Jacobs Engineering: Building Profits

Apr. 1.09 | About: Jacobs Engineering (JEC)

Jacobs Engineering (NYSE:JEC) is one of the biggest US professional service firms with 2008 revenues of $11.252 billion. It also operates in the U.K. and Ireland. It has posted outstanding results over the past decade with last year’s results showing all-time highs in sales, cash flow, earnings and book value.

Despite the poor economic conditions, consensus estimates for 2009 are centered on $3.60 per share up 7.8% from last year’s EPS. The company had $787.9 million in cash as of year end 2008 against only $40 million in total debt (debt = 2% of total capital).

JEC shares have dropped from an all-time high of $103.30 in early 2008 to just $38.36 right now as investor worry about possible project cancellations that would reduce their backlog. That fear may be already more than reflected in the present very low valuation as these shares now trade at just 11.5x last fiscal year’s and < 10.7x this FY’s expected EPS versus a 10-year median P/E of 19x. Fiscal years end Sep. 30th).

Here are the outstanding per share numbers for the past few years as reported by Value Line:

FY ….......…. Sales …… C/F ……. EPS ……. B/V ….. Avg. P/E
2002 .......….. 41.59 …… 1.32 …… 0.99 ……. 6.30 …… 17.5x
2003 .......….. 41.33 …… 1.46 …… 1.14 ……. 7.54 …… 17.1x
2004 .......….. 40.51 …… 1.44 …… 1.13 ……. 8.86 …… 19.3x
2005 .......….. 48.47 …… 1.71 …… 1.29 ……. 9.81 …… 20.2x
2006 .......….. 62.90 …….2.08 …… 1.64 ……12.06 …
23.4x
2007 …......... 70.49 …….2.85 …… 2.35 ……15.34 …….21.6x
2008 .......….. 91.58 …….3.99 …… 3.34 ……18.27 …….24.1x

You can see how cheap the shares are now offered when you compare back to the historical multiples in the table above. Even a return to a lower than typical 14 multiple would bring JEC back to $50.40 before year end. That would make for a 31% gain in less than 9 months.

Value Line assigns Jacobs an ‘A’ for financial strength and notes its stock’s ‘price growth persistence’ and ‘earnings predictability’ come in at the 95th and 85th percentiles respectively (with 100th being best).

Here’s a nice, somewhat conservative longer-term play on a recovery in Jacob’s from now until early 2011:

……………………………............…….….Cash Outlay ….......… Cash Inflow
Buy 1000 JEC @ $38.36 …….........…….. $38,360
Sell 10 Jan 2011 $50 calls @$9.50 ………….................……….. $9,500
Sell 10 Jan 2011 $50 puts @$19.60 ………….......……………... $19,600
Net Cash Out-of-Pocket …..........………… $9,260

On expiration date in January 2011:

If JEC shares are $50 or higher (plus $11.36 or + 30.3% from today), you will have no further option obligations.

  • Your $50 calls will be exercised.
  • You will sell your shares for $50,000.
  • Your $50 puts will expire worthless (a good thing for you as a seller).
  • You will hold $50,000 cash for your original outlay of $9,260.

That’s a best case scenario return of 439% cash-on-cash on a stock that only needed to rise by 31% from inception of the trade.

What’s the risk?

If JEC stays under $50:

  • Your $50 calls will expire worthless.
  • Your $50 puts will be exercised.
  • You will be forced to buy an additional 1000 shares of JEC and put up another $50,000 in cash.
  • You will end up owning 2000 shares of JEC.

What’s the break-even on this whole trade?

On the original shares it’s their purchase price of $38.36 less the $9.50 per share call premium = $28.86 /share.

On the second 1000 shares it’s the $50 strike price less the $19.60 per share put premium = $30.40 /share.

Your break-even point is the average of $28.86 + $30.40 = $29.63 /share.

That’s $8.73 or 22.7% below your starting price of $38.36.

At $29.63 the forward P/E of JEC would be < 8.3x this year’s projected earnings.

You will make money on this trade if the shares:

  • Go Up.
  • Stay unchanged.
  • Go down less than 22.7% by January 2011.

Disclosure: Author is long JEC shares and short JEC options.