Engineer. / Constr. & Drill & Blast

Transcription

1 Engineer. / Constr. & Drill & Blast Srg Limited SRG LIMITED An engineering services firm with committed management SRG Limited is an engineering/construction/contract mining company that has been listed on the ASX for several decades. The services it provides are well regarded within the industry, but in recent years it struggled with financial performance and had a litigation overhang that has now been resolved. The Company has undergone a corporate restructure, including a new nonexecutive Chairman, MD and CFO who all joined in The new management team has a strong track record of financial turnarounds. In particular, the Chairman (Peter McMorrow) was the CEO of Leighton Contractors between 2004 and The MD (David Macgeorge) held senior executive roles with BIS Industries, Cleanaway and CHEP (a subsidiary of Brambles). SRG Construction: reliable specialist services STS has a long track record for delivery of reliable construction and design services. In particular, it has experience in post tensioning services, concrete & façade repair, bridge design & construction, dam anchoring and tank construction. SRG has a products division that manufactures products used by the construction division and its competitors. We expect FY16 divisional EBITDA ~$5.4m. SRG Mining: mainly drill & blast for EVN.asx SRG mining is predominantly drill & blast for Evolution Mining. The contract is now for four sites (Mt Rawdon, Cowal, Mt Carlton and Edna May mine). The products division also supplies consumables to miners and mining contractors. We expect FY16 divisional EBITDA ~$13m. Hartleys expects FY16 NPAT $5.2m, FY17 NPAT $6.0m Company guidance is for FY16 PBT to be >$6m. The Company has an order book of $240m, of which around $160m is in mining. We believe that the 2H16 order book is ~$80m, which means our FY16 revenue estimate is mostly covered by current orders. We estimate FY16 NPAT of $5.2m, based on EBITDA of $14.3m. Note, 1H16 operating cash flow appears weak, but this is due to the payment for the ETP settlement as disclosed in FY15. We estimate that the FY17 order book is ~$70m. We assume modest revenue growth (to $195m) and good EBITDA margins (~8%). We expect FY17 NPAT of $6.0m. Initiate coverage with a Buy recommendation We are initiating coverage with a Buy recommendation. On our estimates, STS trades on a FY17 p/e of 7.9x, EV/EBIT of 3.9x. We like the balance sheet strength (net cash $15m), diversification of revenues and management alignment to shareholders (the Chairman is a substantial shareholder). The valuation is very compelling if earnings can grow and are sustainable, although contract losses and margin erosion are the obvious near term risk. We have a $1.03 twelve month price target, implying an FY17 EV/EBIT of ~6.4x. 4 Mar 2016 Share Price: $0.750 Valuation: $ mth price target: $1.03 Brief Business Description: Global specialist construction services for CBD, dams and bridges. Drill and blast services for Aust mining. Hartleys Brief Investment Conclusion Strong management team and high levels of revenue certainty. Chairman & operations director: Peter McMorrow (Chairman, Non-exec.) David Macgeorge (MD) Substantial shareholders: Hunter Hall (13.9%) JMFG Consol. A/C (9.4%) Peter McMorrow (Chairman) (6.1%) Company Address: Level 1, 338 Barker Rd Subiaco, WA, 6008 Issued Capital: - fully diluted Market Cap: - fully diluted Net Debt (31 Dec '15a): FY15a FY16e 63.0m 66.1m $47.2m $49.6m -$14.9m FY17e Op Cash Flw Free Cash Flw NPAT* (A$m) EPS ($, bas) P/E (basic) 29.3x 9.3x 8.3x P/E (diluted) 12.8x 9.6x 8.3x EV / EBITDA 2.3x 2.3x 2.1x DPS (cps) Franking 100% 100% 100% Dividend Yield 3.3% 5.3% 5.7% N.D. / equity -30% -19% -23% Source: Hartleys Research. * normalised Mar-15 SRG Limited Authors: Trent Barnett Head of Research Ph: E: trent_barnett@hartleys.com.au Analyst has a beneficial interest in STS.asx. STS.asx Buy A$ 0.40 M Jul-15 Nov Mar-16 Volume - RHS Source: IRESS STS Shareprice - LHS Sector (S&P/ASX SMALL INDUSTRIALS) - LHS Hartleys Limited ABN (AFSL ) 141 Page St Georges 1 of 20 Terrace, Perth, Western Australia, 6000 Hartleys does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. Further information concerning Hartleys regulatory disclosures can be found on Hartleys website

