Seeking Alpha
Profile| Send Message|
( followers)  

<< Return to Part 1

Industry Overview

The construction industry as a whole has been beaten down over the last couple years, and Tutor Perini (NYSE:TPC) has no doubt felt the effects of an industry on the downside of their cyclicality. They have most likely reached their bottom and there is no reason to believe that the industry won’t recover from this point on. There is no telling when exactly the private construction industry will pick up, but the public infrastructure industry has already started to pick up as a result of the stimulus money injected into the economy to help spur growth, which currently amounts to around $78 billion.

A recent report on the industry outlook mentioned in the Wall Street Journal stated that the construction industry should see modest gains next year, as a rise in the building of single-family houses, apartment buildings, and highways and bridges offsets drops in commercial and manufacturing property. The residential construction does not pertain to Tutor Perini, but the highway and bridge sector is what does concern Tutor Perini.

Until the commercial construction industry picks up steam again in the next couple of years, Tutor Perini will most likely rely on civil infrastructure and military management service contracts to help them weather the recession. This isn’t really that bad of news for Tutor Perini, because their civil construction and management service contracts have higher margins than the private building contracts do.

The competitors in this industry for Tutor Perini are numerous by definition, but I don’t believe that they pose much of a threat to their core business. The main competitors for them are Fluor (NYSE:FLR), McDermott International (NYSE:MDR), Foster Wheeler (NASDAQ:FWLT), and the Shaw Group (NYSE:SHAW) to name a few. In terms of company size according to revenue, Tutor Perini is the second smallest of those four, ahead of only Foster Wheeler. The only thing is that all of these companies are engaged in heavy construction that is performed in house more so than they are construction contracting. This makes it a little hard to compare the companies on an overall basis.

As mentioned before, Tutor Perini does not have a large moat, but they are not devoid of one. They have some franchise value in that they are one of the biggest and best contractors in the industry, as well as one of the most respected when it comes to getting large projects completed in a timely manner. This helps them be the go to company in the contracting industry currently, but it does not provide them with much of a moat because at any point in time someone else could receive a similar title as one of the biggest and best contractors in the industry.

Valuation

Over the last 4 years, Tutor Perini has grown their consolidated revenues by a CAGR of 19% and improved their operating profit by 198%. This is going to continue to grow with their operating margin continually increasing because of their current focus on obtaining more civil and management service contracts, which typically are higher margin contracts. Not to mention that civil contracts are more fixed price based and the private building contracts are a more variable price based. This is important because it means that in the future, earnings for Tutor Perini will become more predictable, as well as they will be earning a higher profit margin on average, both of which are very good signs.

They currently have an ROE of 11.3%, with a 19-Year average ROE of 7.12%. This is below the current ROE levels for most of their competitors, but I did not find the 19-Year averages for those competitors, as it would have taken quite a while. I personally think that this isn’t something to worry about, but it certainly is something to take into account when evaluating a long-term investment. They have also had a number of years of negative free cash flow, which I see as a result of their M&A culture, but in some periods was probably a result of lackluster earnings.

Overall they have done very well in creating free cash flow, but when they acquire or merge with other companies, that year’s free cash flow has tended to be negative. This last year they did create $74 million in free cash flow. They have not ever really had any debt that would have scared an investor away, and they have always had a high interest coverage ratio (19-year average = 13.35).

They do not pay a divided because they prefer to reinvest their profit back into the company or buy back shares as a way to return value to the shareholders. This is not necessarily a good or bad thing on the surface, but in this case I believe that it is a good thing that even though they don’t pay out a dividend they still find ways to return value to the shareholders when there is no other opportunities for them to reinvest those profits elsewhere.

The company’s beta is currently 1.44, which can be viewed as a result of their cyclicality compared to the market. When the market falls as a whole due to a recession, construction companies tend to fall even more. This can be seen in recent times in the fact that the majority of the companies in the construction industry are undervalued compared to the market.

