AECOM (NYSE:ACM) Q4 2023 Earnings Call Transcript

AECOM (NYSE:ACM) Q4 2023 Earnings Call Transcript November 14, 2023

Operator: Good morning, and welcome to the AECOM Fourth Quarter 2023 Conference Call. I would like to inform all participants that this call is being recorded at the request of AECOM. This broadcast is the copyrighted property of AECOM. Any rebroadcast of this information in whole or part without the prior written permission of AECOM is prohibited. As a reminder, AECOM is also simulcasting this presentation with slides at the investor section at www.aecom.com. [Operator Instructions] I would like to turn the call over to Will Gabrielski, Senior Vice President, Finance, Treasury and Investor Relations.

William Gabrielski: Thank you, Operator. I would like to direct your attention to the safe harbor statement on Page 1 of today’s presentation. Today’s discussion contains forward-looking statements about future business and financial expectations. Actual results may differ significantly from those projected in today’s forward-looking statements due to various risks and uncertainties, including those described in our periodic reports filed with the SEC. Except as law requires, we undertake no obligation to update our forward-looking statements. We use certain non-GAAP financial measures in our presentation. The appropriate GAAP reconciliations are incorporated into our materials, which are posted to our website. Growth rates are presented on a constant currency basis unless otherwise noted.

Any references to segment margins or segment adjusted operating margins will reflect the performance for the Americas and International segments. When discussing revenue and revenue growth, we will refer to net service revenue, or NSR, which is defined as revenue excluding pass-through revenue. NSR and backlog growth rates are presented on a constant currency basis. Unless otherwise noted today’s discussion of key performance indicators will focus on the continuing and core operations of the company. On today’s call, Troy Rudd, our Chief Executive Officer, will review our key accomplishments, our strategy, and outlook for the business. Lara Poloni, our President, will discuss the key operational successes and priorities. And Gaurav Kapoor, our Chief Financial Officer, will review our financial performance and outlook in greater detail.

We will conclude with a question-and-answer session. With that, I will turn the call over to Troy. Troy.

Troy Rudd: Thank you, Will, and thank you all for joining us today. I want to begin by thanking our 52,000 professionals who are the most talented in our industry. Through their technical expertise and global collaboration, we’ve extended our competitive advantage. This includes building a record design backlog that is supported by long-term projects with stable funding sources. I also want to highlight our record safety performance during the year. Ensuring the safety of our teams is essential. Our total recordable incident rate remains well ahead of industry benchmarks and our internal targets, which is a testament to our culture. Turning to our results, we outperformed on every key financial metric in both the fourth quarter and full year.

Organic NSR growth and the design business was 10% in the fourth quarter and 9% for the full year. This was highlighted by the strength of our water, transportation and environment businesses, which are benefiting from strong secular growth trends and organic market share gains. Our margins also exceeded guidance and set a new annual high. Our profitability continues to lead our industry, which enhances the value of our record design backlog. As a result, full year adjusted EBITDA and EPS increased by 10% and 12% on a constant currency basis. Both metrics exceeded our initial and increased guidance midpoints despite headwinds from the strengthening U.S. dollar. Consistent with our track record of strong cash performance, free cash flow was in the upper half of our guidance range, which enabled the execution of our returns-focused capital allocation policy.

This included approximately $475 million allocated to share repurchases and dividends during the year. Based on our strong cash flow profile and the strength of our balance sheet, we also affirmed our capital allocation policy, which is led by investments in high returning organic growth, followed by share repurchases and dividends. Since 2020, we have returned $2 billion to our stockholders. We announced an increase in our share repurchase authorization to $1 billion and an increase to our quarterly dividend by 22%. This marks the second consecutive year of at least 20% increase in our dividend and is consistent with our long-term plan for annual double-digit percentage increases. Please turn to the next slide. Across the results, three key themes were apparent.

First, we are winning key pursuits at a record rate. Both total and contracted backlog in the design business reached all-time highs, led by 21% growth in contracted backlog in the Americas design business. In addition, the profile of our wins continues to shift to higher value, longer duration projects and programs for our largest clients, which adds to our visibility. In fact, wins valued at greater than $50 million during the year increased by 70% from just a few years ago, which has the effect of expanding our long-term earnings power. Second, investments in infrastructure, sustainability and resilience, and the energy transition are converging into a powerful cycle that plays to our strengths. Funding from the IIJA is beginning to flow into our markets, and commitments towards achieving ambitious net zero targets are driving our clients’ investment decisions.