2 SRG Ltd (STS) Recommendation: Buy Company Information Profit & Loss ($m) 6/14A 6/15A 6/16F 6/17F Date 4 Mar 2016 Level 1, 338 Barker Rd Mining - Rev Share Price $0.750 Subiaco, WA, 6008 Mining - EBITDA Week High-Low $ $0.56 Ph: Mining - Margin 17.7% 17.6% 21.8% 22.0% Market Cap ($m) $47.2 Fax: Construction - Rev (100%) Enterprise Value ($m) $ Construction - EBITDA (100%) Ordinary Shares 63.0 Construction - Margin 2.5% 3.5% 4.5% 5.0% Fully Diluted Shares 66.1 Group Revenue Valuation growth -22.9% 5.1% 8.0% Spot DCF (WACC 12.4%, Terminal growth 0.00%) $1.12 EBITDA margin 6.0% 8.2% 7.9% 8.1% 12mth fwd DCF (WACC 12.4%, Terminal growth 0.00%) $1.15 Rep. Depreciation/Amortisation mth forward P/E base case earnings of 10x (mid-cycle) $0.96 Norm. EBIT Dec15a 1x Price / NTA (1x $0.87) $0.87 EBIT / Sales 1.3% 3.5% 4.0% 4.2% 12mth fwd Div Yield of 5.2% (Gross yield=7.4%) $0.82 Net Interest Months Price Target (wgted avg above 4 avg) $1.03 Norm. Profit Before Tax margin 0.9% 3.5% 4.1% 4.4% P / E (6/16F) at price target 13.3x Tax P / E (6/17F) at price target 11.5x Effective Tax Rate 39.8% 14.9% 30.0% 30.0% EV/EBITDA (6/17F) at price target 3.3x NPAT Pre Minorities EV/EBIT (6/17F) at price target 6.4x Net Profit / Sales 0.6% 2.3% 2.9% 3.1% Multiples (S/price at $0.75) 6/14A 6/15A 6/16F 6/17F P / E (reported, basic weighted) 37.3x 29.3x 9.3x 8.3x Minorities P / E (normalised, dil. weighted) 39.1x 12.8x 9.6x 8.3x Normalised NPAT to equity P / E (mkt cap / norm. NPAT) 37.3x 12.2x 9.2x 7.9x Abnormals / discontinued P / E (fully diluted mkt cap / norm. NPAT) 39.1x 12.8x 9.6x 8.3x Reported Profit to equity Dividend Yield 5.3% 3.3% 5.3% 5.7% Group Free Cash Flow (f.c.f) / EV 84.7% 51.2% -15.5% 19.6% Reported EPS (basic, w'ghted) Equity f.c.f. / Mkt Cap -13.2% 18.9% -22.3% 9.2% Normalised EPS (weighted) Norm f.c.f. / Mkt cap -13.2% 18.9% -22.3% 9.2% Normalised EPS (full. diluted) Mkt cap / operating cash flow 1.7x 2.5x -46.3x 3.9x DPS (cps) EV/EBITDA multiple 2.4x 2.3x 2.3x 2.1x Franking 100% 100% 100% 100% EV/EBIT multiple 11.2x 5.3x 4.5x 3.9x Payout Ratio 198.8% 40.6% 51.0% 46.9% Price / Book Value 0.6x 0.6x 0.6x 0.6x Price / NTA 0.9x 0.8x 0.8x 0.8x Cashflow Statement ($m) 6/14A 6/15A 6/16F 6/17F Cash Receipts EBITDA Ratios 6/14A 6/15A 6/16F 6/17F Working Capital Change Return on Average Equity 0.9% 5.2% 6.6% 7.2% Cash from Operations Return on Assets 0.5% 3.2% 4.3% 5.1% Net interest Paid ND / ND + Equity -14.0% -42.2% -24.2% -30.5% Tax Paid ND / Equity -12.2% -29.7% -19.5% -23.4% Net Operating Cash Flow Net Interest Cover (EBIT) Capital Expenditure ROIC 1.1% 6.8% 8.3% 9.0% Asset Sales Other (inc Investments) Free Cash Flow Analysis ($m) 6/14A 6/15A 6/16F 6/17F Net Investing Cash Flow Net Operating Cash Flow Proceeds from Equity Issues Capex (Reported) Net Change in Debt & Leases Group Free Cash Flow (reported) Dividends Paid Fixed Debt Repayments Net Financing Cash Flow Equity Free Cash Flow (reported) Movement in Cash HP Lease Capex (non-cash) HP Lease Capex (non-cash) Free Cash Flow (normalised) Capex (inc HP) / depreciation 11% 25% 56% 76% Balance Sheet ($m) 6/14A 6/15A 6/16F 6/17F Cash Share Data 6/14A 6/15A 6/16F 6/17F Receivables Ord Issued shares (m) Inventories growth -63.5% 0.0% 4.4% 0.0% Other Weighted ave shares (m) Total Current Assets growth -60.0% 0.0% 1.5% 2.9% Property, Plant & Equipment Diluted shares wgted (m) Intangibles growth -61.0% 0.0% 6.5% 2.8% Other Total Non Current Assets Unpaid Capital Total Assets Year Expires Number % ord Avg Price $m unpaid Accounts Payable Jun % $ - $ - Interest Bearing Liabilities Jun % $ - $ - Other Jun % $ - $ - Total Current Liabilities Jun-19 3,165, % $ 0.83 $ 2.6 Accounts Payable Jun % $ - $ - Interest Bearing Liabilities TOTAL 3,165, % $ 0.83 $ 2.6 Other Directors & Senior Management Subs. S/holders Total Non Current Liabilities Peter McMorrow (Chairman, Non-exec.) Hunter Hall 13.9% Total Liabilities David Macgeorge (MD) JMFG Consol. A/C 9.4% Net Assets Robert Freedman (non-exec) Peter McMorrow (Chairman) 6.1% Net Asset Value / Share ($) Peter Brecht (non-exec) NTA / Share ($) Michael Atkins (non-exec) Net Debt (net cash) Roger Lee - CFO Analyst: Trent Barnett Phone: Sources: IRESS, Company Information, Hartleys Research Last Earnings Estimate Changes: 4 March 2016 Page 2 of 20

