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Infrastructure spending in the U.S. is expected to remain solid in the next few years. With the price of oil well above the $70 level, oil and gas companies have continued their major expansion/maintenance projects. Additionally, although federal spending cuts might limit certain projects, other major projects from chemical industries and the transportation sector, among others, are projected to continue at a steady pace. One method of profiting from the increased activity in these sectors is by investing in the engineering and construction (E&C) companies that serve these clients. In this article, I will evaluate 5 major players from the E&C sector and determine the best investment candidates at current levels. The companies selected for analysis are URS (NYSE:URS), Jacobs (NYSE:JEC), Fluor (NYSE:FLR), AECOM (NYSE:ACM) and Michael Baker (NYSEMKT:BKR).

The table that follows presents basic information about the subject companies.

Company Basics

URS

JEC

FLR

ACM

BKR

Market Cap (Billion)

3.6

7.42

10.14

3.24

0.26

Debt to Equity Ratio

55%

11%

14%

55%

0%

Stock Performance 5 Yr

3%

-37%

-33%

-4%

20%

Stock Performance 1 Yr

39%

58%

31%

97%

12%

Dividend Yield

1.8%

0.0%

1.1%

0.0%

2.7%

As can been seen from the table above, FLR is the largest name in the group with a market capitalization of just over $10 billion. BKR on the other hand is a small-cap firm with a market capitalization of $260 million. BKR is also debt free and despite its size, pays out the highest dividend yield. URS and FLR are the other dividend payers on the list. The sector overall has struggled over the past 5 years. JEC, FLR and ACM have all declined during this time period. BKR was the only firm to have appreciated in value in a meaningful way. However last year, the other four firms significantly outperformed BKR with ACM leading the way at 97%.

Growth Rates

Next, I evaluated the historical growth rates of revenue, income, EPS, book value and the projected growth rates. These are summarized in the table shown below:

Growth Rates

URS

JEC

FLR

ACM

BKR

Revenue

10 Year

13%

9%

12%

16%

3%

5 Year

15%

5%

11%

14%

-4%

1 Year

15%

5%

18%

2%

10%

Income

10 Year

18%

11%

11%

-

4%

5 Year

19%

6%

-3%

-190%

-31%

1 Year

-

15%

-23%

-121%

-82%

EPS

10 Year

9%

10%

11%

-

1%

5 Year

12%

5%

-2%

-185%

-33%

1 Year

-

13%

-20%

-122%

-84%

Book Value

10 Year

9%

1%

0%

7%

2%

5 Year

6%

1%

-2%

5%

2%

1 Year

-3%

2%

-4%

-5%

11%

Growth Projections

Next Year

9%

14%

13%

16%

15%

Next 5 Year

10%

14%

12%

16%

8%

URS and FLR are the standout performers in this group when it comes to the historical revenue growth rates. ACM was a laggard with sales increasing by a paltry 2% last year. In fact the company posted a loss during the last financial year. BKR's net income declined significantly during the past 5 years falling at an annual rate of 31%. JEC was the most consistent firm on the list growing its earnings at an annual rate of 11% during the past decade. Going forward, ACM is expected to increase its earnings at a brisk pace of 16% and return to profitability this year. BKR is projected to be a laggard with a projected long-term growth rate of 8%.

Margins

After analyzing the growth rates, the next step was the evaluation of gross and operating margins of the five firms. The results are presented in the table below.

Margins

Averages

URS

JEC

FLR

ACM

BKR

Gross Margins

10 Year

18%

14%

4%

15%

16%

5 Year

6%

15%

5%

6%

18%

Last Year

6%

16%

3%

5%

16%

TTM

6%

16%

3%

5%

16%

Operating Margins

10 Year

5%

5%

3%

4%

4%

5 Year

4%

5%

4%

4%

5%

Last Year

6%

6%

3%

1%

1%

TTM

6%

6%

3%

1%

2%

JEC has historically maintained the strongest margins in the group. It has expanded both its gross and operating margins over the past decade. URS has also reported strong operating margins. ACM has seen its margins decline significantly while FLR has maintained its below-industry-average margins.

Profitability

Operations

Averages

URS

JEC

FLR

ACM

BKR

ROIC

10 Year

2%

13%

15%

8%

11%

5 Year

2%

13%

17%

7%

11%

Last Year

5%

9%

11%

-3%

1%

TTM

5%

9%

11%

-3%

3%

ROA

10 Year

2%

8%

7%

4%

5%

5 Year

2%

8%

8%

4%

6%

Last Year

4%

6%

6%

-1%

1%

TTM

4%

6%

6%

-1%

2%

JEC and FLR have both reported the strongest ROIC ratios. JEC's ROIC has declined to 9% from an average of 13% over the past decade. Not surprisingly, the two companies have also reported strong JEC and FLR ROA ratios. As mentioned earlier, ACM had a terrible last year and the negative ROIC and ROA ratios are testament to that fact. URS was the only firm on the list, which expanded its ROIC and ROA ratios over the past decade.

Valuation

Having developed a good idea about the fundamentals of the four companies, the next step was to perform relative valuation. The multiples used in the analysis were based on historical analysis of individual company and industry multiples. The table below presents the valuation analysis results.

Valuation

URS

JEC

FLR

ACM

BKR

Next Yr Est

$4.71

$3.75

$4.67

$2.84

$1.99

EPS Growth Rate

10%

14%

12%

16%

8%

Future EPS (5 Yr)

$6.51

$5.92

$6.78

$5.14

$2.71

Expected P/E

13

19

18

16

14

Price 5 Yrs Out

$84.61

$112.53

$122.06

$82.28

$37.90

Unlevered Beta

1.74

1.74

1.74

1.74

1.74

D/E Ratio

58%

6%

5%

40%

0%

Current Tax Rate

35%

35%

35%

35%

35%

Levered Beta

2.40

1.81

1.80

2.19

1.74

Risk Free Rate

2%

2%

2%

2%

2%

Risk Premium

6.00%

6.00%

6.00%

6.00%

6.00%

Size Premium

0.97%

0.74%

0.62%

0.97%

2.71%

Cost of Equity

17.3%

13.6%

13.4%

16.1%

15.2%

Fair Value

$38.03

$59.51

$65.08

$38.98

$18.72

Current Price

$47.48

$56.71

$62.23

$31.41

$26.93

% Overvalued

20%

-5%

-5%

-24%

30%

As shown in the table above, ACM is significantly undervalued while BKR is grossly overvalued at current levels. FLR and JEC are slightly undervalued based on today's prices. Based on valuation alone, I would initiate a position in ACM. Looking at fundamentals and valuation, JEC and FLR are my preferred choices to profit from the secular growth trends that I see in the E&C space. I would however wait for a pullback to initiate a position in JEC and FLR. Additionally, I would initiate a short position in BKR and URS based on valuation.

(Kindly use this article for information purposes only. Please consult your investment advisor before making any investment decision.)

Source: Engineering And Construction Firms: 3 Stocks To Buy, 2 Stocks To Sell