SRV’s interim report January–September 2020: SRV’s favourable development continues

SRV GROUP PLC     INTERIM REPORT     29 OCTOBER 2020      8:30 EET

SRV’s interim report January–September 2020: SRV’s favourable development continues

January–September 2020 in brief:

• The coronavirus pandemic slightly weakened revenue and earnings for January-September. The slowdown in housing sales in the second quarter and the restrictions imposed by the Russian authorities on shopping centre operations are particularly evident in the result for the review period.
• Revenue grew by 3.9 per cent to EUR 683.0 million (657.2 1–9/2019). Revenue increased in both housing and business construction. Revenue growth in both housing and business construction was driven by an increase in contracting volume. Fewer developer-contracted housing units were recognised as income than in the comparison period, a total of 280 (301). Growth in business construction revenue largely stemmed from increased volume in alliance contracts.
• Operative operating profit amounted to EUR 12.6 (-9.6) million. Operative operating profit was improved particularly by construction sites’ favourable earnings trends. On the other hand, the decrease in rental income from shopping centres due to the coronavirus pandemic had a negative impact on operative operating profit. Operative operating profit for the comparison period is burdened by the weakening of the margins of two projects – by a total of EUR 9.8 million – and non-recurring expense entries totalling EUR 8.2 million.
• Operating profit was EUR 9.5 (-6.2) million. Operating profit was influenced by the change in the exchange rate of the rouble, which had a net impact of EUR -3.1 (3.4) million. The exchange rate impact, which largely had no effect on cash flow, was caused by the valuation of the euro-denominated loans of associated companies in roubles, hedging expenses and changes in the market value of hedges.
• The result before taxes was EUR -13.4 (-25.1) million. This includes currency exchange rate losses with no cash flow impact of EUR -17.4 million (exchange rate gains of 10.7).
• Cash flow from business and investment activities totalled EUR 33.6 (-86.9) million. Cash flow was improved mainly by the realisation of holdings in both REDI and the Tampere Deck and Arena as well as the release of capital due to the sale of contract sites to investors. 
• Earnings per share were EUR -0.11 (-0.35). The comparison figure has been adjusted for share issues.
• At period-end, the order backlog stood at EUR 1,280.3 (1,592.6) million. New agreements valued at EUR 566.3 (344.7) million were signed in January–September, a year-on-year increase of 64 per cent. The sold share of the order backlog was 86.9 (82.3) per cent.
• During the first half of the year, the company carried out a significant number of measures to improve its balance sheet and liquidity as part of its recovery programme. These measures improved both the equity ratio and gearing. Rouble exchange rate movements in turn weakened the equity ratio and gearing. The equity ratio was 23.8 (27.2) per cent and gearing was 177.4 (199.1) per cent. Excluding the impact of IFRS 16, equity ratio was 29.6 (33.3) per cent and gearing was 98.4 (131.4). Equity ratio in accordance with the loan covenant calculation was 31.4.

14. The company publishes alternative key figures that have been adjusted to remove the impact of IFRS 16 Leases on the balance sheet and result. The company also discloses its operative operating profit, which is determined by deducting the calculated rouble exchange differences included in financial items and their potential hedging impacts from operating profit.

July–September 2020 in brief: 

• Revenue in July-September amounted to EUR 209.9 (227.1) million. Revenue was down due to the decrease in revenue from both business and housing construction.
• Operative operating profit amounted to EUR 7.1 (-7.0) million. The positive earnings trend at construction sites and the year-on-year increase in the number of housing units completed and recognised as income contributed to the growth of operative operating profit. This was positively affected by the dissolution of a EUR 3.1 million provision for expenses that was recognised for the Russian subsidiary in the second quarter, as the court of second instance overturned the earlier ruling on compensation. Due to exchange rate differences, the provision recognised in the second quarter and the dissolution of the provision in the third quarter have a net effect of EUR -0.4 million on the result for January–September. Operative operating profit was also impacted by the decline in rental income from shopping centres due to the coronavirus pandemic. Operative operating profit for the comparison period is burdened by the significantly weaker margins of two projects and impairments.
• Operating profit was EUR 1.7 (-6.3) million.
• The year-on-year growth in new contracts recognised in the order backlog was 25 per cent, amounting to EUR 154.4 (123.3) million.