Finally, our competitive advantage is expanding as evidenced by our industry-leading organic design backlog growth, record high win rates, and our industry-leading margins. The combination of our technical leadership, collaborative culture, and our day 1 advisory, day 2 program management, and day 3 design capabilities has us positioned as the partner of choice across the full life cycle of our clients’ most critical investments. Against a constantly evolving economic and geopolitical landscape, we are in a leading position to deliver. Nearly 90% of our income is generated in the Americas, the U.K., and Australian markets. These economies are amongst the most resilient in the world and feature record funding commitments in our markets. We have diversified our private sector exposure and the majority of our private sector business is linked to markets and clients that are accelerating their investments.

This includes our water and environment practices where we are primarily delivering for clients operating budgets and not capital budgets and where regulatory requirements drive a substantial portion of client spend. This is also true for our facilities business, where 75% of our work in the America’s design business is for public sector clients, where funding is more predictable. Importantly, our exposure to the private U.S. commercial real estate market is less than 3% of total NSR. And while there remains uncertainty around the U.S. Federal budgeting process, the impacts of a typical shutdown are immaterial to us, and we estimate that less than 1% of our business would be impacted. Our contracts are well-funded, and all indications that most of our work will continue through a shutdown.

In addition, our state and local clients are benefiting from historically strong tax revenues, accelerating IHA-related grant activity, and direct funding from the Federal Highway Trust Fund, which is funded through a separate and already completed authorization process. Please turn to the next slide. From our position of strength, we’re investing in key initiatives to extend our competitive advantage. For example, as digital becomes ubiquitous in our industry over time, our commitment to make investments that enhance our long-term growth combined with our scale and collaborative culture creates a substantial advantage. Our libraries of data, which represent the collective knowledge and experience of our professionals, enable us to write and deploy script and code that automate elements of a design.

Through this, we are substantially reducing the time to complete certain work packages while further enhancing quality. These productivity gains create time for our professionals to dedicate to even higher value work. We’re also continuing to expand our enterprise capability centers, which is a critical enabler of expanding our capacity and deploying best practices. Hours delivered through these centers increased by 50% for the year and we see substantial opportunity for further increases over time. In addition, we are continuing to grow our world-class program management and advisory expertise, which is highly synergistic with our design leadership. This creates a competitive advantage when pursuing and delivering the most complex projects and programs.

We are placed in a specific emphasis on growing our energy advisory and digital practices, as our clients are estimated to require $4 trillion per year to achieve global net zero targets and are accelerating digital investments. Taking into consideration our accomplishments in fiscal 2023, our expanded competitive advantage, and accelerating growth in our core markets and geographies, we have initiated strong financial guidance for fiscal 2024. We expect organic NSR growth of between 8% and 10%. We also expect to deliver another year of record profitability, including a 90 basis point increase in the segment adjusted operating margin to 15.6%. This is well ahead of our prior 2024 target and reflects our commitment to continuous improvement and realizing our long-term 17% margin ambition.

At the midpoints, adjusted EBITDA is expected to increase by 13% and adjusted EPS is expected to increase by 20% to $4.35 to $4.55. We also expect another year’s strong cash flow, which will enable continued opportunities to allocate capital growth and shareholder returns. We are exceptionally well positioned for the year ahead and are excited by the continued growth and value creation opportunity at AECOM, which we will discuss in greater detail at our upcoming Investor Day in December. With that, I will turn the call over to Lara.

Lara Poloni: Thanks, Troy. Please turn to the next slide. Fiscal 2023 was a milestone year in many respects. Our teams are energized by our record high design win rate in the year and backlog position, which validates the competitive advantage we have built through our technical excellence. Through our strategy, we are ideally suited to deliver as the global infrastructure megatrends accelerate. We are consistently winning our high priority pursuits at a record rate and on 90% of our wins, our technical score is essential to our success. In addition, as projects become larger and more complex, clients are increasingly asking for more from their consulting partners and through our world-class program management and advisory capabilities, we are distinguished from our competition.