3 STS was founded in Victoria in 1961, with the first project undertaken to supply and install rock anchors for the Snowy Mountains scheme BUSINESSOVERVIEW Founded in Victoria in 1961, the Company commenced trading as BBR Australia Pty Ltd with the first project undertaken to supply and install rock anchors for the Snowy Mountains scheme. CONSTRUCTION The Construction division is the largest revenue contributor (~$ m pa). Clients are predominantly government and CBD construction companies. Building Building is predominantly post tensioning and is one of the most stable and mature parts of the SRG business. The Company has had a long history with Lendlease. Current large contracts include Barrangaroo development in Sydney and the Commonwealth Games Village in Brisbane for Grocon. Fig. 1: Post tensioning Building is predominantly post tensioning and is one of the most stable and mature parts of the SRG business. Source: STS Post Tensioning Post-tensioned concrete applies compression after pouring and during the curing process. The concrete is cast around a duct through which a steel cable. An advantage over pre-tensioning is that the cables can be easily "woven" allowing a more efficient design approach. It also has a higher ultimate strength due to bond generated between the strand and concrete. Pre Tensioning Pre-tensioned concrete is the reverse. The cables are tensioned first, and then the concrete is cast. The cable tensions are released and it compresses the concrete. Generally pre-tensioning requires more pre-fabrication which limits their size. Page 3 of 20

4 Civil is predominantly dam anchoring and specialist bridge construction including incrementally launched bridges. SRG CIVIL Civil is predominantly dam anchoring and specialist bridge construction including incrementally launched bridges. Other construction capabilities include silo and tank construction, waterproofing and slipform. It is lumpy and contract dependant but has potential for further international expansion. Fig. 2: SRG civil focuses on dam anchoring and bridge design Source: STS Page 4 of 20

5 The SRG services is an engineering services business. It offers specialist construction services to property owners and managers, local authorities, designers, contractors and mining companies. SRG SERVICES The SRG services is an engineering services business. It offers specialist construction services to property owners and managers, local authorities, designers, contractors and mining companies. In particular, it offers remedial services and diagnosis for concrete repairs, structural strengthening, façade restoration, structural crack repair, cathodic protection, carbon fibre strengthening and water proofing. Fig. 3: Concrete repair services Source: STS STS has three manufacturing facilities (Welshpool WA and Townsville and Nerangba in Queensland). SRG PRODUCTS STS has three manufacturing facilities (Welshpool WA and Townsville and Nerangba in Queensland). They manufacture post tensioning components and cable bolts. The products division is expected to grow substantially with the rollout of SureLok (designed to eliminate the issues to temporary movement joints in concrete). Other products include Concrete Canvas, ROCK Mesha, Ground Support Products, Geotechnical Equipment and post tensioning components. Fig. 4: Products Source: STS Page 5 of 20

6 MINING The Mining division provides drill & blast (65% or revenue) and geotech & ground stabilisation services (~35% of revenue). The customer base is a mix of small and large companies. The main contracts are with Evolution (Gold) and at Whyalla with BGC Arrium but it also works for First Quantum, QR Rail, Newmont and at the Super Pit. Around half of the revenue in the division (A$30m out of $60m pa) is from Evolution. The Mining division provides drill & blast (65 % or revenue) and geotech & ground stabilisation services (~35 % of revenue). Fig. 5: Drill and blast Source: STS Fig. 6: STS has ~40 ground radars Source: STS Page 6 of 20

