I will be honest with you, I did not find this idea on my own. I was flipping through 13F filings at the SEC of investment managers I respect, and I came across URS Corporation (URS) three times as a new position. Most prominently, URS is a new position for Greenlight Capital run by David Einhorn, a brilliant investment manager, a great poker player and a talented writer. URS was also a new position for Jana Partners, founded by Barry Rothstein, also brilliant, and Glenview, managed by Larry Robbins, also exceptional. This was for the quarter ending June 30st 2013 and their filings were available to the public on approximately August 15th.
I have always found 13Fs a fertile hunting ground for new investment ideas. In particular, I like to focus on a special type of investment manager. They share several common characteristics, which are a value oriented investment style, manage concentrated portfolios, have low turnover and have strong, long term track records. Greenlight fits that category along with Jana and Glenview. However, I should say that I don't buy these investment ideas blindly. I like to do build my own financial models and investment thesis and become thoroughly convinced. This process gives me a higher level of confidence than riding the coat tales of another manager, and therefore I tend to stay with a position even if the market starts to sell off.
The Right Stuff
URS has many of the qualities that I look for in what I expect to be a good investment. First and foremost, the valuation is attractive. It is benefiting from an identifiable macroeconomic theme or trend. It has attractive, sustainable, returns on invested capital ("ROIC") along with significant barriers to entry by competitors. And finally, management is holding themselves out as accountable to shareholders through buying back stock and paying dividends.
URS trades at approximately 1.06 times book value and 6.67 enterprise value to EBITDA of on a trailing basis. These financial metrics are not "crazy cheap" but when taken into consideration the historical rate of growth and the prospect for future growth, the stock looks very attractive.
The compounded annual growth for EBITDA from 2007 to 2012 is 24%. EBITDA rose from $315 million to $920 million. Earnings-per-share grew at 13% over the same period. Despite this growth, the company did not have to lever up to achieve it. Net working capital (CA-CL) is currently $1.55 billion with $2.7 billion of long-term debt and other liabilities, so net debt to EBITDA (i.e. (long term liabilities - net working capital)/EBITDA) is less than 2 times, a reasonable number.
To make things even better, management is using free cash flow to buy back stock and pay dividends. This is one of the most important things to consider when making an investment. Great companies do not make great investments if management is not willing to spread the wealth. In FYQ2-2013, the company repurchased of one million shares and paid a dividend of $0.21 per share. Since 2010, the company has repurchased 14% of the shares outstanding or 12 million shares. So this is not only a cheap stock with a great growth rate but management is doing all the right things with excess cash.
When you consider the growth in unconventional oil and gas production in the US and Canada, URS appears well positioned. This is a big macroeconomic trend, and I have been looking for ways to invest in it, and URS looks like a good candidate. URS revenues come from five categories (1) Federal projects 34%, (2) industrial projects 11%, (3) power 9%, (4) infrastructure 17%, and oil and gas 29%. The company recently acquired Flint Energy, and this positions URS to benefit from the further development of unconventional drilling and development along with infrastructure.
Competitive Durable Advantage
From a long-term investment perspective, I try to ask myself, "does the business have a competitive durable advantage?" I'm concerned with the durability of the franchise. "Are the profit margins sustainable?" In this case, the answer is yes. The company clearly has high barriers to entry, which include long-term contracts, engineering expertise, capital requirements, along with economies of scale. Management commented how they were going to try to take engineering expertise from one business segment and try to assist the oil and gas division in developing new business or challenges.
During questions and answer session, management offered some highlights of what they are seeing on the oil and gas segment, which is my particular interest. The chief operating officer, William Lingard, made the following comments in response to the questions about energy services demand,
"The oil price, of course, is helping. With oil above $100, you're seeing good activity levels, and our clients definitely want to get their production tied in. And a couple other things that are happening with pipelines and bigger projects are giving our clients more confidence. So obviously, TCPL, building that east line and announcing a $12 billion line going to Québec and New Brunswick, helps make sure there's takeaway capacity for oil sands clients. And there's over 30 projects being contemplated now for LNG, which gives us some confidence that the activities for natural gas will slowly continue to recover and gives us some good confidence in that market as we go forward as well."
As of August 6th 2013, the company gave full year cash EPS guidance of $5.25 to $5.50 and to $4.25 and $4.50, on a fully diluted basis so the stock trades at a forward PE of just 10.8 times earnings. Second quarter backlog totaled $11.8 billion.
Given projected earnings along with its historical growth rate, I don't think it would be unreasonable to expect the stock to trade at 14 times earnings. This would equate to an earnings yield of 7% (i.e. $4.50 EPS per share /$65 last sale). I would consider this to be fair value or even intrinsic value. Another way to think about the valuation is price to growth or PEG ratio, at $65 and $4.50 per share in earnings, the stock is still selling at just over 1.1 times its historical five year growth rate of 13%. This company looks undervalued.
My investment thesis has some risks that should be mentioned. One reason the valuation is so low is that the company might see earnings risk from sequestration or budget cuts. Federal projects account for 34% of URS revenues. A second risk is oil and gas prices. A significant decline in energy prices would likely curtail projects, which might lead to an earnings miss or downward revisions. An economic slowdown, or recession, will likely lead to lower earnings guidance. Finally, its auditor did express concern in the 10K about internal financial controls.
URS Corporation is a leading provider of engineering, construction and technical services for public agencies and private sector companies around the world. The Company offers a full range of program management, planning, design and engineering, systems engineering and technical assistance, construction and construction management, operations and maintenance, information technology, and decommissioning and closure services. URS provides services for federal, oil and gas, infrastructure, power, and industrial projects and programs. (Source of company description URS website.)
Additional disclosure: This article does not constitute a recommendation to buy or sell any security. Potential investors should do their own due diligence before initiating a position.