Stock Investing

Leading engineering and construction firms stand to benefit from governments' commitment to fixing infrastructure assets.
By Vikram Barhat | 22/08/18

The technology sector remains hobbled by a slew of speed bumps ranging from slowing growth to stretched valuations, and from trade-war uncertainly to market saturation. By contrast, the relatively unglamorous and far less headline-hogging infrastructure sector appears ready for a rebound on the back of positive data, including the World Bank forecast that global infrastructure needs US$94 trillion worth of investment by 2040 to keep pace with economic and demographic changes.

About the Author
Vikram Barhat is a Toronto-based financial writer specializing in investing, personal finance and small business. His experience working in various editorial capacities in digital and print media spans more than a decade across three continents. He has written for CNBC, BBC, The Globe and Mail, the Toronto Star and other publications. He can be reached on Twitter @vikrambarhath.

Governments both in Canada and the United States recognize that the creaky infrastructure on both sides of the border is in dire need of overhauling. The large-scale upgrades will require massive spending. In fact, the Trump administration plans to invest a whopping US$1.5 trillion on infrastructure initiatives.

North of the border, the Canadian Government has floated its own $180-billion infrastructure spending program. Leading engineering and construction companies in both countries are well positioned to benefit from their respective governments' commitment to fixing roads, railway and highway systems, ports, bridges and other infrastructure assets.

In addition to lucrative projects that will likely provide a significant revenue bump, these companies also benefit from organic growth, tax cuts and a laxer regulatory environment. These are some very compelling reasons why investors should start paying attention to infrastructure stocks.

SNC-Lavalin Group Inc.
Ticker:SNC
Current yield:2.11%
Forward P/E:14.6
Price:$53.57
Fair value:$61
Value:12.2% discount
Data as of Aug. 20, 2018

With offices in over 50 countries, the Montreal-based  SNC-Lavalin (SNC) provides engineering, procurement, construction and commissioning services, plus sustaining capital services in four industry sectors: oil and gas, mining and metallurgy, infrastructure and power.

It is among the handful of global engineering and construction firms that specialize in larger and more complex construction and development projects. SNC has earned a favourable long-term track record in successfully completing major engineering and construction (E&C) projects. The global company sets itself apart by way of "possessing full-service project capabilities that allow it to bid alone if necessary for large contracts in which a broad array of skills is necessary -- for example, a remote mining development that also requires roads, power transmission and port construction," says a Morningstar report.

The other major differentiator is SNC's robust capital investments segment, in which the company participates in public-private partnerships to create infrastructure assets. "In these arrangements, SNC invests as part of a group, typically including a public agency specifically created to design and build a toll road, railway or health care facility," says Morningstar sector director Keith Schoonmaker, who pegs the stock's fair value at $61, reflecting improved prospects for profitability, acquisition benefits, strong performance with infrastructure investments and recent bidding success.

In most cases, SNC typically captures both the engineering, procurement and construction award, as well as long-term operations and maintenance contracts, adds Schoonmaker, who projects revenue to grow about 7% annualized from 2018 through 2022.

On the other hand, the company is aggressively repositioning to better compete in a "lower for longer" commodity price environment while pushing to broaden its base of recurring revenue, strengthen its core infrastructure offering and improve profitability.

AECOM
Ticker:ACM
Current yield:-
Forward P/E:11.0
Price:US$33.01
Fair value:US$37
Value:10.8% discount
Data as of Aug. 20, 2018

One of the largest global providers of E&C and management services,  AECOM (ACM) offers a broad range of technical project and program services with a primary focus on infrastructure work and project services for government entities.

The company operates a fully integrated service model with in-house capabilities to design, build, finance and operate a wide array of projects including skyscrapers, major sports and entertainment venues, high-speed rail and the operation and management of defense systems and equipment.

Aecom offers a multitude of infrastructure-related services to commercial and government agencies both in the U.S. and around the world. It conducts operations in three segments: Design and consulting services (42% of 2017 revenue), construction services (40%) and management services (18%).

Mergers and acquisitions have fuelled much of the company's historical growth. "Under CEO Michael Burke, Aecom has continued a growth-by-acquisition strategy to develop a fully integrated services capability," says Schoonmaker, noting that the acquisition of San Francisco-based URS in 2014, its largest deal ever, "doubled the company's revenue and significantly strengthened its engineering and management services offering."