7 STS is primarily exposed to Australian high rise and State and Federal infrastructure spending. However, it also has meaningful mining exposure through the drill and blast division (primarily gold). INDUSTRY EXPOSURE STS is primarily exposed to Australian high rise and State and Federal infrastructure spending. However, it also has meaningful mining exposure through the drill and blast division (primarily gold). GEOGRAPHIC EXPOSURE STS is predominantly an Australian business, but does have a small presence in the UAE and has recently opened an office in Hong Kong. That said, its specialist engineering have international capabilities and experience. The products business has potential to be exported into international market. Fig. 7: Geographic diversification Source: STS Page 7 of 20

8 Bloomberg Consensus Estimates PEERS AND COMPETITORS NAME TICKER Last M. CAP EV "FY0" EBIT / Sales Price (A$m) (A$m) Year FY2 FY0 FY1 FY2 FY0 FY1 FY2 FY0 FY1 FY2 FY0 FY1 FY2 LABOUR INTENSIVE Construction DECMIL GROUP LTD DCG AU / % % 4.9% 6.1% MONADELPHOUS GROUP LTD MND AU / % % 7.8% 6.5% MASTERMYNE GROUP LTD MYE AU / % % 16.7% 26.0% PROGRAMMED MAINTENANCE SERV PRG AU / % % 10.7% 10.5% RCR TOMLINSON LTD RCR AU / % % 4.7% 5.8% SOUTHERN CROSS ELECTRICAL SXE AU / % % 7.1% 7.1% SRG LTD STS AU /2015 WATPAC LTD WTP AU / % % median % % 7.4% 6.8% average % % 8.6% 10.3% Professional Services AUSENCO LTD AAX AU / % % 0.0% 0.0% CARDNO LTD CDD AU / % % 0.9% 0.9% COFFEY INTERNATIONAL LTD COF AU / % GR ENGINEERING SERVICES LTD GNG AU / % % 10.0% 8.0% LOGICAMMS LTD LCM AU / % % 9.4% 9.4% TEMPO AUSTRALIA LTD TPP AU / % LYCOPODIUM LTD LYL AU /2015 RUNGEPINCOCKMINARCO LTD RUL AU / % % 0.0% 0.0% SEDGMAN LTD SDM AU / % % 19.6% 13.2% median % % 5.1% 4.4% average % % 6.6% 5.2% ASSET INTENSIVE Ships, Trucks, Drill Rig etc Operators / Wet Lease AUSDRILL LTD ASL AU / % % 1.2% 2.3% BOART LONGYEAR LTD BLY AU / % 0.0% 0.0% BOOM LOGISTICS LTD BOL AU / % % BRIERTY LTD BYL AU /2015 GLOBAL CONSTRUCTION SERVICES GCS AU / % % 2.9% 5.2% MCALEESE LTD MCS AU / % MACMAHON HOLDINGS LTD MAH AU / % % 0.0% 0.0% MACA LTD MLD AU / % % 10.0% 10.0% MMA OFFSHORE LTD MRM AU / % % 3.0% 3.0% NRW HOLDINGS LTD NWH AU / % % 0.0% PACIFIC ENERGY LTD PEA AU / % % 6.6% 7.4% WATPAC LTD WTP AU / % % median % % 2.0% 2.7% average % % 3.0% 3.5% Manufacturing / Distribution / Sales / Dry Hire AUSTIN ENGINEERING LTD ANG AU / % % 12.5% BRADKEN LTD BKN AU / % % 0.0% CODAN LTD CDA AU / % % 7.1% EMECO HOLDINGS LTD EHL AU / % FLEETWOOD CORP LTD FWD AU / % % 3.9% 2.9% GLOBAL CONSTRUCTION SERVICES GCS AU / % % 2.9% 5.2% IMDEX LTD IMD AU / % % 0.0% 1.6% MATRIX COMPOSITES & ENG MCE AU / % % 0.0% 0.0% RCR TOMLINSON LTD RCR AU / % % 4.7% 5.8% ROYAL WOLF HOLDINGS LTD RWH AU / % % 6.1% 7.5% BROADSPECTRUM LTD BRS AU ,055 06/ % % 4.1% 7.4% TOX FREE SOLUTIONS LTD TOX AU / % % 3.6% 3.9% SRG LTD STS AU /2015 UGL LTD UGL AU / % % 0.0% 3.8% median % % 3.6% 4.5% average % % 2.8% 4.8% Property FLEETWOOD CORP LTD FWD AU / % % 3.9% 2.9% DECMIL GROUP LTD DCG AU / % % 4.9% 6.1% MINERAL RESOURCES LTD MIN AU ,165 1,035 06/ % % 3.1% 3.9% MMA OFFSHORE LTD MRM AU / % % 3.0% 3.0% PACIFIC ENERGY LTD PEA AU / % % 6.6% 7.4% median % % 3.9% 3.9% average % % 4.3% 4.7% Large Caps Large Caps DOWNER EDI LTD DOW AU ,510 1,715 06/ % % 6.5% 6.2% CIMIC GROUP LTD CIM AU ,741 10,164 12/ % % 3.3% 3.4% LENDLEASE GROUP LLC AU ,608 9,607 06/ % % 4.3% 4.8% ORICA LTD ORI AU ,481 7,277 09/ % % 6.0% 6.1% WORLEYPARSONS LTD WOR AU ,355 2,019 06/ % % 6.1% 6.1% median % % 6.0% 6.1% Source: Bloomberg P/E (dil. for new shs) EV/EBITDA EV/EBIT (curr mkt cap / NPAT) Dividend Yield % % 5.2% 5.3% Page 8 of 20

