Pike Electric Is An Undervalued Infrastructure Play

| About: Pike Corporation (PIKE)
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Pike Electric (NYSE:PIKE) is an attractive way to play the global secular trend of increased infrastructure spending and is a preferred alternative to private equity infrastructure investments characterized by a lack of liquidity and high fees.

Company overview

PIKE provides outsourced utility engineering, construction and maintenance solutions to over 300 customers. The construction segment performs installation, maintenance and repair of power delivery systems including storm restoration services. The all other segment performs siting, permitting, engineering and design of power and telecommunications delivery systems, including storm assessment and inspection services.

Investment thesis

PIKE has a superior risk/reward profile as an infrastructure play on an absolute basis as well as relative to publicly traded peers and private infrastructure investments made by PE firms and pension funds.

Moreover, PIKE should trade at a higher multiple given that it is "power agnostic" (e.g. only cares that power is generated and does not care about the type), unlike many of its customers negatively affected by a secular shift away from certain types of power (e.g. away from nuclear and towards natural gas, solar, wind). The fact that the market has not distinguished between PIKE and its utility customers (evident by the similar poor performance since the end of April when interest rates started to move higher due to concerns over the tapering of QE) presents a compelling and low risk investment opportunity.

On an absolute basis, the mid single-digit EBITDA multiple is more appropriate for a telecom company experiencing a secular decline in its core business than an infrastructure company with multiple growth catalysts (see below).

On a relative basis, PIKE trades at a significant discount to the peer group average multiple despite strong fundamentals (again see below).

Compared to private infrastructure investments, PIKE provides the opportunity for public investors (both individual and the same institutions that would typically invest in PE funds) to enjoy 100% of the gains* from this popular type of investment as opposed to only a large majority.

For example, a PE firm would acquire an infrastructure company at a low multiple, make operational improvements and (hopefully) sell to another buyer/IPO several years later at a higher multiple. The investor would pay the carry, the management fee and various other fees (e.g. transaction fees) that significantly decrease the IRR. Alternatively, an investor could buy PIKE at 5x EBITDA, benefit from the already strong operational performance (and improving) and earn 100% of any gains for themselves.

*Let me be clear: I am not saying an investor could employ this strategy in every instance - only those where there are little to no operational improvements to be made.

"De-risking" of business model deserves higher multiple

PIKE has transitioned from a specialty, distribution-focused electric utility contractor primarily operating in the Southeast to one of the few providers of a national, turnkey energy solution with a diverse customer base.

PIKE successfully acquired and integrated five companies in the past several years, started multiple long-term projects (that it would have been unable to bid on before the expansion) and completed its first international project. These acquisitions (along with organic growth) resulted in a doubling of the geographic footprint since the IPO in 2005 as well as the ability to cross-sell an expanded list of services, which should result in increased revenue visibility and higher market share. Furthermore, long-term customer relationships and a strong industry reputation result in the renewal of the majority of its arrangements before expiration.

This increased service, customer and geographic diversity (especially being less dependent on volatile storm-related revenue) deserves a higher valuation.

PIKE delivers "growth" performance and only receives a "value" multiple

For the most recent fiscal year, revenue rose 34% to $918.7 million (another record high) due to strength in the core business (another record high) and higher storm-related revenue. Gross profit rose 61% to $147.2 million while the gross margin increased 260 basis points to 16% due to a more favorable revenue mix. EBITDA increased 70% to $109.6 million while operating cash flow more than tripled to $82.8 million from $25.7 million, due to higher net income and a decrease in the rate of working capital growth.

On the most recent conference call, management cited increased order visibility and emphasized its focus on improving profitability in the engineering business by being more selective in project procurement as well as increasing its recurring base load work for utilities.

Multiple growth catalysts

PIKE should benefit from multiple growth catalysts, many of which are secular in nature and provide a favorable long-term outlook.

PIKE should benefit from...

The continued rebound in housing as it provides overhead and underground distribution services (including final electricity connections to single and multi-family developments).

The shift towards alternative energy such as wind and solar due to new state mandates, which often requires new substation and transmission infrastructure.

The ongoing outsourcing trend as more utilities outsource infrastructure services in order to cut costs and improve service levels. This is a significant growth opportunity as a majority of utility infrastructure services are still conducted in-house. However, their workforce of utility engineers and linemen is aging and provides another incentive to outsource. Moreover, management said on the most recent conference call that utility services for new housing activity are almost 100% outsourced.

New federal and state regulations requiring increased electric power transmission infrastructure spending. The combination of projected increases in electricity demand, the increasing age of U.S. electricity infrastructure (including a lack of redundancy) and geographic population shifts resulted in a stressed electric grid.

Increased spending in emerging markets to improve the current inefficient (or lack of) infrastructure. As noted above, PIKE is one of the few companies able to provide the turnkey solution to these countries.

Increased visibility from storms as investors seek out alternative stocks to benefit from natural disasters besides Home Depot and Lowe's. Again, PIKE is one of the few companies able to provide proven storm-related services across the country, which can result in new customer relationships. Moreover, state and local governments can actually save money in the long run by better preparing their electric grids for these recurring storms.

Shareholder friendly management

In May 2013, PIKE repurchased $40 million of stock in conjunction with a secondary offering of eight million shares. As a result, private equity firm Lindsay Goldberg vacated its two board seats and completely exited its stake after a more than 10 year relationship with PIKE.

In December 2012, PIKE paid a special cash dividend of $1.00 per share or a total amount returned to shareholders of ~$35 million.

Risks

Customer concentration. PIKE generates a significant portion of its revenue from a limited number of customers due to the composition of the utility industry (e.g. there is a small number of utility generation and transmission companies). The top 10 customers accounted for ~53% of total revenue in FY13 while Duke Energy accounted for ~17%.

Competition. PIKE competes not only against national and regional companies that provide similar services but against in-house service organizations of existing and potential customers

Volatility in storm-related revenue. Storm restoration services revenue is obviously completely dependent on unpredictable weather. Annual storm-related revenue ranged from a low of $46.6 million to a high of $167.3 million during the last five years. There was a high number of storm-related events in FY09 including hurricanes that affected the Gulf Coast and Florida as well as winter storms that affected the Midwest.

Weather dependent. As a significant portion of the work is performed outdoors, PIKE would be negatively affected by unfavorable weather conditions such as rain and harsh ice/snow storms.

Cyclical demand. The demand for infrastructure services is largely cyclical and dependent on favorable economic activity as customers may delay or cancel expansions, upgrades and maintenance.

Fuel costs. PIKE owns a large fleet of vehicles and equipment that primarily use diesel fuel and would be negatively affected by a rise in fuel costs (e.g. a $0.50 change in the price per gallon of diesel would result in a ~$1.5 million cost increase). This risk is mitigated given that ~58% of diesel fuel usage over the next twelve months is hedged at a weighted-average price of $3.90 per gallon.

High debt. The relatively high debt load is fairly standard for the construction/utility industry. This risk is mitigated given the $275 million credit facility (increased from $200 million in June 2012). Furthermore, management said on the most recent conference call that going forward debt repayment will be the preferred use of cash.

Conclusion

The target price of 13.83 is based on a 6x EBITDA multiple. This is conservative given the discount to the peer group average multiple (and only ~1x turn higher than the current multiple), significant business model transition and multiple growth catalysts.

A stop loss should be placed at 10 or ~5.6% below. The time frame is one to two years given the longer term growth story.

Disclosure: I 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.