SRV's order backlog exceeds one billion euros: SRV's interim report 1 January–30 June 2014

SRV GROUP PLC     INTERIM REPORT     6 AUGUST 2014, at 8:30 AM

Reporting period 1 January–30 June 2014 in brief:
• SRV's revenue was EUR 281.6 million (EUR 337.8 million 6/2013), change -16.6%
• Operating profit was EUR 9.3 million (EUR 14.9 million), change -37.4%
• Profit before taxes was EUR 5.6 million (EUR 14.0 million), change -60.3%
• Earnings per share were EUR 0.05 (EUR 0.32)
• The order backlog at the close of the review period was EUR 1,047 million (EUR 959.2 million), change +9.2%
• Equity ratio was 38.4 per cent (35.2%)

SRV's outlook for 2014 remains unchanged. The Group's full-year revenue is expected to be on a par with the previous year (EUR 679.4 million 1-12/2013) and profit before taxes to amount to EUR 10–20 million (EUR 22.8 million 1-12/2013).

Second quarter 1 April–30 June 2014 in brief:
• Revenue was EUR 143.1 million (EUR 179.4 million 4-6/2013)
• Operating profit was EUR 4.9 million (EUR 13.7 million)
• Profit before taxes was EUR 3.4 million (EUR 13.3 million)
• Earnings per share were EUR 0.04 (EUR 0.35)

This interim report has been prepared in accordance with IAS 34. The disclosed information is unaudited.

CEO Jukka Hienonen comments on SRV's result:

SRV Group’s operational profitability improved substantially, even though the Group’s reported operating profit was significantly below last year’s figure because the figures for the comparison period the previous year included, among other things, both a capital gain and a positive change in the fair value of SRV’s minority interest as a consequence of the sale of a share of the Okhta Mall project.

SRV has advanced according to plan in a difficult operating environment. We have improved our profitability by consistently focusing on higher-margin projects and through disciplined development of our cost-efficiency. In Domestic Operations, this has been evident in four successive quarters of improved operating margin, which has already exceeded the five per cent level. Our company has the highest-ever order backlog, at more than one billion euros.

Investors and private customers have laid claim to the one- and two-room apartments in the market, as a result of which the pool of apartments for sale in the housing market has been skewed towards larger homes. We have made the decision to increase new production in the Helsinki Metropolitan Area and the Tampere Region, but growth will be directed at affordable housing, such as small apartments and larger, Hitas-regulated homes.

Owing to the rental housing projects developed by SRV, our housing production volume has grown by 12%. Of our housing production currently under construction, 93% per cent has been sold in advance, so the operational risk profile has also been carefully considered, taking any prolongation of the recession into account.

In Russia, we are continuing the construction of the Okhta Mall shopping centre, which we began in St. Petersburg a year ago. The project has advanced without delays and, with the weakening of the rouble, the project’s cost estimate has fallen by around EUR 20 million. The project’s tenant acquisition has gone well and a positive credit decision on loan financing has been achieved with a Russian bank. The development of visitor numbers at the Pearl Plaza shopping centre, which we partly own, has proceeded beyond expectations. In June, the sale of a majority interest in the Promenade shopping centre project, to be built in a city of the Greater Moscow region, was agreed with a Russian pension fund. SRV will be responsible for the project’s construction and leasing. Construction work is already under way and preliminary lease agreements have been signed for more than half of the leasable floor area. The operating result of our International Operations showed a slight loss, however, due to fluctuations in the recognition as income of long-term projects.

The total volume of construction in Finland has declined for three years in succession and, judging by the number of new building permits, the decline will continue. There are large regional differences, and apartment block production in growth centres, for example, has remained relatively buoyant due to demand from funds and companies engaged in the construction of rental housing. Demand from private customers in housing sales has been weak owing to the low level of consumer confidence.

Demand for construction of business premises has remained low and underutilisation of business premises is still around the ten per cent level. The situation of the retail sector is difficult due to impaired consumer confidence. The largest investments are directed at public sector service construction and renovation construction.

Our large shopping centre projects in Finland and Russia are proceeding, even though the financial crisis and global political events have hampered the advancement of the projects and we have had to make corrections to ensure the projects’ progress. In accordance with SRV’s strategy, the projects are at different stages, so their impact on the company’s profit development must be assessed over the longer term. Many projects were under preparation for years before they reached the construction stage. Projects, moreover, cannot be started and halted based on individual economic and political fluctuations, neither in Russia or in Finland.

