was heavily impacted by the pandemic, so that needs to be kept in mind. The markets have been very strong across our different geographies throughout the quarter and also in the first quarter. Gross margin unchanged compared to the comparison period, 18.4%, very good. Of course, the volume effect drives down the Selling and admin over revenue down to minus 4.1%. We end up the report period here over 14% in operating margin, which of course is a very strong profitability. It's also a testament to the fact that we are able now to control costs in the projects in a very good way, at the same time as we are able to make use of the strong market by working with pricing of our apartments when we sell them. If we look at the different geographies, also Residential Development profits increased in all different geographies. Highly encouraging. Margins are very strong both year to date and in the isolated quarter. The performance in Europe continues, you can say, from the first quarter to be delivered on a very hot market. We have 21% margin now year to date. It was even higher in the first quarter. This is a super good market. We have, as I said, in that market, been able to use it to our advantage at the same time as we can control costs. We end up with very strong results here. If we then move on to homes started and sold, both sold units and started units are up compared to the comparison period, both year to date and in the isolated quarter here. We sold some rental units, but not a lot. That is not what is sort of explaining the difference here. It's the underlying business that are performing very well. We do have a good pipeline, but the zoning processes are unfortunately slow, and that is limiting to some extent our ability to start in a pace that would satisfy market demand at the moment. We're, of course, very happy to be able to increase starts here. If we then move to homes in production, this is now the third quarter in row where we are able to increase the number of homes that we have under production. We have commented a few times that we would like a bit higher volume here. This is precisely what we have been aiming for, very strong. We are starting as fast as we can, essentially. We have a sales rate that is at 80%. That is from a commercial perspective, perhaps a bit high, even if it from a risk perspective is very good. Would perhaps be ideal to be a bit lower here, so we have a good amount of units to sell, but that is sort of the same point as we need to start projects at the same pace as the market demand allows us. Number one, sold completed homes, 132 at the end of the second quarter, which is lower than the comparison period and lower than what we reported on in the first quarter this year. We have absolutely no issue with that at all. It's overall a very strong performance in Residential Development. If we move to Commercial Development, the second quarter was a fairly sort of small quarter volume-wise. We made a number of transactions, but they were smaller ones. We had the divestments for about SEK 1 billion in the quarter isolated and SEK 3.4 billion year-to-date. These divestments are done with very strong profitability. We have around 40%-50% in divestment margin. There's clearly a strong appetite here from the investor market on our properties here. To sum up, it's a small but a very good quarter for Commercial Property Development. If we look at unrealized and realized gains, ending Q2, we had approximately SEK 8.5 billion in unrealized gains in our portfolio, which is then up a little bit more than SEK 2 billion from what we had in the first quarter. We have 34 ongoing projects, started 11 projects in total during these six months here. Of course, in addition to the increase in the unrealized gains, we did realize SEK 0.5 billion in gains during the second quarter. It's good with this start and good that unrealized gains are increasing, of course. As Anders already pointed out, we also started the biggest project ever in the CD stream right outside of Seattle in Bellevue, a very good project in a very good location here. I think it's encouraging here to see that we are now able to start a lot of new projects. We have been talking about this for a while, our ambition to do that we have a strong pipeline, and that we will start when the commercial circumstances are right. Now we sort of execute on what we have been talking about. If we move on to the next slide, here you can see then the completion profile of our Commercial Property Development portfolio. The orange bar represent the total investment for the projects that are completed but yet not sold, unsold for us. That bar is roughly unchanged from the first quarter at right above SEK 8 billion. In that, the situation is sort of unchanged, if you will. There are these couple of problematic assets that we have, but the absolute majority of this is really nice properties with very good outlook. The leasing has, of course, been slower over the last year, as everyone knows. If we look a bit forward here, we completed in the second quarter about SEK 1 billion worth of investment to 82% leasing. We expect to complete around SEK 2.5 billion worth of properties in the third quarter, and these are now leased to 87%. We have sort of a good leasing situation in the properties that we expect to complete soon. In the fourth quarter, we don't expect to complete anything. Then we have smaller property in the first quarter 2022 that is already leased to 83%. Then from there you can see sort of the leasing rate in those properties go down successively, which is absolutely natural. That's quite far out in time, so to speak. If we go to the next slide, you can see leasing here, and the leasing has obviously been slow for quite some time. What started right at the end of the first quarter has continued through the second quarter here, which are that we continue to see this increase in market activity. We have an increasing amount of dialogue with potential tenants. They are specific and they are concrete, these dialogues, and that's very positive. It seems pretty clear to us that underlying sort of the market is starting to improve, even if this does not show in our leasing numbers any longer yet. It takes some time before it starts to become actual signed contracts from that. If we look at the risk balance in the portfolio, Anders already commented on this, but you can see the yellow-orange line and the green line here, they are moving in tandem with the % of completion and occupancy rate in the portfolio. This is a very important sort of risk tool