The ratio analysis part of this valuation is where it really becomes obvious that Tutor Perini Corporation is undervalued in the market. The main reason for that is because they are trading at price multiples lower than just about everyone in their industry and well below most of the biggest and best companies in the industry.
They have an industry low 8.8x price to earnings ratio and an astonishingly low 0.2x price to sales ratio, which is also an industry low. These are the two most recognizable ratios that point to the fact that they are undervalued when compared to their competitors. They have a price to book of 0.9x, which really isn’t accurate because they have a considerable amount of goodwill that has piled up because of the M&A strategy they have had over the last couple of years. Even when you take the intangibles and goodwill out, they still trade at a price to tangible book of 2.1x, when the industry average for that ratio is 4.8x tangible book value.

The trailing twelve month (TTM) management effectiveness ratios, being mainly ROE, ROA, and ROI, are all above the industry averages, albeit only slightly, but I see this as more of a continuing trend for the future rather than a one time event. Over the last 5 years, the industry has gone from higher to lower returns on their equity, assets, and investments, while Tutor Perini has increased their returns on all three of these, during a recession most notably. To me, this is an impressive feat and something that is a sign of managements competency to either see the recession coming and prepare for it, or their ability to react and weather the storm in a very convincing manner, both of which prove the competency of the management team.

Their profitability ratios seem to fall short of the industry averages, but again they are moving the opposite way from the industry. The industry averages for gross margin, operating margin, net margin, etc. have all gone down from the 5-year averages to the TTM averages, while Tutor Perini’s margins in all of those categories have risen from the 5-year numbers to the TTM numbers. All of this comes at a period of time where the construction industry is suffering, yet Tutor Perini seems to have done a good enough job that they have increased their profitability in the middle of a recession.

An even more amazing feat is that during this time they have continued to aggressively grow capital expenditures by 52.5% over the last 5 years. The industry average over the last 5 years for capital expenditure growth is 5%; even the entire S&P average for the last 5 years is only 6%. Add to that a 22.8% sales growth over the last 5 years compared to an industry average of 4.7% over 5 years and it becomes even clearer that management strategy for growth is working.

One would wonder if they were funding their capital expenditures with debt, because that might pose a problem if they couldn’t get the same results out of their expenditures as they had hoped, but that is again not the case. They have very little debt in absolute and relative terms and they currently have enough cash to cover their debt completely at least a couple times. This just shows that they want to expand as much as they can, but they are not willing to put the financial health of the company at risk by taking on debt to finance these expenditures, or maybe they just had enough cash to cover it. Either way you look at it, this company stands to grow substantially when compared to their competitors once the recession lets up and the industry starts returning to the upward part of its cyclical cycle.

Overall, this seems to show me that they are expecting to grow at a pace that is above the industry at least for the next couple of years, yet they are still valued at multiples that are near or at the bottom of the industry. This doesn’t make sense to me and is a very good reason as to why I think this company is undervalued, on a relative and absolute basis.

Summary

For me, all signs seem to point to yes when it comes to deciding whether or not this is a long-term investment. There might not have much of a large, rock solid moat, but in the construction contracting industry they have the closest thing to a moat, which is reputation, resources, and reach to complete any project, anywhere. I believe that an investment in this company is entirely appropriate for an enterprising investor. They are a company priced at the bottom of their industry but perform like they are on top of their industry, and they have the numbers and strategy to prove it. Their growth in their civil business will provide them with explosive growth over the next number of years and the turn around of the construction industry will give them even more prosperity in the years to come.

If one were to do a free cash flow analysis for them, they would see that the potential to at least double ones investment seems almost obvious. When I did so for myself, I came up with a target price of around $60 and when I did a sensitivity analysis with the growth numbers and the competitive advantage period I still didn’t get a target price lower than about $50. So at a current price of $23.93, both of these prices are decent enough returns to warrant a long-term investment in my opinion.

Disclosure: Author long TPC

Source: Tutor Perini: Top Contractor Priced at Industry Bottom Multiples, Part 2