In addition we continue to maintain leadership positions in the market sectors benefiting from these trends. In water which represents 26% of our design NSR investments to address persistent drought, flooding and drinking water scarcity are increasing and play to our strengths, as evidenced by our transformational wins throughout the year. We won a resiliency contract to help the City of New York deliver a new conveyance tunnel that will improve the reliability of its water supply. This win drew on our global water sector expertise and experience working on projects of this scale and complexity. Also, we were selected for a large hydroelectric project in Canada that was the result of our leading hydroelectric engineering capabilities. This win is representative of a growing set of similar opportunities across our markets.

Water trends are equally strong in the international market. For instance, in the U.K., spending across the AMP8 water infrastructure programs is expected to increase by 75% over the next five years as compared to the prior five-year cycle. Our exposure to these clients is expanding just as the total addressable spend is increasing. Turning to transportation where we hold the number 1 rankings in both transit and transportation engineering our largest state and local clients are projecting double digit spending growth in fiscal 2024. Large wins such as our selection to be the lead designer for the IIJA funded Brent Spence Bridge Corridor project in the U.S. are beginning to more materially contribute to our results. Similarly, our leadership in transit was affirmed in our selection for two substantial Canadian light rail transit projects, building on our global successes in this market over the past few years.

These wins further demonstrate the value of combining our design and program management capabilities. And in the environment sector, backlog increased by double digits and included a sizeable win to support San Diego Gas and Electric’s strategic undergrounding program, reducing wildfire risk by moving overhead power lines underground. We were also selected to advise on delivering a carbon neutral COP28, the leading forum uniting the world on the most ambitious sustainability solutions of our time, which is a reflection of our strong leadership position in the market. In addition, given continued regulatory clarity, PFAS remediation work is gaining momentum and we’ve won some of our largest projects to date during the year. This includes our program management win to conduct PFAS investigation and remediation for the U.S. Army National Guard facilities nationwide, where we bring an unrivaled suite of PFAS services and technical expertise to address this critical environmental challenge.

These successes reflect the strength of our Think and Act Globally strategy and our competitive advantages as projects increase in size and complexity. Technical excellence remains the key distinguishing characteristic of nearly all of our significant wins and we have several initiatives underway to fortify those strengths. These include continued growth in our technical academies and technical practice groups, such as a new expert-led ESG and climate change program. As we look to 2024 and beyond, we are setting the bar in terms of technical advantage, higher returning organic growth and profitability, and are confident that through continued discipline execution of our strategy, we will further extend our advantage. With that, I will turn the call over to Gaurav.

Gaurav Kapoor: Thanks, Lara. Please turn to the next slide. We exceeded the midpoint of both our initial and increased guidance ranges in 2023 as we continue to build on our track record of delivering on our commitments and generating long-term shareholder value. This performance included 10% organic NSR growth in the design business in the fourth quarter, industry-leading margin performance and continued strong cash flow. As we turn to 2024, we are encouraged by a strong end-market backdrop, building from a record design backlog and 20% growth in our design pipeline. We are poised to deliver another year of strong NSR growth, record margins and 20% adjusted EPS growth at the midpoint of our guidance range. I am also pleased to report that we announced an increase in our share repurchase authorization to $1 billion and a 22% increase in our dividend.

These actions reflect our confidence in the long-term cash flow profile of the business and the continued opportunity to enhance value creation through our operating performance. Please turn to the next slide. In the Americas, we delivered 9% NSR growth in the design business in the fourth quarter. We are benefiting from a high win rate along with strong client funding. As a result, we achieved a record design backlog which was driven by our water, transportation and environment businesses which all delivered a 1.2 or greater book to burn ratio for the year. The adjusted operating margin was 19% in the fourth quarter and reached a record high for the full year. This strength reflects the benefit of our strategy, which is focused on delivering the highest value elements of a project or program and the emphasis we place on return on time and capital.