that we have, and we have a good balance of this still today. That makes us feel comfortable with the situation in the overall portfolio. If we look at the group income statement, operating income from the business streams in the first six months, SEK 4.9 billion. Central costs are coming down a bit, taking us down to the operating income of around SEK 4.7 billion, which is roughly SEK 1 billion higher than we had in the same period last year. Net financials coming down. Underlying reason to this is mainly we have lower interest rates, and we also have a lower amount of outstanding loans. That explains the difference. We expect to tax out here on 16% in the first, or we taxed out at 16% in the first 6 months, coming down to profit for the period of SEK 3.8 billion. If we go and look at the cash flow, this is sort of a historical development of the cash flow. As you can see, we've had quite a few cash-rich quarters here in the group. We've been in a divestment situation, net divestment situation in RD and CD for quite some time. Now we are, as already explained, we have started a lot of CD projects and we are trying to start more RD projects. We are slowly moving into more territory that will become net investments. The cash flow for that period, we had in the operating cash flow a sizable tax payment that is important to be aware of. The reason to this is, of course, profits. Those profits that were made chiefly from the sale of the Elizabeth River Crossings and the 2NU, both of them located in the U.S., which is a high-tax environment for us. Then we also paid out the dividend, which of course influenced the cash flow in the second quarter. If we look at the working capital situation in Construction, this continues to be very strong. We now have a negative working capital in the tune of 20% of revenue, which is the highest level it's been in sort of modern times here. In the quarter isolated, we had that positive cash flow from change in working capital and construction of approximately SEK 1 billion. The first quarter was negative to roughly the same extent. Year to date, we are more or less flat there. If we go to the next slide, the chart here, you can see that's the investments and divestments that I have already commented upon. We do, as we said, expect this green line that shows net investments on a rolling 12-month basis to continue to come down a bit there. If you look at capital employed, we are roughly SEK 1.5 billion lower than we were in the end of the second quarter last year, with the Residential Development increasing a bit and Commercial Property Development decreasing a bit in this here. If we look at our funding situation, we have plenty of available funds, more than SEK 16 billion at hand. All our external funding is green. During the quarter, we have repaid a dollar-denominated loan to the tune of $65 million. If we go to the next slide and sum up, we can say that we continue to have a very, very strong balance sheet, equity position of SEK 41 billion at the end of the quarter, an adjusted net cash position of close to SEK 14 billion, which gives us a very solid investment capacity going into the rest of the year. Thank you. Anders? Yes. I will go into the market outlook and starting with the Construction. We believe in a stable market, unchanged from the last quarter. We do increase the outlook for non-residential building in Norway and Finland, and also for the civil market in the U.S. The pandemic is still present, but we can see that the activity is increasing in our markets. We can also see the public infrastructure investment to stimulate the economies, but the funding is still uncertain. What we can see, for example, in the U.S., that the activity on the state level is high. The tax revenue comes back to the different states, and they put money into infrastructure and start new projects. That's the reason why the outlook is a bit more positive than last quarter in the U.S. for civil. We can see all over, ambitious investment plans under development in many of our markets, but the lead times are expected to be long as always when it comes to large construction contracts. On the residential development, overall, continue to be a stable market. We increased the outlook for Europe, which is a very strong market, and we expect that to remain strong in the coming 12 months. We can see a strong demand currently, especially in Sweden and Europe. The longer term, of course, there is a balance between potential rising unemployment levels and economic uncertainties. On the other hand, on the positive side, low interest rates all over and structural shortage of home in all our markets. Commercial property development, the investor market is solid. We have a very high interest for our projects and our facilities when we put them out for divestments. The tenant situation is still hesitant. The tenant is still hesitant, the activity is definitely picking up. That's a clear trend we see now in the second quarter, I expect that to continue. To summarize the report here, strong report. We can see that the strategy is paying off. Construction is continuously improving the profitability and the Project Development, solid performance. We are well positioned. We have a strong financial position, we have a robust organization, we can see opportunities arising in a sustainable economic recovery, we're prepared to take advantage of them. Thank you. With that, I leave it to André again with the Q&A. Great. Thank you very much, guys. As Anders said, it's time for the Q&A. Please follow the instructions from the operator. Thank you. If you wish to ask a question, please dial 01 on your telephone keypads now to enter the queue. Once your name is announced, you can ask your question. If you find it answered before it is your turn to speak, you can dial 02 to cancel. There will be a brief pause now while we register your questions. We have one question for you so far. That is from the line of Stefan Andersson of SEB. Please go ahead. Your line is open. Thank you. A couple of questions from me. Starting with the Construction division and the margin there. I know that we should always look at the 12 months rolling and the longer-term perspective just to give a little bit more flavor on the very good margin uptick year-on-year there, also excluding the divestment profits. If I remember correctly, with entering COVID, margin were a little bit on the soft side last year. Is there an element here of cautious profit-taking last year and that the beat, so to speak, is a little bit extraordinary strong in this quarter? Anders