9 STS has had alliance agreement with Multiplex for over fourteen years. KEY SUPPLIERS & CUSTOMERS STS has had an alliance agreement with Lendlease for over fourteen years. It has worked for most of the large construction companies, including Brookfield, Probuild, Grocon, Multiplex, CBI and Civmec. Evolution Mining (EVN) is a very significant customer for the mining division. The recent contract is a three year plus two year agreement and is expected to generate ~$30m pa. Arrium (ARI) is an important mining customer contract. Page 9 of 20

10 Economic Exposure of Board and key management Directors MANAGEMENT, DIRECTORS AND MAJOR SHAREHOLDERS Biographies are taken from the Company website Peter McMorrow - Chairman Peter McMorrow joined the Board of SRG as a Director in July 2010, and moved into the role of Chairman in July He is also a member of the Remuneration and Benefits Committee. Peter has over 35 years project and executive experience and is a respected leader in the infrastructure and resources industries. Encompassing a wide variety of large and complex infrastructure projects both overseas and within Australia, his industry knowledge extends to all facets of engineering, project identification, winning and delivery as well as management of dynamic, profitable and long lasting business operations. Most recently, Peter was Managing Director of Leighton Contractors, for the period between 2004 and September Under his guidance, Leighton Contractors expanded considerably with turnover increasing to over $5 billion and the workforce increasing fourfold to approximately 10,000 employees. Peter is an advocate for health and safety, and brings a strong zero harm vision to both SRG and the industry in which it operates. David Macgeorge - Managing Director David Macgeorge joined SRG as Managing Director in May David has extensive senior executive experience in contracting, logistics, infrastructure and mining service industries and has a strong record of leading business transformations, driving value creation and growth through a unique understanding of strategy, customer focus and shareholder returns. Prior to joining SRG, David held senior executive roles with BIS Industries, Cleanaway and CHEP (a subsidiary of Brambles). He also provided consultancy to Leighton Contractors. David holds a Bachelor of Business and has completed the Senior Executive Management program at INSEAD Business School in France. Robert Freedman Non-Executive Director Bob Freedman has been involved with SRG since 1970 when he joined the business as Manager WA. He held the role of Managing Director from 1985 until 2009 and has Page 10 of 20 Total Total Shares Total Options Economic Position Exposure rank Peter McMorrow Chairman 3,866, ,000 4,266,608 1 David Macgeorge Managing Director 366, , ,000 3 Robert Freedman Non-Executive Director 1,099, ,000 1,299,136 2 Peter Brecht Non-Executive Director 514, , ,311 4 Michael Atkins Non-Executive Director 100, , ,000 8 Key Management Personnel Roger Lee CFO 200, , ,000 6 Mark Palmer GM Construction 500, , ,000 5 Joe Thomas GM Mining and Products 151, , ,106 7 Amy Hancock GM People not disclosed Michelle Quigley General Counsel not disclosed Corey Maranesi GM Commercial not disclosed Source: STS