In Ukraine, the situation has taken a worrying course. The confrontation of Russia and the EU has escalated to the stage of intensifying sanctions. These actions are leading towards isolation, and the EU has put the political agenda ahead of economic interests. It is difficult to predict how the situation will develop. Companies that have established a long-term presence in Russia must adapt to prevailing conditions and to date SRV has managed to make the necessary corrections.

We have strengthened our balance sheet and financial reserves to be ready for the launch of our long-prepared major projects, which will facilitate SRV’s participation in the projects and ensure significantly better earnings than from contracting.

Our return on capital is low and in this respect I still consider our achievements to be modest, even though the delivery-based revenue recognition practice will partly shift our earnings into the future. Operationally, the early part of the year was relatively successful in a difficult operating environment, but efforts to improve profitability and accelerate capital turnover still must continue. It is important, however, that we know how and from where they will continue. In the near-future, we must ensure the launch of our developer-contracted major projects and a high level of operational activity. Our strong order backlog gives us an excellent starting point for this.

Overall review

The Group's order backlog rose to an all-time high, EUR 1,047.0 million (EUR 959.2 million 6/2013), thanks to strong growth in new contractor agreements in Finland. The share of the order backlog that has been sold is 83 per cent, which amounts to EUR 873 million in total. The value of the Group's new agreements increased to EUR 502.0 million (EUR 424.5 million 1-6/2013).

The Group's revenue declined to EUR 281.6 million (EUR 337.8 million 1-6/2013). Revenue from Domestic Operations remained almost on a par with the comparison period. The domestic volume was supported by the growth in both business construction and SRV's housing development projects sold to investors. However, revenue from developer-contracting projects decreased due to the significant contraction in sales of housing projects to consumers. Revenue for International Operations in the comparison period, 1-6/2013, was increased by the sale of 55 per cent stake of the Okhta Mall shopping centre project in June 2013 and the construction volume of the final phase of the Pearl Plaza shopping centre.

Consolidated operating profit decreased to EUR 9.3 million (EUR 14.9 million). The operating profit margin was 3.3 per cent (4.4%). The profitability of Domestic Operations improved significantly as domestic operating profit more than doubled. Consolidated operating profit decreased, as operating profit for the comparison period included capital gains from the sale of the 55 per cent holding in the Okhta Mall shopping centre project in St Petersburg in June 2013. In addition, operating profit for the comparison period was increased by the EUR 8.3 million change in the fair value of SRV's holding in the Okhta Mall shopping centre project.

Several factors contribute to the quarterly variation in the operating profit and operating profit margin: SRV's own projects are recognised as income upon delivery, the part of the order backlog that is continuously recognised as income mainly consists of low-margin contracting, a share equivalent to the ownership of SRV's associated companies is eliminated from the profit margins of construction carried out for these companies, and the project development nature of operations.

The Group's net financial expenses rose to EUR 3.8 million (EUR 0.9 million). Interest expenses for the review period increased due to the fixed-interest bond issued in December 2013. Financial income for the comparison period was increased by interest income from SRV's associated company Etmia II, which during Q2/2013 refinanced its construction funding obtained from SRV with a long-term project loan of about EUR 33 million.

The Group's profit before taxes was EUR 5.6 million (EUR 14.0 million). Earnings in the 1-6/2013 comparison period were improved by the sale of 55 per cent stake of the Okhta Mall shopping centre project in St Petersburg, the fair value change of SRV's holding and financial income from the associated company Etmia II.

The Group's equity ratio was 38.4 per cent (35.2%, on 30 June 2013). Profit performance, together with the decrease in total assets, contributed to the increase in equity ratio.

The revenue of Domestic Operations was EUR 255.3 million (EUR 264.0 million 1-6/2013). Operating profit improved to EUR 13.7 million (EUR 6.1 million), with an operating profit margin of 5.4 per cent (2.3%). The increase in profitability was driven by improved construction margin management, more efficient purchasing and higher development project volumes. On the other hand, the level of operating profit was affected by the fact that the commercial development order backlog recognised as income mainly consisted of low-margin contracting. The domestic order backlog rose to EUR 920.0 million (EUR 771.6 million). In order to improve profitability, the company has shifted the focus of operations to increasing developer contracting, development projects and negotiated contracts.

The total domestic housing sales increased and SRV sold a total of 448 housing units (401 1-6/2013) to consumers and investors. SRV had 1,638 housing units under construction (1,525 on 30 June 2013), of which 171 were developer-contracted. 93 per cent of housing units under construction have been sold, and 90 per cent of production consists of rental and right-of-occupancy units. 60 per cent (63%) of housing units are production developed by SRV.

Revenue from International Operations was EUR 26.6 million (EUR 73.9 million). Operating profit was EUR -0.9 million (EUR 11.5 million). The international order backlog amounted to EUR 126.9 million (EUR 187.6 million). 

