AECOM (NYSE:ACM) Bank of America Merrill Lynch Global Industrials Conference December 6, 2011 2:30 PM ET
John Dionisio - CEO
Mike Burke - President
Good afternoon everyone, and thank you for attending AECOM’s presentation. What I’ll do first is give you a high-level overview of AECOM and describe our diversified business growth strategy, which is focused along geographies, markets, as well as services. I will also try to explain how this diversified global strategy has really helped us throughout the past several years from the global recession to what we see now, the softness in some of the economies around the world.
I’ll turn it over to Mike Burke, who will go into a deeper dive in terms of diversification model, but focus in on funding sources. So let me just begin. For those of you who may not be familiar with AECOM, AECOM is a global provider of professional technical and management support services. What that means is we’re engineers, planners, architects, builders, who plan infrastructure projects, facilities, water waste, water projects, commercial buildings around the world.
To give you background on the success that we’ve had, over the past five years, we’ve doubled our revenue. We’re in 125 countries around the world. At any one time, we have about 30,000 projects and we have a staff globally of 45,000 people.
The vision of AECOM is to be the industry leader in each of our markets and geographies, providing exceptional integrated services to all our clients, and be recognized as a consultant of choice as well as the employer of choice to our staff. We are ranked number one in the United States as a top designer, and in Asia we’re also ranked number one among international designers.
Historically, we’ve maintained a conservative risk profile. We do not do self-performing construction. We do construction management, construction management of risk, and operation and maintenance.
This diversification strategy, as I mentioned, has served us well over the past several years. The model has helped us navigate through the global recession and now some of the softness we see in some of the economies like Europe and it has positioned us well for our continued growth.
This slide tells the entire story of our diversification model. It’s broken up into three pieces: our end market diversification, our services diversification, and our geographies. Our end markets - we’re primarily in five end markets: facilities, transportation, environment which is water and wastewater, power and energy, mining, and government services.
The facilities market, which is about 38% of our business, is our largest market. It includes work in sports and leisure, healthcare, education, commercial development, and we work for both public and private clients, many multinational clients around the world.
I’ll just take two examples of what we do in the facilities market and the opportunities. Sports, for instance. And this is something that I was amazed as we got into this several years ago. In any one four-year period there are about 20 major events: World Cup games, Olympic games. There’s a capital expenditure of about $20 billion a year, and of that, 10% is related to sports, 90% is related to infrastructure improvement. So we did the master planning for the London Olympics, and if you think about it, 90% of the cost for that program was in developing highways, rail, water, and wastewater.
The other market is our corporate clients. Right now we see a movement from public sector spending into private sector, and when we look at some of the world’s largest corporate clients, they have a capex of about $10 billion a year. And what we’re doing is we’re targeting the top 50 of those clients in terms of providing them services, people like GE, IBM, Microsoft.
Transportation is our second largest end market, which constitutes about 26% of our business. We do highway and bridge, transit and rail, marine, aviation. And as we see today, much of the funding coming into that market comes from dedicated funds as well as public-private partnerships. So there has been a shift from the public side into the private side.
On the environmental side, about 20% of our business, as I said, is water, wastewater, and environmental management. And our smallest piece, but growing, is our power, energy, and mining. Currently it’s about 6% of our revenue, and we’re focused on the energy and power on hydroelectric transmission distribution, solar, and wind.
Mining, however, provides a really significant growth opportunity. Mining in 2012, which is around the world, the capex is $80 billion, and the five top companies, Vale, Rio Tinto, BHP, Billiton, and Xtrada, make up $56 billion. So these are clients that we’re working for, or positioning ourselves to work for. And basically, again, about 90% of it has nothing to with the mine itself. We don’t do the drilling in the mine, but what we do is from the “pit to port,” that’s the terminology, which is the infrastructure around the mine, the port facilities, the plant facilities, utilities, and the rail.
And our last market is our government services segment, which is about 11% of our business, and in that, we work primarily for the US government. One of the major clients is the Department of Defense, but we also work for the Department of Justice, Department of State. But here we don’t do major hardware. We’re not involved in aircraft, in missiles, or vessels. What we provide is cybersecurity, intelligence, and environmental remediation.
So we have a good mix of the market. The other thing that we do is we have a full-service offering in terms of the types of work we do. So as I mentioned, we do from up-front planning, design, architectural and engineering design, program management, construction management, as well as operation, maintenance and logistics. Today about one-quarter of our business is from higher-margin types of services we provide, which is in program management and construction management.
