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The Blueprint
SECTOR REVIEW
The New E&C Reality
■
The New Reality. The outlook for the E&C Group for 2009 is uncertain
reflecting global recession fears, falling crude prices, all of which has been
exacerbated by a global credit crisis. With the stocks off 60% year to date
and forward multiples cut in half, the market has already priced in most of
the bad news. In this piece, we attempt to lay out what the stocks are pricing
in at today’s levels and where spending is most at risk. Furthermore, we
attempt to address major differences in the industry versus previous cycles.
■
What’s The Market Pricing In? Enterprise Value-to-Backlog is averaging
0.2x, which represents a ten-year low. This compares to 0.7x last year and
the historical average of 0.4x. This suggests the mkt is already pricing in
significant cancellations. Interestingly enough, the mkt is not differentiating
among higher quality E&C names like JEC & FLR.
■
Energy: Are We On Hold Or Is The Cycle Really Over? While the S/T is
less certain, we continue to believe the L/T fundamentals for Energy remain
positive, which is supported by the CS Energy team. Furthermore, falling
material/labor costs could ultimately improve the overall economics of future
projects. If so, investors with a longer term horizon (2-3 years) can stand to
make sizable returns. For investors that believe that this recession is similar
to the early 80’s, run for the hills!
■
The Outlook For Power A Bit Dimmer. We remain concerned utilities will
cut capex reflecting recession fears along with difficulty raising capital. We
believe capex cuts will be most dramatic on new generation along with
maintenance. In our opinion, spending on Transmission remains favorable
L/T helped by Obama’s focus on Renewables.
■
Infrastructure: Could The Stimulus Bill Save Us? Usually, investors
should avoid infrastructure plays in a recession as this spending is hurt by
cuts in state/local budgets and the inability to finance projects. However,
experts indicate spending on infrastructure could range anywhere from $30-
$90 billion if the stimulus bill is passed.
■
Top Picks For 2009. We believe investors are best suited to stick with the
more diversified, higher quality Engineering and Construction names like
Fluor and Jacobs. We also believe that with Obama as President,
Infrastructure and Renewables (impacting transmission spend) will be a
major theme over the next 12-18 months. URS and PWR stand most to
benefit among our coverage universe.
New Reality
The outlook for the Engineering & Construction Group for 2009 is clearly uncertain
reflecting global recession fears, the falling price of crude, all of which has been
exacerbated by a global credit crisis. The reality is financing of future projects will not only
be more difficult, but more expensive. Furthermore, even companies with cash rich
balance sheets may look to hoard cash and slow the pace of capital expenditures.
Even so, the market has priced most of this in with the group off 60% year to date.
Forward multiples have been cut in half (now trading in line with 2002 forward P/E
multiples) suggesting this is the peak of the cycle. In our mind, this is unclear. We admit
the best is behind us and the easy money has been made. Unlike the past several years,
the market is less forgiving today. Stocks soared on backlog growth and the rising price of
crude driving multiples to unprecedented highs. Execution didn’t matter as current backlog
was viewed as more profitable, which ultimately led investors to believe double-digit EPS
growth was sustainable for the foreseeable future. The new reality is given global
recession fears and financing challenges, the pace of new awards will likely slow after
several years of robust spending.
While the short term is less certain, we continue to believe the long term fundamentals for
Energy remain positive supported by the CS Energy team. Furthermore, falling material
and labor costs could ultimately improve overall economics of future projects. If so,
investors with a longer term horizon (2-3 years) can stand to make sizable returns.
However, for investors that believe that this recession is similar to the early 80’s, run for
the hills!
Until there is greater clarity on the global economy and the price of crude, the next 12
months will likely be challenging for the group. We believe investors are best suited to
stick with the more diversified, higher names like Fluor and Jacobs. We also believe that
with Obama as President, Infrastructure and Renewables (impacting transmission spend)
will be a major theme over the next 12-18 months. URS and PWR stand most to benefit
among our coverage universe. If we are right, both companies will likely experience
backlog and earnings growth despite the challenging macro environment.
In this piece, we attempt to lay out what the stocks are pricing in at today’s levels and
where spending is most at risk. Furthermore, we attempt to address major differences in
the industry versus previous cycles.
Backlog Growth On Pause
Exhibit 1 highlights the group’s backlog since 1999. Since 2004, backlog has grown on
average 60% a year reflecting the strength in the hydrocarbon market and the global
economy, in particular, the developing world. Backlog growth and the rising price of crude
drove stocks and multiples to unprecedented highs. The outlook today appears less
certain with a global recession pending. While the short term is less certain, we continue to
believe the long term fundamentals for energy remain positive. Furthermore, falling labor
and material costs could ultimately improve overall economics of future projects. However,
given global recession fears and the financing challenges, the pace of new awards will
likely slow after several years of robust spending.
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