Events after the period

On 19 October 2020, SRV and the Premises Services unit of the City of Espoo signed an agreement to implement the Matinkylä upper secondary school in Espoo. This new building project will be carried out as a cooperative project management contract valued at about EUR 41 million, of which SRV’s contract accounts for around EUR 33 million. The project will be started immediately with a half-year development phase, after which it will be recognised in SRV’s order backlog.

CEO’s review

New projects and financing solutions in the first part of the year have strengthened our key stakeholders’ confidence in the company. As announced earlier, during the last months of the year, we will kick off new developer-contracted residential projects with RS financing agreed upon with several banks. We successfully recruited new personnel, laying the foundation for future development. In September, we were highly visible in the recruitment market, hiring many people for on-site managerial tasks and expert positions. We have maintained our position as an innovative and responsible employer.

Housing sales were strong during the entire quarter. Very few completed housing units remained unsold – only 45 in Finland and none in Russia. Sales of units at Loisto in Kalasatama have picked up in line with our expectations, with about one year remaining until completion, and since both the Kalasatama area and the feedback from residents are developing favourably.

Our part-owned shopping centres in Russia reopened in July-August after the end of the first wave of the coronavirus pandemic. The shopping centres experienced a strong recovery – in August-September, both visitor and sales figures rebounded to almost the same level as a year ago. Shopping centre floor area per inhabitant is significantly lower in Russia than in Western countries and e-commerce is still quite undeveloped and thus we expect to see a rapid recovery of shopping centres after the current wave of the pandemic is over.

The earnings trend in construction remained favourable during the review period and our ongoing projects progressed largely in line with plans. A previously recognised provision for damages payable by our subsidiary in Russia was entered back into operative operating profit when the dispute was settled in our favour in the court of second instance. Positive development continued, with both operative operating profit and cash flow in the black.

As planned, we have altered our project portfolio to reduce its risks and require smaller capital commitments. The inflow of orders was greater than in the previous period, but the order backlog decreased. However, the number of projects in which an agreement is close to being signed is strong and thus we are well-poised to achieve a good order intake in the last months of the year.  In addition, I am pleased to note that the developer-contracted housing projects that will be launched in the latter part of the year – after a break of about a year and a half.  These projects will be recognised as revenue in 2022.

The exceptional arrangements implemented to prepare for the coronavirus pandemic have continued to usher in some additional costs, but we have avoided the most serious consequences and all our sites have remained in operation in spite of the unusual circumstances. To date, the impacts of the pandemic have been moderate on the whole, but its effects on the construction market are unclear and cloud the outlook for the future.

We will continue to develop our operative earnings performance and business operations. We manage development with a strongly centralised project management model. In addition, we have started strategy work based on the further development of the company’s strengths.

Thanks to numerous successes and disciplined work, confidence in SRV has improved significantly. I would like to thank our customers and financiers for their good cooperation and our personnel for their and strong commitment and excellent work on our turnaround.

Saku Sipola, President & CEO

Overall review

1. Operative operating profit is determined by deducting the calculated rouble exchange differences included in financial items and their potential hedging impacts from operating profit. Net exchange rate differences during the review period amounted to EUR -3.1 (3.4) million, of which the effect of currency hedging was EUR 5.7 (-3.4) million.
2. The figure has been adjusted to remove the impacts of IFRS 16.
3. The Group’s order backlog consists of the Construction business.

1. The figure has been adjusted to remove the impacts of IFRS 16.
2. The comparison figures have been adjusted to reflect share issues.
3. The comparison figures have not been adjusted to reflect share issues.

Earnings trends for the segments

Construction January-September 2020

Revenue from Construction grew to EUR 678.1 million (654.6 1–9/2019) in the January–September period. Revenue was up in both business construction and housing construction. Revenue from housing construction was up 5.0 per cent. Revenue from contracting grew, but on the other hand fewer developer-contracted housing units were completed and recognised as income than in the comparison period. Revenue from business construction was up 3.1 per cent. Growth in business construction revenue largely stemmed from increased volume in alliance contracts.

Construction’s operating profit rose to EUR 18.7 (3.5) million. This improvement in operating profit was particularly due to construction sites’ favourable earnings trends, especially in business construction. On the other hand, fewer apartments were completed and recognised as income than in the comparison period, which had a negative impact on operating profit. Operating profit for the comparison period was weakened by the lower margins of two projects and an expense entry for REDI Majakka’s water damage, totalling EUR 14.3 million.

