Jacobs Engineering: Fundamental Analysis Suggests Strong Infrastructure Play

By Ryan Johnson and Rob Weigand

David Fessler wrote a compelling recommendation in favor of Jacobs Engineering (JEC) on June 26, summarizing the many compelling macroeconomic themes that favor this stock right now:

• The need for higher capacity transmission lines to move power from the midwest to the densely populated coasts.
• Larger pipelines to move natural gas from Alaska and Canada to the lower 48 states.
• Storage facilities for both oil and natural gas.
• Liquid natural gas terminals in the U.S. and other countries.

Additionally, Fessler notes:

Jacobs has over 100 years of experience in the gasification and carbon-capture technologies, electrical transmission systems, and power and switching plants . . . [and] is active in the development of renewable energy projects, including wind farms, tidal power, hydro-power, tidal stream and waste energy plants.

Some commenters on Fessler’s article asked for a complementary financial analysis of the stock — we provide a brief analysis below. As is the case with all the stocks we run through our process, we analyzed JEC’s financials for the past 5 years and forecasted their financials for the next 10 based on the following assumptions:

• Average growth in revenues for the next 5 years of 20%, tapering to 6% by year 10, growing at 4% per year thereafter.
• Ratios held stable at their historical averages in the forecast include COGS/Sales at 85.8%, SG&A/Sales at 9.7%, an effective tax rate of 36.0%, Cash/Sales of 5.5%, and PPE/Sales of 2.6% (pay particular attention to this last ratio in the analysis below).
• JEC does not pay a dividend and we did not forecast a dividend initiation.
• Beta of 1.5, cost of equity of 13.5%, and because they carry almost no debt, a weighted average cost of capital (WACC) of 13.4%.

Jacob’s 5-year historical compound revenue growth is 25.3%. Normally, with the global recession, we’d be concerned about a huge dropoff in revenues in 2009. With the resurgence of government spending and the compelling need for world spending on infrastructure, however, we’re confident that JEC will only grow slightly more slowly in the next 5 years (average of 20% per year).

JEC’s margins are low, but consistent with the rest of their industry, including McDermott (MDR), Quanta (PWR) and Fluor (FLR):

Although our forecast assumptions result in stable margins over the next 10 years, note that if JEC increases the mix of government-funded contracts in its portfolio, these will tend to have a positive effect on their margins (as governments wastefully pay higher prices than private-sector firms).

Jacbos’ ROA and ROE are not particularly high, but unlike many firms, their historical and forecasted ROIC is much higher — close to 20% historically and a little higher in our forecasts — due to their efficient balance sheet management (driven primarily by the low PPE/Sales ratio cited above).

The key point here is, even using a very high WACC hurdle for this firm (13.4%), their ROIC is well above the WACC, which is one of the principle drivers of long-term value creation. Add in the fact that JEC is likely to grow at 20% per year into that robust ROIC – WACC spread, and the stock is well below its high of $86 from last year (recently trading at $41), and the story on JEC begins to get interesting.

Jacobs has had good growth in Net Operating Profit After Tax (NOPAT) and Free Cash Flow (FCF) historically. After forecasting a slight decline in 2009, we predict that growth in these items is likely to resume over the forecast horizon.

The consistent growth in NOPAT and FCF means Jacob produces positive EVA (Economic Value Added) and MVA (Market Value Added). All JEC has to do to continue growing these value-creation metrics is grow revenues 5% slower over the next 5 years, taper down to 4-6% in 10 years, and maintain its other ratios at their historical averages.

Jacobs had an abrupt rise in its short interest in Summer-07, but short interest subsided in 2008-2009.

JEC’s Days to Cover ratio has been more stable because the increase in short interest was accompanied by a general increase in trading volume as JEC began attracting the attention of traders in 2007.

Insider selling in JEC is modest (most firms have cumulative insider selling over time as insiders diversify their holdings):

JEC scores a solid 10 out of 11 on the extended Piotroski Financial Fitness Evaluation Scorecard:

And their Altman Bankruptcy Z-Score of 5.2 is triple-A compared to most firms these days.

Using the forecast assumptions outlined above, we obtain a discounted cash flow price on Jacobs of $50 a share, vs. its current price of $41. Overall, we think Dave Fessler has it right and Jacobs Engineering merits a strong buy recommendation, based on the macroeconomic themes outlined in his blog posting and the fundamental analysis provided above. We’d love to hear what you think about this and other infrastructure plays.

Comments

[Gravity404]

Thanks for the info. I am a big big fan of JEC especially at these levels. This information just confirms my thoughts.

There are several other names (EPC cos) I think are strong long term opps in this area, I own some and are watching some. I think they are all great value plays for <+3 years.

ABB - even though they are very big, they are number one in electrical transmission and a leader in smart grid technology. Very small share in the US, which is a renewed focus.

KBR - too much cash on hand for the price levels. This is a no brainer especially when cash is king, like now.

FWLT - a smaller version of JEC, nimble, great free cash flow along with a solid backlog.

FLR- lots of cash. I've been waiting for a chance to jump in on this one.

2009 Jun 30 09:37 AM

[Ferdinand E. Banks]

Larger pipelines from Canada and Alaska to the lower '48. Hmm.

If I remember correctly Governor Palin suggested the same thing, and some representative of Big Gas called her suggestion 'politically wise but economically stupid'. I certainly am no supporter of Ms Palin, but she might have been correct. Might! The issue of course is how much gas would actually reach the US, and not be siphoned off (in laterals) to be shipped (in LNG form) to Asia. I also think that I mentioned in my energy economics textbooks that nobody in Canada or Alaska is likely to ship any gas toward the US as long as its price is where it is now.

2009 Jun 30 11:16 AM

[Robert A. Weigand]

All good points. At the time we originally recommended the stock the long-term price forecasts for oil and gas were bullish across the board. These have moderated a little recently, but our thesis is that peak oil is real, which will necessitate larger moves into nat gas sooner than the market is currently forecasting. On this, we won't know for sure for 3-5 years, but that's our thesis right now. Thanks for commenting.


On Jun 30 11:16 AM Ferdinand E. Banks wrote:

> Larger pipelines from Canada and Alaska to the lower '48. Hmm.<br/>
>
> If I remember correctly Governor Palin suggested the same thing,
> and some representative of Big Gas called her suggestion 'politically
> wise but economically stupid'. I certainly am no supporter of Ms
> Palin, but she might have been correct. Might! The issue of course
> is how much gas would actually reach the US, and not be siphoned
> off (in laterals) to be shipped (in LNG form) to Asia. I also think
> that I mentioned in my energy economics textbooks that nobody in
> Canada or Alaska is likely to ship any gas toward the US as long
> as its price is where it is now.

2009 Jun 30 04:06 PM