And the third element, which is at the bottom of the slide, is our geographic diversification, which is an important cornerstone to this diversification growth model. Approximately 60% of our revenue is generated outside the United States, so AECOM is not a US company working abroad. We’re truly a global company.
Over 40% of our business is from emerging market economies such as Asia and natural resource economies such as Australia and Canada. AECOM will continue to grow this footprint through its well-positioned M&A in emerging markets, such as Africa, Latin America, Southeast Asia, and India.
Our global platform enables us to be considered as a local partner with our clients, but at the same time provide them with fully integrated services and global expertise. We also manage and allocate resources cost-effectively. For instance, we currently have a client in Australia who hired us to work on project that they want to build in Africa and all the engineering is being done in North America. So with the fact that we have this global footprint and we provide the global types of services, we’re able to effectively manage our resources to meet the clients’ needs.
AECOM is positioned for continued profitable growth. First, we continue to gain market share in high-growth markets in the United States. Despite what you may read or hear, it does remain a strong market within the United States, and what you need to do is find out where the money is being spent. As I said, dedicated funds, public-private partnerships, the rebound in the commercial real estate markets, the growth in transit, and the aviation markets.
Also we’re focusing on the growth, as I said, in emerging markets, Africa, Southeast Asia, Latin America, and we’re looking at the natural resources marketplace. And that market constitutes about 40% of our business today and we’re looking at 2015 to make it about 50% of our business, so we see a growth potential in those markets.
Second, as I also mentioned, we leverage our services across our global platform. For instance, we won the master planning for the Rio Olympics, and we were able to win that because of our local relationships, our local presence, and providing our sports expertise. We’re also looking at targeting higher-margin types of work. As I said, the program management, construction management, and through improving efficiencies within the company, reducing our overall cost point and cost structure.
The third item in terms of positioning us for profitable growth is this growing program management, construction management, where we could provide an integrated delivery to markets. What clients want today is full service. They don’t want to go shopping around. The beauty of the public-private partnership is that they can get funding, they get design, and they can get the construction.
We own 30% of a company called Meridian, and teaming with them, they provide the financing on some significant infrastructure projects and on many of them we do the design and also we could be doing the construction management. So that resonates very, very well in the marketplace.
Also, there is a lot of work being done outside the United States, in terms of the public-private partnership. We’re on a team to do the design and program management of a new highway from Moscow to St. Petersburg and the funding is coming from a group of Russian investors. Vale, which is a French construction company, is doing the construction, and AECOM is doing design.
And finally, our M&A model is critical to our success. Historically, over the past 10-12 years, we’ve been able to grow 20% a year, 10% organically and 10% through mergers and acquisitions. That hasn’t been the case in the last couple of years, but clearly we try to have a balance of organic growth as well as mergers and acquisitions. The M&As primarily focus on getting us into new geographic areas as well as maybe into new market sectors. We believe these four items, combined with our diversification model, are critical to our success.
I’m going to turn it over to Mike Burke, who’s going to speak about our diversified business profile in terms of funding sources. Looking at the center chart here, you see that our revenues are fairly well distributed between public-private clients, both in and outside the United States. I believe this balanced mix of clients and funding sources has enabled us to normalize our revenues and not be significantly impacted by a shortfall in any one particular market.
As I mentioned, at any one time we have 30,000 projects. So one or two projects, five projects, fall off the table, it’s not a serious blow to AECOM because of this diversification model. We’re looking at it in terms of non-US. Right now 60% of our work is done outside the United States. In three years, in 2015, we see that shift going to about 65%.
So with that, I’d like to turn it over to Mike, who will go into a much more deep dive into our funding sources. Mike?
Thank you John. As John said, one of the things that’s allowed us to continue to grow through the recessionary environment of the past three years is this diversified model. And John talked about diversification as it relates to geographies, and as it relates to service offerings and end markets, and what I want to do is really help you understand where does the money come from. When we talk about public sector, all public sector entities are not created alike, and so we’d like to give a little more detail and help you understand where the money ultimately comes from.
So as John said, first of all, 38% of our business is private sector, and that is the fastest-growing segment of our overall business. When we look at the private sector, first of all about 55% of that business is inside the United States, 45% is outside the US. So the private sector, fairly evenly balanced inside the US and outside the US.
The single biggest component of that is our commercial building sector. That commercial building sector is a fairly broad and diverse segment and when you look at the commercial segment here in the US, there’s a wide variability in the marketplace.
