John Beck
At this point in the meeting, Scott Balfour and I would like to take a few minutes to review some of the key developments and opportunities that we see on Aecon's horizon.
As all of our business segments reported operating profits in 2005, some of our comments will focus on initiatives that we have already taken to improve Aecon's performance.
But most of what we want to share with you today is about where we see Aecon going in the future – specifically the targets we have set for Aecon's operational and financial results over the next eighteen to thirty months.
Frankly, we are very excited about what we see in our forward planning window.
To ensure the widest possible disclosure of what we are about to share with you, we have just issued a news release that communicates to the investment community the key points in this presentation. Copies of the news release will be available out front at the conclusion of the meeting.
There are several reasons why Scott and I, along with the rest of Aecon's management team, believe the time has come to give you – our shareholders – better clarity on where we, as management, think Aecon is headed.
Scott Balfour
One of the reasons, is that for the first time in a number of years, we have better visibility on Aecon's markets, and we have a clearer view of our prospects within those markets.
That is not to say that there is no risk in achieving the targets that we have set for each of our divisions. After all, this is still a business with many moving parts.
In particular, we are still dealing with two legacy projects – the Nathpa Jhakri hydro-electric project in India and the Eastmain Hydro project in Northern Quebec – where settlement negotiations are ongoing with the project sponsors. However, we believe the range of outcomes arising from these legacy projects is now reasonably well defined.
The projects have been successfully completed, and the claims and change order settlement issues are on the table and being actively negotiated.
As a result, management's visibility on Aecon's potential performance should actually improve as we move further away from the financial noise that these legacy projects create.
Of course, two other areas of identifiable risk for any company doing business in this country, as well as the international marketplace, are the direction of interest rates and foreign exchange rates. In this Aecon is no exception.
But notwithstanding all of the appropriate cautionary language, we have become more bullish in our outlook because we believe that there are very strong fundamentals at work in the Canadian construction industry – particularly the areas where Aecon is well positioned.
We are also more bullish on our outlook because of the very strong demand for infrastructure concessions in the international market.
Trading in the ownership of these concessions is at pricing levels that give us confidence that when we bring these investments to market we will realize returns that will meet or exceed our expectations.
This strong demand for both domestic construction services and international infrastructure concessions means that we have a better perspective on both the near term and longer term factors that influence our profitability.
John Beck
By sharing management's forward-looking perspective, we also hope to provide the investment community with a more comprehensive understanding of the fundamentals that can impact the market's valuation of Aecon.
For the past few years, we believe investors have looked at Aecon as a good investment – not because it was in the hottest sector of the economy – not because it was growing revenue and earnings – but because it was undervalued relative to its peer group and relative to its underlying assets – a value story.
While that value proposition remains intact, we believe that some of the other reference points the market has been using to define us are changing.
As the data on this slide from Global Insight suggests, after China and India, Canada now ranks third as the fastest growing construction market in the world. And when you look at what is fuelling this demand for construction services in each of these countries – you see the same thing – an urgent need for infrastructure.
In the case of China and India, much of this is “greenfield” development that needs to be built to accommodate a rapidly expanding middle class.
In Canada, it is being driven by different factors.
For decades, Canada has been accumulating a deficit. This deficit does not show up in the government accounts. It shows up in our congested roads, our crowded cities and our deteriorating municipal services.
This infrastructure deficit, as it has been termed, is estimated at nearly a hundred billion dollars.
It is primarily a product of prolonged underinvestment by all levels of government in the replacement, refurbishment and renewal of everything from highways to sewer systems to public transit.
What has changed in the last couple of years is the acknowledgement by all levels of government that, like the fiscal deficits that we were burdened with for so many years, the time has come to fix the problem. There are still issues being debated about which level of government will foot the bills or what the role of the private sector should be, but there is no debate that the issues must be addressed.
The resulting demand for construction services is expected to be a powerful driver in the growth of our industry for the remainder of this decade and well into the next.
Scott Balfour
Consider the impact of our own – and increasingly the world's – demand for energy.
Canadian energy development projects, from the $100 billion multi-year oilsands processing and refining operations in Western Canada – to the recently announced refurbishment of the Bruce Nuclear facility in Ontario – to the construction of Liquefied Natural Gas facilities in eastern Canada – are all underway or under development.