Please turn to the next slide. Turning to the international segment. Fourth quarter and full year NSR increased by 11%, and we delivered on our 10% adjusted operating margin target in the fourth quarter, which increases our conviction towards delivering on our best-in-class margin target over time. Growth was strong across market sectors and included double-digit growth in transportation and strong growth in water. Both sectors are benefit from increased investment in our largest markets, including the U.K. and Australia. Even with our strong revenue growth in 2023, backlog increased by 20%, which underpins our expectations for continued NSR growth and margin expansion in 2024. Please turn to the next slide. We delivered $591 million of free cash flow in the year, which was in the upper half of our guidance range and marks the ninth consecutive year of delivering on our cash flow guidance.

This strong performance enabled allocation of approximately $475 million of capital to shareholders through repurchases and dividends. We have now reduced our shares outstanding by 19% since we began repurchasing stock in 2020, and we have increased dividend by at least 20% in each of the past two years. Our capital allocation policy is centered on generating shareholder value and is supported consistently by strong cash flow that we allocate to highest returning opportunities. Our priorities with our capital have not changed. Our focus is on investing in organic growth, which is primarily through our margins in form of business development, talent and digital innovation. This is followed by repurchases given our confidence in delivering strong long-term earnings growth and then dividends.

Our ability to invest in high returning opportunities and create value for our shareholders is also supported by our strong balance sheet. Against a backdrop of rising rates and steepening yield curve, we have created certainty. Approximately 80% of our debt is fixed or capped at highly attractive rates, and we do not have bond maturities until 2027. In 2024, we expect another strong year of cash flow with free cash flow guided at least 100% of adjusted net income, further enabling our growth and efficiency initiatives and continued return of capital to shareholders. Please turn to the next slide. Our 2024 guidance reflects the conviction we have in our strategy, our strong track record of execution, favorable demand drivers in our markets and our record design backlog coming into the year.

We have initiated fiscal 2024 guidance for adjusted EPS growth of 20%, an adjusted EBITDA growth of 13% at the midpoint of the respective ranges. This guidance reflects our expectation for organic NSR growth of 8% to 10% and 90 basis points of margin expansion to 15.6%, which is well in excess of 8% to 10% and 90 basis points of margin expansion to 15.6%, which is well in excess of the 15% target we had previously set for fiscal 2024 and keeps us on track towards our long-term 17% margin target. Approximately two-third of the expected margin increases is a result of highly profitable organic growth. The remaining amount reflects the benefit from actions we are taking to accelerate our margin potential which are primarily focused on the next phase of our real estate transformation, where the payback is expected over the next several years.

We have a culture booked on continuous improvement and the actions we are taking to produce a high ROI and compounding benefits to the organization. I also want to note that consistent with our historical phasing of earnings, we expect adjusted EBITDA in the first half of the year to approximate 45% to 48% of our full year earnings. Taken together, we remain confident in further growth in our ability to continue creating substantial value for our stakeholders. With that, operator, we are ready for questions.

Operator: [Operator Instructions] Your first question today comes from the line of Michael Feniger from Bank of America. Your line is open.

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Q&A Session

Michael Feniger: Hi, everyone. Thanks for taking my question. Just to kick it off, Troy, you’re forecasting growth to remain stable to actually slightly accelerate in 2024. Just what gives you that confidence today to see NSR growth grow to that 8% to 10%? Is that even through the year to start lower and pick up in the second half? Is there anything you want to flag about the moving pieces for us to think about that growth staying stable – growth rate seems to be able to slightly picking up in 2024?

Troy Rudd: Yes. Thanks for the question. Good morning. So I would – I mean really our confidence in our growth is attributable to a number of different things. First is – we go through the same process every year that we do when we build up our plan. We start by looking at our backlog. And when you look at our backlog this year, our design business, which represents about 94% – 93%, 94% of our business is actually – our contracted backlog is actually up 15% this year. And so that gives us tremendous confidence. And then in our CM business, which represents about 6% of our business, we have about four years of work, so it sits in that business. So that’s the starting point, is that just our backlog gives us great confidence that we can continue to grow, frankly, at the same rate we did in the second half of this year.