Construction’s order backlog stood at EUR 1,280.3 (1,592.6) million. Several of the new projects entered into the order backlog during the January–September period were for investors and public-sector organisations of good financial standing, and none of SRV’s capital will be tied up in these projects. The company has enhanced its project selection process in the manner described in the recovery programme. Although the order backlog has declined, it remains at a good level, and 87 (82) per cent of the order backlog has been sold. New agreements valued at EUR 566.3 (344.7) million were recognised in the order backlog in January–September.

The most significant projects entered into the order backlog in the third quarter were premises for the Finnish Security and Intelligence Service, a design contract for the Uusikaupunki education and wellness campus, and a housing project with 47 units for Tampereen Vuokra-asunnot. Major projects recognised in the second quarter were the basic renovation of operating theatres at HUS Jorvi Hospital, the Siuntio education and wellness campus, which will be implemented as a lifecycle project, the Jousenkaari school in Espoo, the Hovirinta school in Kaarina, the Ojanko bus depot in Vantaa and the residential buildings Lumo One and Piispanristi for Kojamo. Major projects recognised in the first quarter included the basic renovation project for the Finnish National Theatre. A complaint has been lodged in the administrative court concerning the deviation decision on the National Theatre basic renovation project. The client is investigating the progress of the project.

Construction’s capital employed totalled EUR 417.4 (462.6) million.

Construction July–September 2020

Revenue from Construction totalled EUR 209.1 million (226.0 1-9/2019) in the July–September period. Operating profit was EUR 5.2 (-3.4) million. New agreements entered into the order backlog in July-September amounted to EUR 154.4 (123.3) million.

Investments January-September 2020

Investments’ revenue totalled EUR 3.9 million in the January–September period (4.2 1–9/2019). It mainly consists of revenue from shopping centre management. In accordance with SRV’s operating model, revenue from associated companies’ projects and joint ventures is reported under the Construction segment.

The operative operating profit totalled EUR -3.8 (-8.4) million. In addition to SRV’s Group companies, the result contains a share of the result of the associated company that owns the Okhta Mall, including not only the mall’s operating margin, but also depreciation, financial expenses and taxes. The company also recognised EUR 0.5 million in income with a cash flow impact due to the final dissolution of the investment in the VTBC fund.

During the comparison period, operative operating profit was weakened by EUR -3.0 million in write-downs related to the Etmia office project and the dissolution of the investment in the VTBC fund. SRV’s holding in the REDI shopping centre was sold at the beginning of the review period, and thus the result will no longer be consolidated with SRV’s result. On 31 December 2019, the Pearl Plaza shopping centre was designated as an asset held for sale, and the proportion of the result equivalent to SRV’s holding will therefore no longer be consolidated with SRV’s result.

In the case of the Russian subsidiary, a EUR 3.1 million provision for expenses that was recognised in the second quarter was dissolved in the third quarter when the court of second instance overturned the ruling on compensation by the court of first instance. The dissolution of the provision had an impact of EUR 2.7 million at the September exchange rate, and thus the euro-denominated result for the review period is burdened by expenses of EUR 0.4 million. At the end of the review period, it was not as yet known whether the plaintiff will appeal to the court of third instance. The lawsuit concerned an agreement for an electrical connection that was never implemented.

The coronavirus pandemic that began at the end of the first quarter of 2020 has negatively impacted shopping centre operations by undermining tenants’ ability to do business. The authorities restricted the opening of stores in March-August, which weakened the operational capabilities of shopping centres and reduced their rental income. Shopping centres opened gradually in the third quarter, which was reflected in the rising visitor numbers and sales in August to September. The decline in rental income has short-term impacts on the liquidity and loan management capabilities of shopping centres. SRV has agreed on arrangements with banks and co-investors in the shopping centres to secure financing for the shopping centres during the period in which the restrictions set by the authorities are in effect.

The coronavirus restrictions imposed in Russia vary from city to city. In St Petersburg, most of the tenants in the shopping centres managed by SRV closed their doors on 28 March, in compliance with official regulations, and only essential services such as pharmacies and grocery stores remained open.  Most of the shops could be opened again in July-August. In Moscow, shopping centres closed their doors about one week earlier than in St Petersburg, and the operations of tenants returned closer to normal earlier than in St Petersburg, as restrictions were gradually lifted.

Investments’ operating profit was EUR -6.9 (-5.0) million. The net effect of currency exchange fluctuations was EUR -3.1 (3.4) million, which arose from valuation of the euro-denominated loans of associated companies in roubles and the net impact of currency hedging. Exchange rate differences with no impact on cash flow vary in each interim report in line with fluctuations in the exchange rate of the rouble.

