Construction and Engineering Firms: The Real Multinationals

by: Danny Furman

Two stocks I have profited from this year and generally follow, URS Corp (NYSE:URS) and AECOM Tech. (NYSE:ACM), sold off prior to reporting earnings last Thursday. Both are among the most internationally integrated and rapidly growing engineering and construction services companies. Each beat Q3 FY09 estimates, however ACM guided EPS for FY10 down from expectations, still fairly healthy at $1.90-$2 per share, supported by a backlong 3 times its market cap. Since reporting last Thursday, shares of ACM have rallied from $25 to currently $28+, over 12%. At 14+ times forward earnings, ACM seems fairly priced to me near $28 since it does not pay a dividend.

URS appears to be positioned and priced better than ACM. With similar market caps, URS has over 3 times the backlog and twice ACM's annual sales, not to mention greater earnings. In a day and a half of trading since URS reported, the stock is up from $40 to over $45 per share, still less than 12 times forward earnings.

I was disappointed enough with the outlook for ACM to replace it on my buy radar with other companies in the same sector. Engineering and construction services, as well as the aerospace and defense sectors, will continue to be dominated internationally by firms from the United States. Emerging nations will not chance security or infrastructure projects by using cheaper domestic firms. I consider companies like URS and Tetra Tech (NASDAQ:TTEK), which focuses on water and environmental services, the real "multinationals." Companies like Johnson & Johnson (NYSE:JNJ), while operating worldwide, still depend primarily on the American Consumer and don't have anywhere near the pricing power of a services firm. URS bids on government contracts, which logically assures profitability since a bid in excess of completion costs should never knowingly be made. Household items are easy to reproduce and it is hard to believe the rest of the world, when faced with 5 identical items with 5 vastly different price tags, will be as ignorant to generic products as Americans. On the other hand, any company able to undercut URS likely will not be able to do similar work.

While I believe shares of URS should trade near $60, I feel like I missed the boat by not buying a week ago and expect the stock to trade with the overall market in the near future. Of the engineering companies that pay a regular dividend, only Fluor Corp (NYSE:FLR) appeals to me on a valuation and growth basis. Recent insider selling scared me away from General Dynamics (NYSE:GD), and Northrop Grumman's (NYSE:NOC) loss last year makes me skeptical of any contractor heavily dependent on Bush financing. I didn't consider Boeing (NYSE:BA) because the aeroplane business doesn't excite me. I'm looking for companies that directly make places safer and more efficient, both environmentally and economically. The clearest signs of leadership are recent historic growth and new contracts, both of which make URS and TTEK top choices. In addition to liking FLR, Jacobs Engineering (NYSE:JEC) made my list.

The only stock I'll discuss here that I own was recently downgraded by Goldman to "sell," meaning their analysis values the company below 12 times FY09 earnings and 9 times earnings for FY10. DYNCORP (DCP) has even reported through Q2 FY10, with net income up over 33% YOY and slightly ahead of estimates. Recent contract wins include up to $375M from AFRICAP and multiple US Air Force contracts. Total backlog is over $6.8B with FY09 sales over $3B and DCP is valued around $900M. The stock currently trades near $16.50 and has traded as high as $22.03 this year, spending most of recent months around $19. Apparently the Goldman downgrade overpowered an earnings beat and rising stock market. I bought right after the sell off on what I considered good news, but perhaps I should have paid up for URS. Regardless, leaders in engineering, construction and aerospace sit alone atop a truly competitive worldwide industry and represent some of the best value in an outrageously priced US stock market.

Disclosure: Long DCP