Although Group Five has grown revenues sharply – revenue was up over 55% in the six months ended December 2013, compared to the previous period – the growth in operating profit has been more modest. G5 reported that operating profit from continuing operations was up 27.5% in the six months ended December last year compared to the six months ended December 2012. This suggests that the group is having trouble keeping its margins up, which CEO Mike Upton admits. According to Upton, margins, which are currently at between 3 and 4%, need to improve if the company is to continue to deliver growth and dividends. Margins have been shrinking since late 2008; between 2004 and 2008 Group Five maintained margins of between 6 and 7%, compared to today’s 3-4%. But Upton is confident that various upcoming projects can help the company improve margins and continue to deliver strong results. – FD
To watch this CNBC Power Lunch video click here
ALEC HOGG: Group Five reported its interim results this morning; earnings pretty stable, but the revenue jumping sharply. Company Chief Executive Mike Upton joins us for a closer look at the numbers. Well, the market likes it Mike, four-and-a-half percent improvement in the share price this morning. You, I suppose, have to just try and get the margins back to where they were some years ago and then you’d really be flying.
MIKE UPTON: Absolutely. Thanks for having me. I don’t follow the share price, so that’s good news. I think revenue growth, but obviously, weaker margins: there are a few factors in there. One is that we went into the oil, gas, and power markets some years back. We created a new business called ENC Engineering and Construction that was focused on turnkey delivery and services, and that’s been a big revenue jump. That’s grown one billion Rand plus on its own on a like-for-like, year-to-year basis.
ALEC HOGG: So that’s your prime reason for this huge increase.
MIKE UPTON: That’s one of them. The other is that we’ve been able to gain quite a lot of…some new traction in the real estate market, so our buildings business has grown again, and that’s off a reputation for delivery. Those two things really, are the big drivers of the revenue. Those two big drivers of revenue are also amongst the lower margins in our group, so that’s why the mix has changed in terms of revenue and profit.
ALEC HOGG: We have a lovely graph we’re going to put up on the screen now, which shows your margins between 2004 and 2008 – the profit margins, where it was between six and seven percent. Subsequent to that – as you can see it on screen – 2012/13/14: these are all, for the first half, like-for-like you’re between three and four percent. The question has to be, were the 2008 – 2011…was that normal, or is where we are now the new normal?
MIKE UPTON: I think where we are right now is a norm in this market, where it’s very tough trading. The work is hard-won. It’s very competitive. There’s a lot of overcapacity still, so what’s a normalised market dip through the cycle? Obviously, in the peaks of the World Cup etcetera, that was an abnormal market. On the other side of the scale, there was a shortage of resources. There was a lot of work going on. There was also quite a lot risk in terms of short-term lead times and contracts. They were all milestone-driven in terms of ‘had to meet’ dates, so there were many things that were different then to what the situation is now. We’d like to think that the normalised margin in our business is on an upward trend in terms of the business model and the business mix, where we’re mixing turnkey production…large turnkey EPC contracts with the services base, and a more expansionary look at Africa. That model should actually produce better margins, going forward.
ALEC HOGG: How much?
MIKE UPTON: I wouldn’t like to guess.
ALEC HOGG: Well, you’re three to four now. You’re seven to eight over there, so somewhere between.
MIKE UPTON: We need to be a plus five percent business before we start, and then the vagaries of the markets or targeted actions need to move it above that. We’re suboptimal now in terms of margins, and that’s very clear.
GUGULETHU MFUPHI: Is the outlook more positive for you now, given government’s infrastructure plans, going forward?
MIKE UPTON: Well, government’s infrastructure plans are not that visible at the moment, so I think what we’re saying is that this order book and these results are hard-won, from having to make a plan in spite of weak South African markets. Our theme is really that the SA market is quite flat. There are pockets of activity, which would be on the power side…a little bit of water…a bit in healthcare with government, but generally the market’s quite flat. Our excitement – if you like – has come from the power market and from an overboard expansionary set of stunts, which is not shown in the order book but in terms of margin generation work outside is generally better for us in terms of margins.
GUGULETHU MFUPHI: Mike, before we let you go our Executive Producer Janine is going to be upset about this, but your expectations for budget next week…
MIKE UPTON: I would hope – and I think it’s a budget before an election – so obviously that maybe would change what might be a budget post the election when the new cabinet’s in place etcetera. I would hope there’s more traction in terms of the timeline, the funding, and the capacity building for the rollout of infrastructure, because South Africa really is on the back foot now. We need to have the economic growth and infrastructure is the enabler.
ALEC HOGG: That was Mike Upton, hoping for the impossible during an election year, but nevertheless…