Capital employed totalled EUR 181.1 million (245.7 12/2019). The divestment of SRV’s holding in REDI and the reduction of its holding in the Tampere Deck and Arena decreased the amount of capital employed in the first quarter. In addition, investments were repaid to the owners of the Pearl Plaza project in the first quarter, which reduced the capital employed in the project by EUR 7.0 million. The weakening of the rouble exchange rate also affected capital employed. The net exchange rate impact entered through the income statement was EUR -11.6 million, and the total impact of translation differences on capital employed was EUR -17.4 million. Total capital employed decreased by about EUR 64.6 million compared with the beginning of the year.

The return on investment was -8.6 (-0.3) per cent. When calculating the return on investment, the income from interest on loans granted to associated companies and changes in the value of loans are also taken into consideration.

SRV is a co-investor in three shopping centre projects through its associated companies. SRV is also responsible for leasing, marketing and managing premises in completed shopping centres. SRV intends to sell its holdings once stable rental income has been achieved or the market situation allows. Stable rental income is usually reached 3–4 years after opening. The coronavirus pandemic that began during the first quarter of 2020 has impacted shopping centre operations by undermining tenants’ ability to do business. This has temporary negative impacts on shopping centres’ rental income. However, as mentioned in the risk section, due to the coronavirus pandemic and economic uncertainty in Russia, it is possible that the sale of Russian shopping centres may be postponed. 

Investments July–September 2020

Investments’ revenue totalled EUR 1.1 million in the July–September period (1.4 7–9/2019). Revenue was generated by shopping centre management. Operative operating profit amounted to EUR 1.6 (-3.7) million.

Outlook for 2020

During 2020, SRV’s revenue and result will be affected by several factors in addition to general economic trends, such as: the timing and amount of income recognition for SRV’s own projects, which are recognised as income upon delivery; the part of the order backlog that is continuously recognised as income mainly consists of contracting; trends in the order backlog’s profit margins; the start-up of new contracts and development projects; and the rouble exchange rate.

The largest ongoing projects are Tampere Deck and Arena, the extension of Helsinki Airport, and several hospital projects.

• The company’s main focus in 2020 will be on major business premises contracts, hospital projects, and housing development projects for investors. Fewer developer-contracted housing units will be completed in 2020 than in the comparison period. It is estimated that a total of 520 developer-contracted housing units will be completed in 2020 (808 in 2019).
• Measures to boost operational efficiency and achieve savings in procurement are expected to improve the company’s earnings performance. The recovery programme measures that were carried out in late 2019 are also expected to improve the company’s cost structure.
• Full-year consolidated revenue for 2020 is expected to fall in comparison with 2019 (revenue in 2019: EUR 1,060.9 million). Operative operating profit is expected to improve on 2019 and to be positive (operative operating profit EUR -96.8 million).

Espoo, 29 October 2020

Board of Directors

All forward-looking statements in this review are based on management’s current expectations and beliefs about future events. The company’s actual results and financial position may differ materially from the expectations and beliefs such statements contain due to a number of factors that have been presented in this interim report, and in particular the ongoing coronavirus pandemic.

Briefing, audiocast and presentation materials

A briefing for analysts, fund managers, investors and media representatives will be held on 29 October 2020, starting at 12.00 EET as an audiocast and conference call. The audiocast can be followed live at www.srv.fi/en/investors. The recording will be available on the website after the presentation. The materials will also be made available on the website.

For further information, please contact:

Saku Sipola, President & CEO, tel. +358 (0)40 551 5953, saku.sipola@srv.fi 
Ilkka Pitkänen, CFO, tel. +358 (0)40 667 0906, ilkka.pitkanen@srv.fi 
Maija Karhusaari, SVP, Communications and Marketing, tel. +358 (0)45 218 3772, maija.karhusaari@srv.fi  

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SRV in brief

SRV is developer and innovator in the construction industry. We want to offer the best customer experience as a constructor of urban city centres, while also being the most attractive employer in the industry. Our genuine cooperation and enthusiasm for our work comes across in every encounter. Sustainability is reflected in all our activities.

Established in 1987, we are a publicly listed company since 2007 in Helsinki Nasdaq stock exchange that operates in growth centres in Finland and Russia. Our revenue in 2019 was EUR 1,061 million. Over 1,000 people work for us and we employ a network of almost 4,000 subcontractors in our projects.

SRV – Building for life