Added to this is the demand for the renewal, expansion or extension of some of our major roadways – from the Sea to Sky Highway in Vancouver to the Queen Elizabeth Way in Hamilton. Here in Ontario, the Ministry of Transportation is booking work at levels that have not been seen in years – most recently demonstrated by the announcement on Friday of a five-year $3.5 billion plan for highway improvements in southern Ontario.
We are also seeing major commitments from Ontario municipalities for the renewal and expansion of sewer and water systems, as well as the fast-tracking of expansion of our power generation capacity.
Then there are the special projects that have also been crowded onto Canada's construction work order – beginning with all of the facilities that will be required for the 2010 Winter Olympics now less than four years away. Added to this, is the slow but determined progress being made to redevelop the waterfront here in Toronto.
Our objective is not to be on every bid list. Our objective is not to chase the biggest project with the highest profile. To put it in baseball terms, we are not going to swing big at every pitch with the hope of putting one over the fence. Our objective is to string together a number of singles and doubles, driving in runs and making money for our shareholders.
Where it is in our realm of expertise – and where we believe we can make a healthy profit - Aecon is bidding and winning our fair share of these projects. But the point I want to make is that we stand to benefit from all of them – not just the jobs we win.
To the extent there has been excess capacity in the Canadian construction industry, based on the workflow that we see for the remainder of the decade, that capacity is being rapidly consumed.
More demand in the industry means better margins. All of which means a better environment for revenue and earnings growth. We are already seeing the early signs and benefits of this as the margins contained in our backlog begin to grow.
Our backlog is at its highest level in almost four years, and our backlog margins as a percentage of revenue are increasing as well. At the end of the first quarter last year, those margins stood at 7.2 percent. At the end of the first quarter of this year they had grown to 10.2 percent – a 40 percent increase!
John Beck
We said we were going to be specific about our targets so here they are.
We'll start by looking out to the end of the current fiscal year, which, as Scott mentioned, is less clear as a net earnings number, in large part because of pending resolutions on two legacy projects.
However, what we are expecting for 2006 is top line revenue in line with the 1.1 billion dollars that we recorded in 2005, but with improved segment profitability. Better margins on a steady top line are expected to result in overall profitability for Aecon generally in line with published analyst estimates – an important milestone given the difficulties of the past few years.
Moving further out in the planning horizon, for 2007, we are targeting to accelerate profit growth through a modest expansion of our top line revenue and continuation of the margin gains that we are making in 2006.
By 2007 we expect to be on the other side of the resolution of our legacy projects, which will mean less distortion between operating profitability and net income. Taken together, this should mean significantly improved profitability in 2007 – at least in line with that currently expected by Aecon's analysts.
For 2008, which is at the outer range of our planning perspective, we are expecting further modest growth of the top line and have set for ourselves the ambitious but, we believe, achievable target of delivering earnings per share of 75 cents.
Please keep in mind a couple of things. First, these are our planning estimates and targets, and there are a great many variables – some that are identifiable and many that are not – that will impact the translation of these estimates into actual results.
The second thing to keep in mind is that the above targets do not include the monetization of our investment in the Cross Israel Highway – which analysts have pegged at between a dollar thirty and two dollars fifty cents per share.
So, coming back to my earlier comment about investors looking at Aecon as a value story, it still is. But in addition, it is now also becoming an earnings story.
Scott Balfour
Now that you know where we believe we can take Aecon over the near term, we'd like to discuss the strategy that we have engaged to get us there.
1. First, we will focus on our core expertise – bidding and winning profitable projects that are in proportion to our size - bringing in partners or working as a subcontractor – or passing altogether if a project goes beyond the scope of what we truly do best and most profitably.
2. Second, we will focus on Canada. The domestic market is currently generating an unprecedented amount of work that is squarely in our area of expertise.
3. We will focus on profitable growth in our Industrial segment with particular emphasis on Alberta and Ontario-based energy development projects.
4. In the Civil and Utilities sector, we plan to build on our dominant position in Ontario and leverage opportunities in the buoyant economy of Western Canada by adding civil construction capacity to our existing business in Alberta.