11 been a Director since 1985, serving as Chairman of the Board between 2009 and He is also a member of the Audit Committee. Bob has been involved in the construction industry since 1967 and has been involved with the construction of many iconic projects, including Sydney Tower, Stadium Australia and the Emirates Tower. He was responsible for establishing SRG s overseas operations in Asia, the United Kingdom, the Middle East and South Africa. Bob is a Member of the Institution of Engineers Australia, and holds a Post Graduate Diploma in Business Administration (W.A.I.T). Peter Brecht - Non-Executive Director Peter Brecht joined the Board of SRG Limited in September He is Chairman of the Remuneration, Nomination and Benefits Committee. Previously the Managing Director - Construction Australia for Lend Lease, CEO of Bilfinger Berger Australia, Managing Director of Abigroup, Peter has more than 35 years experience in the construction industry. Peter is Chairman of SMC (Sydney Motorway Corporation) and Fulton Hogan Limited. He has been a Member of the Australian Institute of Company Directors since Michael Atkins - Non-Executive Director Michael joined the SRG Board as a Director in September 2014, and is Chairman of the Audit Committee. Michael was a founding partner of a national Australian Chartered Accounting practice from 1979 to 1987 and was a Fellow of the Institute of Chartered Accountants in Australia. Since 1987 he has been both an executive and nonexecutive director of numerous publicly listed companies with operations in Australia, USA, South East Asia and Africa. Since February 2009 Michael has been a Director Corporate Finance at Paterson Securities Limited and is currently Non- Executive Chairman of Australian listed companies Legend Mining and Azumah Resources as well as a Director of Perth Theatre Company. Michael is a Fellow of the Australian Institute of Company Directors. Page 11 of 20

12 MAJOR SHAREHOLDERS There are three substantial shareholders. The fund managers Hunter Hall and JM and the Chairman, Peter McMorrow. The main holders of the options are staff and directors. Fig. 8: Shareholders Subs. S/holders Hunter Hall 13.9% JMFG Consol. A/C 9.4% Peter McMorrow 6.1% Source: STS OPTIONS, CONVERTIBLES AND UNPAID CAPITAL The main holders of the options are staff and directors. There are 500k options at $0.835 expiring in Jun 2018 and ~2.6m options with $0.827 strike expiring in November Fig. 9: Options Expiry Exercise Price number of shares Unpaid capital 19-Nov-18 $0.83 2,665,000 2,203, Jun-18 $ , ,500 TOTAL $0.83 3,165,000 2,621,455 Source: Hartleys Research Estimates Page 12 of 20

13 FINANCIALS PRODUCTION / PROFIT & LOSS Guidance is for improved profit performance for FY16 against the underlying NPBT result of $6m in FY15. Company guidance In February, the Company said it expects improved profit performance for FY16 against the underlying NPBT result of $6m in FY15. Hartleys Forecasts We expect FY16 PBT of $7.4m. We expect NPAT of $5.2m and a final DPS of 2cps. For FY17 we assume modest growth. Fig. 10: Profit and Loss Profit & Loss ($m) Dec-13(a) Jun-14(a) Dec-14(a) Jun-15(a) Dec-15(a) Jun-16(e) FY16e Contract Mining - Rev Contract Mining - EBITDA Contract Mining - Margin 16.6% 19.0% 15.6% 19.9% 21.1% 22.4% 21.8% Construction - Rev (100%) Construction - EBITDA (100%) Construction - Margin 5.3% -1.0% 5.6% 1.2% 4.4% 4.6% 4.5% Group Revenue sequential growth -53.5% -20.5% -10.1% -6.5% -2.4% 22.9% 5.1% EBITDA margin 8.2% 3.3% 9.0% 7.3% 7.2% 8.5% 7.9% Depreciation/Amortisation EBIT EBIT / Sales 3.5% -1.5% 4.1% 2.9% 3.7% 4.2% 4.0% Net Interest Profit Before Tax margin 3.0% -1.7% 4.0% 3.0% 3.7% 4.4% 4.1% Tax Effective Tax Rate 32.9% 24.0% 20.1% 7.5% 33.3% 27.7% 30.0% NPAT Pre Minorities Net Profit / Sales 2.0% -1.3% 2.7% 1.8% 2.5% 3.2% 2.9% Minorities Normalised NPAT to equity Abnormals / discontinued Reported Profit to equity Reported EPS (basic, w'ghted) Normalised EPS (weighted) Normalised EPS (full. diluted) DPS (cps) Franking 100% 100% 100% 100% 100% 100% 100% Payout Ratio 62.4% -75.3% 84.2% 276.1% 62.3% 41.1% 51.0% Source: Hartleys Research Estimates Page 13 of 20

14 BALANCE SHEET Balance sheet is net cash Fig. 11: Balance Sheet Balance Sheet ($m) Dec-13(a) Jun-14(a) Dec-14(a) Jun-15(a) Dec-15(a) Jun-16(e) FY16e Cash Receivables Inventories Other Total Current Assets Property, Plant & Equipment Intangibles Other Total Non Current Assets Total Assets Accounts Payable Interest Bearing Liabilities Other Total Current Liabilities Accounts Payable Interest Bearing Liabilities Other Total Non Current Liabilities Total Liabilities Net Assets Net Asset Value / Share ($) NTA / Share ($) Net Debt (net cash) Source: Hartleys Research Estimates Gearing ratios Fig. 12: Gearing Ratios Ratios 6/14A 6/15A 6/16F 6/17F Return on Average Equity 0.9% 5.2% 6.6% 7.2% Return on Assets 0.5% 3.2% 4.3% 5.1% ND / ND + Equity -14.0% -42.2% -24.2% -30.5% ND / Equity -12.2% -29.7% -19.5% -23.4% Net Interest Cover (EBIT) ROIC 1.1% 6.8% 8.3% 9.0% Source: Hartleys Research Estimates Page 14 of 20