Consolidated second-quarter revenue amounted to EUR 143.1 million (EUR 179.4 million) and operating profit to EUR 4.9 million (EUR 13.7 million). The Group’s revenue and operating profit in the comparison period were substantially improved by the sale of the 55 per cent stake of the Okhta Mall shopping centre project in June 2013 and the fair value change of SRV's holding.

Of SRV's major international projects, the Pearl Plaza shopping centre in St Petersburg was opened in August 2013, and the number of visitors has outperformed the target level. 96% of the shopping centre's premises have been leased. At the Okhta Mall shopping centre, that is under construction in St Petersburg, preliminary lease agreements have been signed for 40% of the retail space. For the Promenade shopping centre, in Moscow, an investor solution was accomplished and construction work has started. Co-ownership-based investor negotiations for the REDI shopping centre, SRV's large-scale project in Finland, and car park are underway.

SRV's own project development operations are paving the way for substantially increasing operating volumes in Finland. These projects require long-term development work and are carried out over the course of several years. Many of SRV's projects are so-called landmark projects – innovative new solutions for the needs of sustainable regional construction. Such projects include, for example, the Keilaniemi Towers housing project, the Kalasatama Centre, or REDI, in Helsinki, and a project to develop the area adjacent to the Niittykumpu metro station in Espoo. In St Petersburg and Moscow, SRV focuses on the development of shopping centre projects or developer-contracted shopping centre projects.

Financial targets

On 13 February 2014, SRV's Board of Directors confirmed the Group's strategic goals for 2014–2018. The following strategic targets were set:
• During the strategic period, SRV will focus on improving profitability rather than on growth
• The average annual revenue of International Operations will rise to more than EUR 150 million
• The operating profit margin will reach 6 per cent
• The return on equity will be at least 15 per cent
• The equity ratio will remain above 30 per cent
• A dividend payment equalling 30 per cent of the annual result, taking into account the capital needs of business operations

For the set targets to be achieved, the number of developer-contracted projects must be stepped up substantially.

Outlook for 2014 remains unchanged

The quarterly variation and development of revenue and result in 2014 will be affected by several factors, such as: SRV's own projects are recognised as income upon delivery, the part of the order backlog that is continuously recognised as income mainly consists of low-margin contracting, the development of the order backlog's profit margins, the sales volume of developer-contracted housing and the completion schedules of the properties, the number of new contracts, the start-up of own projects, the project development nature of operations, and the realisation of planned project sales. Investor demand for commercial properties in Finland is estimated to remain muted and the outlook for 2014 does not include the sale of the Derby Business Park property. The construction of the REDI shopping centre that SRV is developing in Kalasatama is expected to start in 2014. Based on current completion schedules, SRV estimates that a total of 186 developer-contracted housing units will be completed during 2014.

SRV estimates that its developer-contracting volume will increase in 2014. The recognition of revenue and earnings in 2014 will be affected by the recognition of income upon delivery and the elimination of a share equivalent to SRV's holding from profit margins. The Group's full-year revenue is expected to be on a par with the previous year (EUR 679.4 million 1-12/2013) and profit before taxes to amount to EUR 10–20 million (EUR 22.8 million 1-12/2013).

Press conference

The interim report will be presented to the media and analysts at a press conference which will take place on 6 August 2014 at 10.30 a.m. at conference room Tapiola at Hotel Scandic Simonkenttä, address Simonkatu 9, Helsinki. The press conference will be held in Finnish. CEO Jukka Hienonen and Executive Vice President, CFO Hannu Linnoinen will be present, among others.

A live webcast of the press conference will be available on the company’s website www.srv.fi/en/investors. The webcast will be in Finnish. The presentation material of the press conference will be published in English and Finnish on www.srv.fi/en/investors after the conference.

Disclosure procedure

SRV Group Plc follows the disclosure procedure enabled by Standard 5.2b published by the Finnish Financial Supervision Authority. This is a summary of SRV’s interim report and the complete report is attached as a pdf-file to this release and is also available on the company website at www.srv.fi/en/investors.

Espoo, 5 August 2014

Board of Directors

All forward-looking statements in this review are based on management's current expectations and beliefs about future events, and actual results may differ materially from the expectations and beliefs such statements contain.

For further information, please contact:

Jukka Hienonen, President and CEO, +358 (201) 455 213
Hannu Linnoinen, Executive Vice President, CFO +358 (201) 455 990, +358 (50) 523 5850
Taneli Hassinen, Vice President, Communications, +358 (201) 455 208, +358 (40) 504 3321