here. Hello, Stefan. No, I would not say so. The one-off we had is the divestment of the infrastructure. The underlying performance here is around 3.5% in the quarter. I would say last year we were hit by COVID. We saw that the revenue went down and it took some time to reduce the cost at the same pace. We have been successful doing that, the last part of 2020. We're in good shape. I can say the reason is more that the strategy works, it's paying off. That we have been selective now for some time. We are going for project where we can see we have a competitive advantage and also been successful in the history. That we also have the right people in place, the right team. That's crucial for us. Our approach is definitely no team, no bid approach, and we have been successful on that. Great. Thank you. On the city side, I mean, you have a very strong balance sheet, I know that. Historically, if I go back many years, if you haven't received top dollar for the houses, you always shelve it and wait until the market is stronger. If you look at your portfolio right now, the leasing is a little bit on the weak side, but the investor appetite is super high. What I'm trying to ask about is, would you, at this point, consider divesting, even if you have not reached the level of lease rate that you would like to have to get the top pay, given the very strong end market? Do you keep with that strategy to lift the properties to its top before you sell? What's your thinking about that judgment that you could do? Hi, Stefan, this is Magnus here. Thank you for your question. We consider the properties we have to be absolutely top class, and we don't see any reason to de-risk our portfolio and compromise on the profit we will get from selling them. We have the capacity to stick with these properties. We are good at leasing, so we think it's in the best interest of the company and our shareholders to wait a little bit longer to sell them. That's the commercial reason to why we act as we do. Yeah. Okay, good. Going to the material side, you touched on it. We don't see any effects right now, but two questions there. If the prices are where they are now on material, what are the risks for you? How much do you think you can pass on? Connected to that, this issue with the cement manufacturing in Slite. You're an international operation. You source from many countries. In the worst case, would you be able to offset this, or would you also be hit by that impact? Okay. I'll start with the material price increase. We have seen that a couple of quarters now, at least, high increases on certain material like steel, timber, and so on. We have been able to mitigate that. We have a very limited impact on the last 2 quarters when it comes to material prices. We've also seen quite a big volatility on different material. Our way to handle this in the past and also for the future is, of course, to secure that we have suppliers that can deliver. That's number 1. Also to secure prices before we bid for projects, and as far as possible. If we can't secure everything, every price, we buy it as soon as possible after we win the project. We price projects today with the prices we have in the market, and we secure that. We don't want to take risk in that because the market is too volatile. I think uncertain. I think that will continue for some time. When it comes to supply of cement in Sweden, we're talking about the Swedish market now. That, of course, if the main supplier of cement in Sweden with a short notice of three months cannot continue to produce cement, that will have a severe impact on the Swedish construction industry. I expect that to be solved. There is ongoing dialogue between the Swedish construction industry stakeholders with the government of Sweden. I expect it to solve in a short time. Having said that, of course, we are preparing for all scenarios in this, as we always do when there is uncertainties in the market. As we speak, we have groups that are preparing for all scenarios. Okay. Thank you. Thank you. Once again, if there are any further questions, please dial zero one on your telephone keypads now. We have a third question come through. That's from the line of Erik Bergström of Carnegie. Please go ahead. Your line is open. Thank you. Good morning. I have one question, and it's regarding commercial development. You mentioned that you've seen the leasing market pick up throughout Q1 and into Q2. Could you be a little bit specific as to where you are seeing activity? In what markets are you seeing leasing activity picking up? Hey, Erik. This is Magnus. Thank you for your question. Absolutely. I would say we see this increased activity in all markets. Maybe it's most clear in the CD business we have. It is across all these markets. It is about the type of, and the number of discussions that we have with potential tenants. These have been ongoing for some time, but when you see an activity increasing, and it's also about the quality of discussions. How specific are you? Are you discussing terms, or are you generally just looking at a leasing situation? We definitely feel that the market is underlying improving here, but as we say, it will take time before it will show in the numbers. We see this improvement across all markets. Okay, a follow-up on CD then. Can you say something about your ambitions to increase your activity in the Los Angeles area in the U.S.? How far have you come there, and are there any opportunities opening up post-pandemic? Yes. We see there's quite a lot of opportunities in the L.A. market. The strategy with that remains as before, that we want to be cautious when we start something to sort of find our way forward in the market. The commercial development market, city by city, they are quite specific. You really need to understand the business dynamics in each city, the locations, the tenants, and so on. We are there now. We made a couple of investments, and our ambition is to do it long-term, and there is plenty of opportunities out there in this market. We need to start small and sort of prove to ourselves that we know how to do this business there before we go in with bigger things, bigger investments. Okay. Thank you. Those were my questions. Thank you. Thank you. Once again, if there are any further questions, please dial zero-one on your telephone keypads now. There seems to be no further questions from the phones at this time. I'll hand the floor back to our speakers. All right. Everything seems to be crystal clear. What remains then is just for us to wish you all a great summer. Thank you very much.