15 There is freehold land on the balance sheet for ~$5.5m Fixed Assets STS has ~$26m of PP&E on the balance sheet. There is freehold land valued at ~$5.5m and plant & equipment is the balance (at cost worth ~$90m). We estimate that utilisation on the plant & equipment is <75%. Fig. 13: Property plant and equipment June 2015 Source: STS Debt STS has $4.6m of gross debt, which is mainly HP. It amortises at ~$1.2m/qtr, and hence is expected to be substantially repaid in FY17. Cash flow was impacted by the settlement of the legal case provided for in FY15 CASH FLOW Reported operating cash flow was weak in 1H16, but this is due to the settlement of the legal case provided for in FY15 (~$8m). Underlying cash flow was better. Fig. 14: Cash Flow Statement Cashflow Statement ($m) Dec-13(a) Jun-14(a) Dec-14(a) Jun-15(a) Dec-15(a) Jun-16(e) FY16e Cash Receipts EBITDA Working Capital Change Cash from Operations Net interest Paid Tax Paid Net Operating Cash Flow Capital Expenditure Asset Sales Other (inc Investments) Net Investing Cash Flow Proceeds from Equity Issues Net Change in Debt & Leases Dividends Paid Net Financing Cash Flow Movement in Cash HP Lease Capex (non-cash) Source: Hartleys Research Estimates Page 15 of 20

16 Capex has been relatively light as the Company works the assets harder. Capex requirements Capex has been relatively light as the Company works the assets harder. We expect that eventually maintenance capex will need to run in-line with depreciation if the Company is going to remain in drill & blast. However, for the next few years we expect capex ~$5-6m pa. Free cash flow We expect the Company can deliver reasonable free cash flow over coming years. Dividends The Company has a history of paying dividends, which we expect will continue. There was a franking balance of $9m at the end of June The Company has a history of paying dividends. EQUITY ISSUANCE Based on our growth projections the Company does not require additional funding. SENSITIVITIES FX exposure The Company has a small amount of offshore earnings, but it is relatively immaterial. Interest Rate exposure The Company has a small amount of debt. Commodity price exposure The drill & blast division s main customers are gold and iron ore producers. The rest of the Company earnings are diversified away from mining. Page 16 of 20

17 Hartleys Limited Srg Limited 4 March 2016 VALUATION CONSIDERATIONS AND PRICE TARGET METHODOLOGY VALUATION We value STS at $1.12 based on the Company eventually generating ~$8-10m pa of free cash flow (FY25). Fig. 15: Key assumptions and risks for valuation Assumption Revenue above $200m, for next several years Risk of not realising assumption Downside risk to valuation if assumption is incorrect Comment Moderate High The outlook for the industry suggests that this is achievable EBITDA margins ~8% Moderate to High High Appears reasonable, although not conservative Capex is very low Moderate Moderate STS is predominantly a services business, and hence capex is low. Note, the drill & blast division is capital intensive, and hence there will be an eventual capex replacement cycle. No substantial acquisitions High Upside / Downside We believe it s likely STS makes further acquisitions Conclusion Source: Hartleys We believe our assumptions are reasonable. The largest risk, in our view, is the capex cycle for the mining division. In the short term, it is likely to be revenue growth that results in changes to our valuation. PRICE TARGET Our price target is a weighted average of several valuation metrics. STS Price Target Methodology Weighting Spot 12 mth out DCF (WACC 12.4%, Terminal growth 0.00%) 50% $1.12 $ mth forward P/E base case earnings of 10x (mid-cycle) 30% $0.87 $0.96 Dec15a 1x Price / NTA (1x $0.87) 15% $0.87 $ mth fwd Div Yield of 5.2% (Gross yield=7.4%) 5% $0.77 $0.82 Risk weighted composite $0.99 $ Months Price Target $1.03 Shareprice - Last $ mth total return (% to 12mth target + dividend) 43% Source: Hartleys Estimate Page 17 of 20