5. We will focus on margin enhancement in our Buildings segment, placing increased emphasis on design-build, construction management and ongoing ‘program work' where our value added – and therefore our margins – can be maximized.
6. We will continue to invest in the development of our people. Aecon is in a service business, and we understand that our most valuable assets go home every night.
7. We will resolve our legacy issues. Specifically, we will resolve our outstanding client issues on the Nathpa Jhakri hydro-electric project in India and the Eastmain project in northern Quebec.
8. We will commence construction on the new Quito International Airport, a project we expect will generate solid construction profits and also create longer term value through our equity investment in the concession.
9. And we will commence the monetization of our investment in the Cross Israel Highway concession – so shareholders can realize the value gains earned on this investment.
The market realities anchoring this strategy are rooted in the expected growth that we see in two key sectors – transportation infrastructure and energy development.
In both of these sectors, Aecon has a well-established presence and the resources to seize the emerging opportunities.
Aecon is one of Canada's leading road builders. We have been in the business of building roads since the days of the Model T. We know roads.
We have taken that knowledge and leveraged it into the excellent and long-standing working relationship that our Roadbuilding Operations have with the Ministry of Transportation of Ontario.
So far this year, this Ministry has awarded Aecon eight road building jobs worth a total of nearly 140 million dollars. And we have won this work with good solid margins.
One of the reasons that we are so competitive in this market is because we have strategically and successfully organized ourselves to be vertically integrated within the sector.
As such, we self-perform all facets of road construction from crushing the rock to placing the asphalt – from grading the alignment to building the bridges – and from utilities engineering to installing the highway lighting.
This broad mix of skills and capabilities provides our customers with more value, because we can better control quality, schedule and risk by doing more of the work ourselves rather than subcontracting to others. At the same time, it also provides for an improved competitive position and incremental margin contributions to Aecon.
John Beck
We've leveraged this road building expertise into our Concessions Development business with our success in the development, financing, design, construction, operation and in some cases ownership of a number of toll roads – from the 407 here in Toronto to the Cross Israel Highway – today the world's most advanced all electronic toll highway.
We are an attractive partner in the joint ventures that develop this type of infrastructure because of, among other things, our intimate knowledge of the construction and maintenance issues involved in building and operating highways.
We also know when to optimize this value. In the case of the Cross Israel Highway, for example, we are confident that we are entering the window that will allow us to maximize proceeds from the sale of our interest which, on a stand alone basis, has been pegged by third party analysts at anywhere between fifty and one hundred million dollars.
During the next twelve to eighteen months, even as we continue to earn revenue from work on expansion of this highway, we expect to monetize a portion of our investment, thereby starting the process of realizing for our shareholders the value that has been created through our development and investment in this project.
And we also look for substantial value creation from our investment in the Quito International Airport concession in Ecuador. As many of you well know by now, the Quito airport project is one we've been developing for some time.
Last summer, along with our partners, Aecon signed the key financing documents for the project, and in January of this year the concession took full effect.
The final step is for the financing to close and the first tranche of funding to flow – which we expect sometime in the next two weeks – with construction to begin immediately following.
Our business is very capital intensive. You need a strong balance sheet and the financial capacity to seize the opportunities that a robust market presents.
Earlier this year, with the evidence of a growing backlog of work and the increased demand in our core markets, Aecon took advantage of the opportunity to raise more than 29 million dollars of additional equity.
We believe this financing will serve the long-term interests of our shareholders by enabling Aecon to act on one of the strongest growth cycles that we have seen in the Canadian construction industry in a very long time.
As Scott mentioned earlier, this is also a business with a lot of moving parts. To make money in it you need the data and the tools to be able to track all of the details of every project – from the bidding process through to the resolution of change orders.
During the last eighteen months, we've been implementing more advanced process controls across Aecon. The biggest beneficiary of this effort has been the Buildings group which last year saw a fifteen million dollar improvement in operating results.
This was achieved partly because we improved our management process with better analysis, tighter controls and increased market focus.
As a result, we actually bid on and won fewer projects. But the ones we brought home are increasingly profitable. Better information and controls allowed us to bid smarter and improve our execution with less waste, higher margins and a better bottom line.
