|Shares Out. (in M):||151||P/E||9.25||8|
|Market Cap (in $M):||4,200||P/FCF||0||0|
|Net Debt (in $M):||4,245||EBIT||0||0|
ACM, a poorly understood architecture, engineering & design (AE&D) company with stable and counter-cyclical free cash flows, lower risk cost-plus contracts with minimal balance sheet risk versus E&C comps, and one of the lowest exposures to oil&gas, is currently trading at an attractive 7x normalized cash earnings. After completing essentially a leveraged recap of URS (a high FCF business) at an attractive price (<7x EBITDA and 10x FCF), there is a reasonably clear path to $4.00/share of normalized cash earnings after cost synergies and interest cost savings. At 10-12x multiple, ACM could be worth $40-50/share in 2-3 years, and any upside from a recovery in infrastructure spending, we get for free. With the stock trading at a high-teens FCF yield, we also have good downside support in the mid-20s area.
For background, gi03’s ACM and URS write-ups and msbab317’s URS write-up do an excellent job highlighting the “prodigious” FCFs of these AE&D businesses.
Please refer to the December Analyst Day presentation available at this link for business mix of new ACM (including URS).
Approximately 45% is Design and Consulting Services which is effectively tied to public sector budgets. Around 35% is Construction Services which is tied to non-residential construction. The remaining 20% is Federal Management Services, which is undergoing a mix shift to higher-value higher-margin businesses (lower sales higher margins).
A rough regional mix is follows: Canada 15%, US 65%, Asia 10%, EMEA 10%. ACM has around 20% FX exposure to non-USD denominated currencies (primarily CAD, EUR, and AUD).
The global infrastructure market is large around $55-60 trillion with $4.0-5.0 trillion annual spend and ACM has low single digit market share. While ACM’s brand name and project work on some of the most prestigious iconic projects, such as the new World Trade Center and London/Rio Olympics is a differentiator, the AE&D business is ultimately a commodity business with fierce regional competition and mid-single digit EBITDA margins.
Lower-risk and more predictable engineering & design business model
ACM has effectively no fixed price construction exposure which differentiates ACM’s business model versus other E&C companies. Page 16 of the Investor Day presentation (link provided above) provides a pie-chart at bottom-right which highlights this point. While fixed price construction is only 3% of backlog, even that overstates the exposure because ACM’s subcontractors must be insured which effectively covers ACM against any loss.
ACM’s business, which generates FCF on a more predictable basis, through downturns, enabled the company to lever up to 4.4x at attractive interest rates (blended interest rate of around 4.3%) to buy URS.
Low oil and gas exposure
Since September, ACM shares are down 30% which is more than the S&P1500 construction index which is down 16%, essentially giving back the 30 percentage points of outperformance in the first half of 2014, even though ACM has one of the lowest exposures to oil&gas amongst its peer group.
ACM has around 15% oil & gas exposure with a third (5 percentage points) tied to upstream capex which is most at risk from low oil prices. Another third is tied to maintenance/opex related work which is somewhat exposed. And the remaining tied to environment feasibility studies. There are offsets to this exposure with declining oil prices creating new opportunities in plant retirements and decommissioning work.
Leveraged recap of URS
ACM acquired URS at less than 7x EBITDA and 10x FCF. Before the deal, URS was projected to generate $10+ per share of FCF in 2014 and $5-7+/share in outer years suggesting that the final offer price of $53 at closing was something of a bargain. ACM management exhibited discipline during the bid process and the price offered was ultimately only modestly superior to other competing offers (including private equity). Prior to the deal, several analysts covering URS believed the stock could be worth $60-90 versus the final price of $53. ACM appears to have gotten a good deal because URS was a motivated seller (value creation committee, activist holders), certain near-term issues (uncertainty due to ramp down of URS’ projects) masked the underlying health of URS’s business, and other logical buyers (FLR, JEC, CBI) were busy digesting other deals.
Cost synergies from the deal are expected to be huge, $275M gross (>$1.00 per share), from relatively low risk low hanging fruit initiatives (e.g., consolidating real estate).
While hard to project EPS/FCF with any degree of precision with 10,000-20,000 contracts, we can triangulate on a normalized earnings power based on the announced cost synergies and de-leverage. And get some comfort on downside protection with the stock trading at a high-teens FCF yield and pending growth from backlog growing 20+%.
EARNINGS PER SHARE VALUATION
FY2015 EPS of $2.75-3.00: Management’s FY2015 EPS guidance is $2.75-3.35/share. ACM’s fiscal year ends September and as we are almost halfway through FY2015 and because this guidance already incorporates two haircuts to operations due to FX, sluggish NA infrastructure design work, and oil prices, its reasonably safe to assume that guidance has been mostly de-risked, particularly at the low- to mid-end. To get to the high end, ACM would need some pull forward of E&C awards or realization of cost synergies – which we don’t assume in this base case EPS ladder.