18 Hartleys Limited Srg Limited 4 March 2016 RECOMMENDATION & RISKS We are initiating coverage on STS with a Buy recommendation. INVESTMENT THESIS & RECOMMENDATION We are initiating coverage on STS with a Buy recommendation. We believe the Company is growing a sustainable earnings stream and yet the multiple is lower than peers that have had negative earnings revisions. The management team is experienced in both the sector and in company turnarounds. They are also financially aligned with shareholders, in our view. RISKS The key risks for STS (like most industrial companies) is earnings disappointments given the industry is volatile and earnings can disappoint due to cost overruns, project delays, loss of contracts or slower than anticipated new project wins. Although some earnings disappointments can be short term and just a timing issue, other disappointments can be materially value destructive and can sometimes overhang stocks for a long period of time (for example contract disputes). Such disappointments can be very difficult to predict and share price reactions can be severe and immediate upon disclosure by the company. High financial leverage can increase the impact. SIMPLE S.W.O.T. TABLE Strengths Weaknesses Opportunities Threats Source: Hartleys Research Diversified revenue Long history of operations Board and management own stock Building business at cyclical low point Relatively capital light Decent term contracts for mining division Large mining division Weak industry conditions Key man risk International roll out of products International roll out of civil Contract disputes Cancellation of mining contracts Takeover Page 18 of 20

19 Hartleys Limited Srg Limited 4 March 2016 EV/EBIT BANDS Fig. 16: Using Hartleys base case forecasts Shareprice STS Actual Hartleys Target 12x EV/EBIT 10x EV/EBIT 8x EV/EBIT 6x EV/EBIT 4x EV/EBIT Source: Hartleys Estimates, IRESS Page 19 of 20

20 HARTLEYS CORPORATE DIRECTORY Research Trent Barnett Head of Research Mike Millikan Resources Analyst Scott Williamson Resources Analyst Simon Andrew Energy Analyst Janine Bell Research Assistant Corporate Finance Dale Bryan Director & Head of Corp Fin. Richard Simpson Director Paul Fryer Director Ben Wale Associate Director Ben Crossing Associate Director Stephen Kite Associate Director Scott Weir Associate Director Rhys Simpson Manager Registered Office Level 6, 141 St Georges TcePostal Address: PerthWA 6000 GPO Box 2777 Australia Perth WA 6001 PH: FX: info@hartleys.com.au Note: personal addresses of company employees are structured in the following manner:firstname_lastname@hartleys.com.au Hartleys Recommendation Categories Buy Accumulate Neutral Reduce / Take profits Sell No Rating Speculative Buy Share price appreciation anticipated. Share price appreciation anticipated but the risk/reward is not as attractive as a Buy. Alternatively, for the share price to rise it may be contingent on the outcome of an uncertain or distant event. Analyst will often indicate a price level at which it may become a Buy. Take no action. Upside & downside risk/reward is evenly balanced. It is anticipated to be unlikely that there will be gains over the investment time horizon but there is a possibility of some price weakness over that period. Significant price depreciation anticipated. No recommendation. Share price could be volatile. While it is anticipated that, on a risk/reward basis, an investment is attractive, there is at least one identifiable risk that has a meaningful possibility of occurring, which, if it did occur, could lead to significant share price reduction. Consequently, the investment is considered high risk. Institutional Sales Carrick Ryan Justin Stewart Simon van den Berg Chris Chong Digby Gilmour Cooper Rogers Wealth Management Nicola Bond Bradley Booth Adrian Brant Nathan Bray Sven Burrell Simon Casey Tony Chien Tim Cottee David Cross Nicholas Draper John Featherby Ben Fleay James Gatti John Goodlad Andrew Gribble David Hainsworth Neil Inglis Murray Jacob Gavin Lehmann Shane Lehmann Steven Loxley Andrew Macnaughtan Scott Metcalf David Michael Jamie Moullin Chris Munro Michael Munro Ian Parker Charlie Ransom (CEO) Conlie Salvemini Mark Sandford David Smyth Greg Soudure Sonya Soudure Dirk Vanderstruyf Samuel Williams Jayme Walsh Disclaimer/Disclosure The author of this publication, Hartleys Limited ABN ( Hartleys ), its Directors and their Associates from time to time may hold shares in the security/securities mentioned in this Research document and therefore may benefit from any increase in the price of those securities. Hartleys and its Advisers may earn brokerage, fees, commissions, other benefits or advantages as a result of a transaction arising from any advice mentioned in publications to clients. Any financial product advice contained in this document is unsolicited general information only. Do not act on this advice without first consulting your investment adviser to determine whether the advice is appropriate for your investment objectives, financial situation and particular needs. Hartleys believes that any information or advice (including any financial product advice) contained in this document is accurate when issued. Hartleys however, does not warrant its accuracy or reliability. Hartleys, its officers, agents and employees exclude all liability whatsoever, in negligence or otherwise, for any loss or damage relating to this document to the full extent permitted by law. Page 20 of 20