And then the other important element of this is just the overall markets that we play in. Our longer-term confidence even beyond the year is based on the fact that we are exposed to some long-term investment cycles in infrastructure and sort of resilient to your sustainability. You think about that as sort of things like supply chain shifts or investments in coastal resiliency. And then there’s an energy transition. And so that also gives us confidence. And then beyond that, 90% of our revenue is actually coming from four geographies. It’s Canada, the U.S., Australia and the U.K. So all those things taken together give us confidence. And the one thing in the past that has sort of been a headwind to growth was actually the ability to add people fast enough to the business.

And I think we’ve got in a position now where turnover is certainly voluntary turnover is at a much lower rate. And we’re adding people to the business that are right that supports that growth. So all of that leads to confidence around our forecast for this next year.

Michael Feniger: Thanks Troy. And just to follow up. There’s just a lot of focus right now on how higher rates are weighing on construction. Mostly obviously private side. You touched in your comments about your exposure to commercial real estate, you do have certain exposure to private customer base. Can you just unpack that private side? How much of that do you see is vulnerable to high rates of economic uncertainty? What are you seeing in that portfolio outside of maybe commercial real estate? And just lastly, Troy, like are you – in 2024, are you forecasting a further weakness, stability? What are you kind of seeing in that construction management segment that people kind of focus on what are you kind of embedding for 2024 there? Thank you.

Troy Rudd: Okay. Yes. Well, I’m going to take this a number of different ways. So first of all, if I look across the business. Overall, our exposure to commercial real estate is less than 3% of the entire business, whether that’s construction management or the design business. And frankly, we continue to move towards the broader opportunities that exist in infrastructure. And so the people in our business are, again, have been focusing perhaps on commercial real estate, have the skills to participate in other types of infrastructure, design, program management and even construction management. So again, across the entire business, less than 3% is our exposure to commercial real estate. But if you sort of take a different cut at the business.

Our exposure to business is to about 24% of our revenues from water, 35% from transportation, about just to say a little more 10% is from environment and, frankly, energy. And then the rest is our facilities business and construction management. And within our design business, 70% of that design business is actually public sector focused. So within that, our private sector exposure within facilities is very small. But again, when you look at that, that facility’s exposure is spread across a whole number of clients. And again, it’s not in the commercial real estate. It’s in private sector and data centers in transportation, decarbonization activities. So it’s fairly well diversified. So again, our confidence is fairly well spread across the business.

And last four year is – our guidance takes into account our exposures to all of the businesses that we see globally.

Michael Feniger: Thank you.

Operator: And your next question comes from the line of Andy Kaplowitz from Citigroup. Your line is open.

Andy Kaplowitz: Hi. Good morning, everyone.

Troy Rudd: Good morning.

Lara Poloni: Good morning.

Andy Kaplowitz: I know you probably want to save this at the Investor Day, but since you’re growing 90 basis points in margin in FY ’24 and one-third of that is related to your restructuring cost out. Could we see that kind of impact as we move forward into ’25 and ’26? So you could see that margin growth after ’24 and assuming somewhat similar growth to what you’re going to do in ’24. Maybe you could hit your 17% longer-term target by FY ’26 or earlier? I know you want to keep it long term, but how do we think about that?

Troy Rudd: I’ll tell you what, Andy, we’re going to give – we’ll give more detail at the Investor Day. So this is a plug for you to show up. But we’re focused on actually continuing to expand margins in the business and then we set a 17% target. And so that’s where we are headed over a longer period of time and the things that we’ve done this year will contribute to that. But maybe for a little more detail. I’ll turn it over to Gaurav.

Gaurav Kapoor: Hi Andy, thanks for that question. Of course, there’s plenty of opportunity from here. And I think FY ’24 is an example of that, where we added 90 bps of margin well ahead of our own expectations we had coming into the year and the long-term target we have put forth almost three years ago to already an industry-leading margin. So that clearly demonstrates the point. With almost two-thirds of that 90 bps increase coming from expansion is from our growth. It clearly indicates that we’re operating from a position of strength practically in every facet of the business we operate from capitalizing on market opportunities, taking market share, including having 80-plus percent win rate on our enterprise critical pursuits and having the best technical professionals delivering solutions for our clients and communities, this is all really important because it’s allowing us to have plenty of opportunity to expand on that 17% target.