Cost Synergies of $275M gross and estimated $220M net synergies: FY2015 already includes around $88M net synergies. Incremental cost synergies of $132M net or around $0.60/share (using a 32% tax rate). The sources of cost synergies are overhead costs, eliminating redundancies in real-estate, and labor. These appear to be within management’s circle of competence. ACM management knows the URS business well, did a bottom-up analysis during the due diligence phase, and management has good experience in wringing out similar synergies and driving margins in the legacy ACM business.
Deleverage: By paying down $2B of debt by FY2017, ACM will save $0.40/share in interest expense.
Total EPS of $3.75-4.00/share in two-three years appears reasonable, which at 10-12x multiple translates into a $40-50 stock.
While I don’t incorporate any upside from growth of the underlying business, backlog has been growing 20+%. And any revenue synergies and recovery in spending to upgrade North America’s aging infrastructure could drive upside to these estimates. Before the downturn, ACM grew 7-10% organically for over a decade.
STABLE FCF AND ATTRACTIVE FCF YIELD
ACM has a stable FCF profile that’s sometimes ignored by the street with FCF materially higher than GAAP earnings due to amortization of intangibles and capex running below depreciation ($170M capex vs. $210M depreciation). The capex to depreciation delta adds about $0.25/share to FCF.
ACM’s FCF is counter-cyclical - when sales decline working capital becomes a source of cash supporting FCF. ACM has $1.7B of working capital ($11+/share). DSOs in December were 92 days versus a more normalized 80-85 days. Normalization of DSOs could free up $2.20-3.80/share of FCF (assuming 12 days reduction at $28-48M per DSO day). December quarter FCF was $1.68/share versus cash earnings of $0.71/share. Working capital contributed $1.00/share to FCF. Release of working capital alone could add $1.00/share to FCF per year.
Including working capital release, it is not inconceivable for FCF to run at around $4.00-5.00/share over the next three years.
Management seems to agree, projecting $600-800M of FCF per year (or $4.00-5.30/share per year) over the next three years.
While 83% of roughly $5B debt is due after 2019 and blended interest rate is an attractive 4.3%, management plans to aggressively pay down $2B of debt with FCF over the next three years, de-levering to 2.0x from 4.4x. The company has already begun de-levering with debt at end of December down $320M to $4.98B from $5.3B at the time of closing of the URS transaction.
CFO comments from the last earnings call on 2/10/15: “The implication in our guidance to get down to approaching 2 times is roughly $2 billion in debt pay down over that three-year period, which would imply somewhere between $600 million and $800 million in cash flow a year, and our expectation is that we will do that. The reason we put a range on it is that cash, unlike accrual accounting -- if a payment comes in, and one period or one day versus another day, it could flow between quarters and between years.”
Trading at <10x FY2015 cash earnings and trading at a high-teens FCF yield provides good downside protection in the mid-20s area. At a 10% FCF yield, ACM could be worth $40-50. As management pays down $2B of debt over the next 2.5 years de-levering to 2.0x from 4.4x the stock should begin to screen more attractively potentially leading to a re-rating.
Management has a superior track record of capital allocation and management’s compensation has been modified, after feedback from shareholders and ISS recommendation, to align with shareholders with a focus on per-share metrics. Management purchased 20% of shares in 2012/2013 with the shares trading in the 6-11x PE range.
That said, there could be some concerns with management: With the URS deal announced last July, ACM gained exposure to oil&gas at perhaps the worst possible time - near peak oil prices. Also from a corporate governance perspective, having the same person holding both the Chairman and CEO titles can be somewhat concerning.
Oil prices: While the direct impact of lower oil prices can be quantified and ring-fenced (15% of business), the 2nd order impact of lower oil prices on infrastructure spend of oil-dependent economies such as Canada and Saudi Arabia is somewhat harder to quantify.
Contract loss (e.g., Sellafield) is an ongoing risk given the relatively low visibility on the status of individual contracts.
Consistent high FCF generation
Realization of cost synergies leading to margin improvement
Ongoing debt payments
|Entry||02/16/2015 07:40 PM|
Those are very fair points and I'll try to address them to the best I can..
The CFO is relatively new, promoted in 2011. After management lost an ISS say-on-pay vote in 2011 (briefly mentioned in the writeup) at least their actions have been more shareholder friendly with a greater focus on per-share metrics (EPS, FCF per share). Note that mangament repurchased 20% of shares in 2012/2013. So at least the CFO's actions appear to be more shareholder friendly than the average E&C company.
