Aecom - Fundamentals Tell A Different Story

| About: AECOM Technology (ACM)

Summary

Aecom’s reliance remains largely on commercial construction projects where capital spending has slowed over the last quarter of 2015 leading to reduced demand for the future.

Going forward margins will also come under pressure due to acquisition related costs in 2016 but will gradually increase within the limits of their operating structure.

Although the stock remains fundamentally undervalued, I recommend a Sell rating on mounting global macro concerns.

 AECOM Technology Corporation Background:

Aecom (NYSE:ACM) is an integrated professional and technical services firm positioned to design, build, finance and operate infrastructure assets for public and private sector clients. The company is among the leaders in its industry and was ranked number one in terms of design revenue by Engineering News Record (NYSE:ENR). Following the acquisition of United Research Services ((NYSE:URS)) in 2015, the company has realigned its business into three distinct segments. (1) Design and Consulting Services ((NYSE:DCS)) dedicated to provide consulting and design services to private and public clients in the fields of transport, facilities, environment, energy, water and government. (2) Construction Services ((NYSE:CS)) which is engaged in construction services for energy, infrastructure and industrial construction and mainly comprises of operations taken over from URS. (3) Management Services ((NYSE:MS)) which provides management, training, logistics, consulting and other related services to the public sector for specific programs. The acquisition of URS has made Aecom the world's largest construction and engineering firm with their combined experience in the sector exceeding 90 years employing 92,000 permanent and temporary staff.

Financial Analysis:

Traditionally, DCS forms the larger share of revenues, up to 90% in years of high performance but not below 80% when experiencing slow business momentum. However, its chunk in the revenue mix has been decreasing as the CS segment has demonstrated huge revenue growth post-URS as restated in the FY15 financials. Overall revenue growth for FY15 has been 115% which has been entirely provided by the acquired operations otherwise the revenues would have decreased by $2.30 million. The organic contraction is primarily attributed to decline in operations in the Americas and Asia Pacific region in the DCS and MS segment coupled with a negative currency impact. Support to revenues was provided by the CS segment mainly from a high-rise project in the New York city. The overall construction starts have weakened during 2015 after the higher pace observed in the prior two years. That growth has reduced the demand for construction in the current outgoing period leading to slower revenues especially from public works, manufacturing plant construction and energy sector which have kept the DCS and MS segment down. Whereas the growth in commercial, institutional and residential construction continues to advance supporting the growth in revenues during the year. The situation is similar in the UK markets where the fall in construction starts continues into the last quarter of the calendar year.

Aecom gross margins hovered around 5% to 7% pre-URS acquisition, but the same has dipped to 3% following the buyout. Major portion of this negative impact is due to the lower gross margin of the acquired operations which was kept afloat at 3% by the higher margin of the operations exclusive of acquisition. Excluding the acquired operations, the company's gross margin was also lower than its historical average because of lower sales on the back of depressed market conditions. Acquisition and integration expenses had a further pull on the gross margin bringing down the operating income to 1% of revenue. Support on this line was provided by equity in earnings of joint ventures which comprise of various variable interest entities and partnerships under different kinds of agreements where Aecom combines its resources on specific projects. Profit before taxation (NYSE:PBT) was negative resulting in an income tax benefit but was not able to bring the bottom line in the green as the interest expense of the company increased more than six times. The company assumed new debt of $4.60 billion associated with the acquisition of URS and allocated towards acquisition costs, repayment of old debt and other miscellaneous requirements of their expanded operations. Net margin was -0.40% and after adjusting for income from non-controlling interest and consolidated subsidiaries the net margin attributable to Aecom shareholders was -1% compared to 3% in the prior year.

Cash flow from operations depicted a different picture as they more than doubled during the period because non-cash expenses of the combined operations kept the income on the P&L down. Further support came from high earnings from unconsolidated joint ventures and better collections which helped more than four times more cash inflow from working capital changes allowing the overall operating cash flow to double. Costs of acquisitions were offset against debt issuance which netted a cash inflow from financing activities resulting in an increase in the net cash balance at period close where cash balance increased 19%.

in millions USD

FY10

FY11

FY12

FY13

FY14

FY15

Revenue

6,546

8,037

8,218

8,153

8,357

17,990

Revenue growth

7%

23%

2%

-1%

3%

115%

Net margin

4%

4%

-1%

3%

3%

0%

Basic EPS

2.07

2.35

(0.52)

2.38

2.36

(1.04)

Capex/revenue

1%

2%

1%

0%

1%

3%

Depreciation & amortization/revenue

1%

1%

1%

1%

1%

3%

Click to enlarge

Source: Company 10-Ks

Valuation:

Aecom already had an established position in the market with involvement in a number of key projects around the globe building a strong reputation. With the acquisition of URS its position is further strengthened with a larger pool of resources and reach to new customers. While the market has been down in the year of acquisition pushing down revenues combined with higher costs from acquisition impacting income negatively, the same is expected to reverse in the coming years as pressure from these one-time costs lay off. As far as the market is concerned Aecom's reliance remains largely on commercial construction projects where capital spending has slowed over the last quarter of 2015 coming from high growth rates in the prior periods leading to reduced demand for the future. This leads to lower revenue expectation for the company from energy, manufacturing and public works markets but there is positive light in the commercial buildings area where activity is picking up with the gradual economic pace. Moreover, there is positive light also from environmental public works and modest gains in the highways and road construction sector. Based on this analysis, revenue growth will slow down in the coming year especially after coming from a period of high growth where revenues were boosted by an acquisition. Going forward margins will be slightly under pressure in the coming year due to acquisition related costs but will gradually increase within the limits of their operating structure. The company is therefore expected to experience lower growth over the long-term given the current trend which will gradually pick up pace in the next four periods as the current projects age. This leads to maintenance capex coming up in the future while the cash flow grows with expanding revenue and profitability and thus increasing returns to investors. In light of the above stock price for December end is forecasted at $30.73.

in millions USD

FY16E

FY17E

FY18E

FY19E

FY20E

Revenue

19,249

20,212

21,222

22,283

23,843

Revenue growth

7%

5%

5%

5%

7%

Net margin

2%

2%

2%

2%

3%

Basic EPS

2.83

3.05

3.31

3.54

3.87

Capex/revenue

2%

2%

2%

2%

2%

Depreciation & amortization/revenue

2%

2%

2%

2%

2%

Click to enlarge

Conclusion:

The stock price has been trending downwards over the past week with increasing standard deviation which given the historical pattern over the past few months leads to expectations of a reversal in value. However that climb in value may be gradual on the back of slow growth in the industry. Long-term prospects for the company remain positive especially with the combined resources of URS which also has a large customer base and well developed operations. The reorganization post acquisition has made the company an integrated construction management and consultancy firm with capabilities for all kinds of projects which is enhanced through their global footprint. This leads to an overall positive outlook on the stock albeit only in the long-run.

Disclosure: I/we 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.