For my explanation on pair trading, please see here.
Heavy Construction Industry
Heavy Construction stocks have taken a beating this year as global spending shrinks and the credit markets have tightened up, limiting the amount of capital available for extensive projects. However, there may be some better news coming as an economic stimulus package is expected to increase the activity in the industry and return spending to a normalcy, after many of the companies are now trading at record low valuation levels and credit markets are beginning to thaw out. Although growth prospects will be subdued for the near term there is still robust opportunities over the longer term, and the companies with large net cash positions and efficient operations are expected to outperform industry peers.
Long: Foster Wheeler (FWLT), $16.24: Foster Wheeler shares are down 79.05% year to date, and much of the weakness is attributed to its ties with engineering projects in the oil industry, which has recently collapsed with falling crude prices. However, at current valuation shares are too cheap to ignore, and FWLT shares trade cheaper than industry averages on almost every metric, while also outperforming in efficiency and liquidity ratios.
Shares are trading at a forward p/e of 4.2 (compared to industry average of 7.65) and at a meager 1.66x cash. Shares recently bounced off of 2005 highs at $15.50 that will now serve as support. FWLT is one of the best positioned companies in the industry with its high net cash position, low risk profile, and growing business in the global power segment.
Short: Granite Construction (GVA), $29.87: Granite Construction shares are only off 16.5% year to date, despite the average security in the industry falling more than 60%. Much of this can be attributed to the recurring revenue stream from private contracts, because GVA receives government contracts for construction projects, and is less reliant of corporate and consumer spending.
However, shares are now at a valuation disconnect with the rest of the group and GVA remains one of the highest shorted stocks in the group. Its operating margins and ROA are weaker than FWLT’s, and shares trade 3x as high on a forward earnings basis. GVA’s EV/EBITDA at 3.63 far exceeds FWLT’s EV?EBITDA of 1.976. Shares recently broke support at $30.
FWLT: Long 1 May ’09 Vertical Call Spread $20/$30 for net debit of $2.20
GVA: Short 1 March ’09 Vertical Call Spread $25/$30 for net credit of $2.65
Disclosure: no positions