Emcor Group: Strategic Acquisition Has Potential To Send Shares To Fresh All-Time Highs

Jun.20.13 | About: EMCOR Group, (EME)

Shares of Emcor Group (NYSE:EME) are trading with solid gains after the electrical and mechanical construction company expanded its presence in the refinery and petrochemical sector. On Monday after the close, Emcor announced the acquisition of RepconStrickland, to great enthusiasm from its shareholders. The strategic deal will already be accretive to this year's earnings per share, and has the potential to send shares to fresh all-time highs in the coming weeks.

The Deal

Emcor Group announced that it has reached a definitive agreement to acquire RepconStrickland. Emcor will pay roughly $455 million in cash for the privately-held company, which is a leading provider of recurring turnaround and specialty services to the North American refinery and petrochemicals markets. RepconStrickland was previously in the hands of private equity firm ArcLight Capital Partners LLC. RepconStrickland focuses on a range of turnaround and specialty services. This includes shutdowns, overhauls, revamps, engineering, welding and emergency repair, among others.

CEO Tony Guzzi commented on the rationale behind the deal, "The acquisition of RepconStrickland strengthens our position in the industrial and energy sectors which are attractive industries poised for future growth. RepconStrickland is an extremely well-run organization that provides turnaround and specialty services across North America, with a focus in the US Gulf."

The company generated annual revenues of around $400 million for 2012, valuing the business at 1.1 times annual revenues. Emcor expects that the deal will be accretive to 2013's annual earnings per share by roughly 10 cents. This excludes deal-related charges which are expected to come in between $6 and $7 million. The deal is expected to close as early as July, subject to normal closing conditions and regulatory approval.

Valuation

Emcor ended its first quarter with $499.1 million in cash and equivalents. The company operates with $155.4 million in total debt including capital lease obligations, for a net cash position of around $350 million. The company reported annual revenues of $6.35 billion for 2012, up 13.1% on the year before. Net earnings rose by 12.1% to $146.6 million.

Trading around $40 per share, the market values Emcor at $2.75 billion, or its operating assets around $2.4 billion. This values operating assets at around 0.4 times annual revenues and 16 times last year's earnings. Emcor pays a very modest quarterly dividend of $0.06 per share, for an annual dividend yield of just 0.6%.

Some Historical Perspective

Long-term holders of the stock have seen decent returns over the past decade as shares of Emcor have roughly tripled. Shares rose from low teens in 2003 to high thirties in 2007, before falling back to their low-teens again during the financial crisis in 2008. Ever since, shares have seen a steady recovery reaching all-time highs of $42 earlier this year, currently exchanging hands around $40 per share. Between 2009 and 2012, Emcor has increased its annual revenues by a cumulative 21% to $6.35 billion. Net earnings actually fell by 9% in the meantime, coming in just below $147 million.

Investment Thesis

Shareholders react positively to the strategic deal. By acquiring RepconStrickland, Emcor is using its balance sheet flexibility to boost its operations, increase earnings per share and create shareholder value. The $445 million price tag values the company at 1.1 times annual revenues, which is a significant premium compared to its own valuation at 0.4 times revenues. Yet the profitability of Repcon is much greater, as the company reports low double-digit EBITDA margins, while Emcor reports margins in the low single-digits.

Consequently, earnings per share could easily increase by $0.20 in 2014, given that Emcor expects an acceleration of earnings accretion into next year. This implies that after-tax earnings could be boosted by some $15 million, already factoring in the financing cost of new debt and lost interest income on its cash balances. Combined, both firms would generate revenues of around $6.75 billion, while being valued at $2.75 billion and operating with merely $100 million in net debt. Earnings could accrue to $160 million on a pro-forma basis, approaching the $2.50 per share mark. This would value the firm at 0.4 times annual revenues and 16 times earnings.

Besides generating higher margins, the deal has other advantages to Emcor. While there are few cost synergies, there is a lot of potential for revenue synergies following Emcor's acquisition of Ohmstede back in 2007. Both firms are operating in niche markets, having their own specialties which are complementary to each other. As such, Emcor could provide a broader range of services to the refinery and petrochemical industry. Another comforting fact is the recurring nature of revenues, as Repcon generates 85% of its revenues from maintenance.

Emcor made an excellent deal and shareholders rightfully applaud the firm for doing so, sending its shares to levels approaching their all-time highs. The deal makes strategic sense, is executed at fair valuation multiples, and brings even more diversification to the business. I would not be surprised to see shares trading at new all-time highs in the coming weeks.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.