Schoonmaker assesses the stock's worth to be US$37 and forecasts continued improvement in operating margins, better cash flow performance and a moderate rebound in infrastructure project demand.

Aecom's third-quarter earnings report showed 10% organic growth, a record US$9.4 billion in wins, and a 15% increase in adjusted EBITDA, key metrics that support evidence of consistent progress, says a Morningstar report. Prompted by these results, management reiterated full-year adjusted EPS guidance of US$2.50 to US$2.90, adjusted EBITDA guidance of US$880 million, and free cash flow at the low end of the US$600 million to US$800 million range. The company also plans to shed noncore businesses in oil and gas. "These targets are reasonable considering lower income tax rates and continued organic growth," says Schoonmaker.

Fluor Corp.
Ticker:FLR
Current yield:1.48%
Forward P/E:25.5
Price:US$56.90
Fair value:US$52
Value:9.4% premium
Data as of Aug. 20, 2018

 Fluor (FLR) is a global provider of engineering, procurement, fabrication, construction and maintenance services to a wide range of customers, including oil and gas, manufacturing, mining companies and the U.S. government.

"Fluor is one of a handful of global E&C firms that specialize in larger and more-complex construction and development projects for major industrials, miners, utilities and government entities," says a Morningstar report, stressing that the company "targets multibillion-dollar projects where competition is inherently more limited."

The industrial behemoth's competitive strengths include its lengthy track record, vertical integration, diversified project mix, sophisticated support services and financial strength. This means the firm "performs services from pre-construction feasibility studies and front-end engineering and design work to detailed engineering, procurement, construction and project management, as well as post-construction commissioning, operations and maintenance," says Schoonmaker, who recently nudged the stock's fair value from US$51 to US$52, due to the mechanical time value of money, bullish macro developments such as U.S. federal tax and regulatory reform, and the rise in crude prices.

Fluor's project portfolio, which is diversified across geography and industry, includes a US$31 billion backlog comprising the single-largest global petrochemical complex (in Saudi Arabia) and the largest single support services contract for the U.S. military (in Afghanistan). Such high-visibility projects, says Schoonmaker, tend to "attract motivated project managers and a preferred group of technology providers, subcontractors and suppliers with whom to collaborate."

Further, as rising commodity and energy prices and U.S. tax and regulatory reforms drive cyclical recovery in project demand, Schoonmaker anticipates "Fluor to exploit opportunities across the energy chain, petrochemicals, LNG and other healthy niches to recharge growth and profitability."

Jacobs Engineering Group Inc.
Ticker:JEC
Current yield:0.83%
Forward P/E:13.8
Price:US$71.99
Fair value:US$63
Value:14.3% premium
Data as of Aug. 20, 2018

 Jacobs Engineering (JEC) is one of the largest and most diverse global engineering and construction firms, with 200 offices in 25 countries and annual revenue of about US$10 billion. It provides front-end engineering and design, engineering, procurement and construction, project management, fabrication, as well as logistics, operations and maintenance services to industrial, commercial and government clients.

The company's wide range of in-house services appeal to customers seeking end-to-end solutions to their capital project requirements, says a Morningstar equity report. Aside from its core E&C activities, Jacobs performs less traditional services such as economic and market studies, architectural design, office design, project finance advisory, IT network design and security, and wireless communication systems development.

The firm uses M&A as a core strategy to broaden its capabilities and geographic presence as well as expand internal development and strategic alliances.

The company's strong third-quarter results indicate accelerating signs of stability and growth, prompting Schoonmaker to raise the stock's fair value from US$60 to US$63 and increase 2018 and 2019 forecasts for revenue growth and profitability. "The recent uptick in fortunes for Jacobs contrasts positively with a challenging period over the past few years," he says. "Third-quarter results represented laudable top-line growth stemming from improving total project demand."

Jacobs' order backlog increased to US$27.2 billion, up 8% from a year ago, the bulk of which constitutes higher-margin businesses. "The future backlog will benefit principally from demand across aerospace, technology and buildings and infrastructure," projects Schoonmaker, who further notes that the company will benefit from "lower tax rates, repatriation incentives and regulatory reforms which will provide incentive for greater capital outlays on customer project work."

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