I cannot speak for the CEO. And based on the URS proxy they seemed relatively disciplined through the URS acquisition.
That said, I wouldn't pound the table on management or call them "good". Just that their recent actions suggest a more shareholder friendly orientation than the average E&C company, which may not be saying a lot.
Were you referring to Hunt Contruction as the other "significant" deal? My understanding is that was not a huge deal from a profit perspective, notwithstanding the large dollar revenue number. And the integration is not a siginificant undertaking.
Here is the press release (even the purchase price wasn't disclosed).
Your comment on synergies is also valid: In management's defense, they have been wringing costs out of the ACM business even before the URS acquisition. At least the things they have been talking about as "cost synergies" such as real estate savings seem very reasonable and similar to projects they have been doing even before the deal. That said, it will be hard to grade management on synergies, except in so far as it drives margins.
Regarding future acquisitions, the high leverage and management's stated first and highest use of the significant FCF this business will generate to pay down debt, should keep them honest, hopefully.
|Subject||Re: Re: Re: mgmt|
|Entry||02/17/2015 08:38 PM|
Broadly speaking, the infrastructure market is a large fragmented multi-trillion market.
There are no dominant players. The major US public E&C companies in order of size are Fluor, ACM (+URS), Jacobs, CB&I, AMEC/FosterWheeler, KBR, and Babcock&Wilcox. Major Canadian E&C companies are Stantec, Aecon, Stuart Olson, WSP GLobal
These are not perfect comps with differing end-market exposures and skill sets that don't perfectly overlap. Examples of end markets are Facilities (sports stadiums, hotels - some examples below), infrastructure, oil&gas, power, mining, and industrial.
The types of work very broadly speaking can be divided into design work (AE&D) and build work (construction mangaement).
ACM is the largest design company in the world. URS is more of a hybrid with more construction management as well as industrial/energy exposure.
ACM's global scale and reputation of having worked on many iconic projects gives them some advantage in bidding for new design projects. Some of ACM's projects are: Master planning for London/Rio Olympics; World Cup in Qatar; general contractor for World Trade Center; architect for Brooklyn’s Barclays Center and CenturyLink;
There are some barriers to entry in the government business (20% of ACM) from relationships, security clearance etc. For larger multi-year government projects, the larger companies (like ACM/URS/Foster Wheeler) can form consortiums which are probably not available to smaller companies.
That said there's no denying is this is still a commoditized business with mid single margins.
This is a hard question to answer because conditions are always changing, so it is difficult to say that synergies havent led to margin expansion because to be honest, larger E&C M&A transactions seem to have occured closer to the peak of cycles so margins have come down because of market conditions rather than not harvesting synergies. Recent examples of where at least cost synergies have been harvested are CBI/SHAW and JEC/SKM but again even in these recent acquisitions market conditions have deteriorated so its difficult to see end results.
As far as ACM's history, ACM has done a lot of acquisitions but none on the scale of URS to actually see synergy evolution. URS did many big acquisitions - Wash Group, Scott Wilson, Flint but again in every situation, markets fell off shortly after closing.
This is consistent with Nails4's comment/concern about M&A leading to value destruction although the broader takeaway is that E&C is no different than most other sectors in that M&A happens close to a peak.
So whats different about ACM/URS? I think the major difference for what its worth is that while I would not dismiss the same peak M&A argument in some of URS end markets, the combination was driven in part by
1) Activist involvement - which is different than other E&C M&A. URS was shopped around for almost a year (speaking from memory here) and was a motivated seller and other natural buyers (CBI. FLR, JEC) were busy integrating other acquisitions.
2) More than half of ACM/URS end markets were already weak at the time of the annoucement (infrastructure/government in particular).
Regarding pricing: Pricing has generally been relatively stable for ACM/URS. Recall that its hardest to manage pricing/margins if you have fixed price construction projects. Cost-plus projects and fixed price design work have much less pricing/margin risk.
The flip side is cost-plus contracts tend to have lower margins than fixed price contracts if the contractor can manage the project well (rarely happens). ACM's de-minimus exposure to fixed price construction contracts is a positive in my view.
Synergies specific to ACM/URS: Speaking from memory here, but I think URS had over 300 offices in the US alone to service its US infrastructure business while ACM has something south of 100. The overlap between the two in infrastructure is significant and URS just had too many local offices.
Sorry for the long-winded answer. Hope it helps
|Entry||09/01/2015 07:52 PM|
Macquarie (in their JunQ note) makes reference to a "lack of accounting transparency" with respect to purchase price accounting adjustments and other adjustments. This sounds very similar to the stuff that had been going on at CBI last year. Do you have any insight on this issue? How do you gain comfort around it?