Scott Balfour
The domestic market for construction services in Canada is likely the strongest that it has been in nearly 15 years – since the real estate recession of the early 1990s - and there is every expectation that this demand is going to see us through to at least the end of this decade.
This opportunity is the reason we have made the Canadian market the primary focus of our growth strategy. In the current fiscal year we are already benefiting from these improved market conditions with increased backlog and improved margins.
This is expected to flow through to the income statement throughout the remainder of the year with continued improvement in 2007 when our domestic work flow will be complemented by the construction operations at the Quito airport.
This sets up 2008 as a year of very strong potential for Aecon, with the management objective of generating $0.75 of earnings per share as previously outlined by John.
Over that time, the demand will be stronger in some segments than in others. But we believe there are macro forces that will override this ebb and flow and deliver exceptional opportunities for Aecon. One of those forces is the rising cost of energy.
While there is little consensus amongst the experts on what a barrel of oil is going to cost next year, next month or even next week – what they will all say with conviction is that the days of $20 oil are gone.
The rising cost of oil and substitute energy sources is having a profound effect on every industry including our own. But in our case there is more good news than bad, in higher energy costs.
Perhaps the most obvious place where we are seeing this is in the amount of work that our Industrial segment is doing in Western Canada, in projects that are directly related to the development of the oilsands.
In 2004 and 2005, of the more than $450 million of work that our Industrial segment booked almost 70 percent was directly related to energy projects.
In our planning horizon we expect to continue to participate in the exceptional growth in demand for construction services in Western Canada's energy industry.
We will do this through our facility in Alberta and our facilities in central and eastern Canada which are ideally positioned to handle the fabrication requirements that cannot be handled by the capacity generally available in Alberta.
In addition to the energy boom in Alberta, there is also a strong energy infrastructure market in Ontario. Aecon is a major participant in the nuclear renaissance and a large contractor for maintenance of the existing fossil fuel energy base as well as the new wave of gas fired power generation.
Growing demand and high energy costs are also impacting other areas of our business. Because the technology delivers measurable payback on energy savings, the order pipeline for Innovative Steam Technologies is strong and we believe this business has a very bright future and inherent value.
John Beck
As you have now heard, we believe that Aecon has a lot more going for it today than we have had at any time in the last fifteen years –
§ we have expertise in core business areas that are experiencing robust demand;
§ we have a very strong domestic economy where the public sector has the fiscal flexibility to address infrastructure renewal and expansion needs;
§ we have the internal procedures and controls that allow us to bid and build with confidence that we are going to make money at the end of the day; and
§ we have a strategy to bring all of these things together to grow both the top line and the bottom line of our business.
Before closing this presentation and opening the floor for questions, I want to emphasize one of the other key elements of Aecon's growth strategy – the strength of our human capital. None of the projects that we have mentioned can be built without experienced people. In the kind of construction growth cycle that we are entering, this asset is of critical importance.
Aecon has developed very strong and trusted relationships with our unions. Together we have worked very hard to ensure that Aecon has the best safety program and safety record in our industry. We have also invested in the development of our managers and non-unionized staff to ensure that we have the right people in the right place with the right skills to get the job done.
We have come a long way together. As Aecon's largest personal shareholder, I look forward to your continued support in the next stage of our journey.
Scott and I would now be pleased to answer your questions.
The information in this speech includes certain forward-looking statements. Forward-looking statements are based on estimates and assumptions derived from past experience and interpretation of historical trends, current conditions and expected future developments.
Many factors could cause Aecon's actual results, performance or achievements to vary from those expressed or inferred by these statements, including without limitation, the future of the Eastmain Joint Venture to recover the value of unpriced change orders, failure to achieve the targets associated with the Quito Airport, the achievement of lower than anticipated volumes of work in Western Canada and the failure of Innovative Steam Technologies to secure anticipated contract award levels.
Risk factors are discussed in greater detail in the Section entitled “Risk Factors and Uncertainties” in Management's Discussion and Analysis of operating results and Financial condition for the year ended December 31, 2005 filed on SEDAR at www.sedar.com. Although Aecon believes that the expectations reflected in forward-looking statements are reasonable, it can give no assurance that the expectations of any forward-looking statements will prove to be correct. | 