Our biggest geographic representation in the commercial building sector is right here in New York City, where we have a fairly dominant market share, about 50% of all the new tall buildings in New York City we are involved with, including seven of the eight structures at the World Trade Center site. So it’s a fairly significant part of our business here in the US, but it is a business that is focused on certain key geographies.
The rest of that business is fairly widely distributed. Outside the US, a significant amount of commercial buildings also, but you also see a greater share of mining work outside the United States as you would expect. So fairly even representation, except the US has more healthcare opportunities, and outside the US you see more mining, minerals, natural resource opportunities, as well as the sports end market that John talked about. You see that in the bottom left corner here, as the oil and gas, mining, minerals portion of that pie starts to increase.
Moving outside the private sector, I think one of the issues that we continue to hear from investors is the skepticism about government spending, and John pointed out the need to focus on the individual line items in the various budgets. There are some budgets that are decreasing , but there also are a significant number of line items in governmental budgets around the world that are increasing.
But the important part here to focus on, first of all, is the non-US-government spend. About 25% of our business is in non-US governments, and the governments represented by that segment of our business are very strong governments. Like I said, all governments aren’t created equal, but what you see here is Australia and Canada and Asia, the governments of those countries, China and Hong Kong in particular in Asia, are very strong.
They’re in surplus positions. They are significantly investing in infrastructure and the public sector markets there are very strong. In the Middle East, the public sector clients obviously have petrol dollars behind them, so very secure financing. And of course the one weak component is that 13% of the 25%, which is funded by European governments, is frankly not quite as healthy.
So the important takeaway here is when you look at the government sector, you need to drill down just a few more layers. And with that, I’d like to drill down into the next segment of our business. The US federal government represents 20% of our overall business, and you see the headline threats of the reduction in the federal government budgets and the upcoming sequestration, but there’s a few important points to note there.
First of all, those cuts are not a cut in actual budget dollars over the next 10 years, but a reduction in the growth rate. But what you should focus on here is the individual components of that. As John mentioned, the biggest reduction in the Department of Defense budget will be in hardware and new weapons systems, which an area in which we do not participate. So we’re fairly protected from that.
The Department of Defense operations and maintenance area, which is, as you can see, a significant portion of that overall pie, are areas that will continue to grow, and the type of work we do, where they are both pulling back resources and assets from overseas operations and resetting or refurbishing those assets, is an area that we play in in the O&M space.
The other big, growing piece there is the classified segment. This is a strategic bet that we made a few years ago, through the acquisitions of McNeil and SSI, that gave us a few thousand people with top secret clearances, allowing us to provide engineering design services and other services to classified departments in the areas of Homeland Security, cyberwarfare, etc.
And if you look at the federal budgets, those areas are the areas that are expected to grow significantly. In spite of some of the budgetary pressures, the amount of money being spent on Homeland Security and intelligence and cyberwarfare will significantly increase over the coming years, and we have, over the past few years, redirected our development to those areas, and therefore we are fairly confident in that growth opportunity.
The state and local budget, about 17% of our overall revenues come from state and local governments here in the US. As you see, a good share of that comes from some of the larger states, the five larger states: New York, California, Texas, Florida. A couple items to note there is that in those markets those are the largest infrastructure projects are resident in those states.
You look at the projects here in New York, whether they be Second Avenue Subway or the new PATH terminal at Ground Zero, you look at the very significant transportation projects in Southern California, those are the projects that we are particularly well-suited to do, being the largest provider of transportation engineering services in the world. We have a comparative advantage on the large end of the transportation sector. The more complex the project, the better we are positioned to win that work.
The other thing of note, if you look in those large states about half of the work that we do in those states does not come from general obligation sources. What it comes from is the either user fees or dedicated funding sources. So for instance, in Los Angeles, where you have a half a percent addition to the sales tax that is wholly dedicated to transportation infrastructure. And so you see in Los Angeles, where over the next 18 months they’ll let out about $10 billion of transportation construction projects from that dedicated funding source. So the markets in which we play are focused on those markets where we have great visibility to future revenue sources.
So that’s the diversified business profile. What is that leading us to? Well, it’s that diversification model that has been underway for quite some time, and we continue to become more diversified outside the United States, more diversified in the private sector, more diversified in the energy and natural resources sector.
But it’s that diversification that has allowed us to perform quite well over the past three years through this difficult recession. Over the past three years we’ve had a compound annual growth rate of our earnings per share of 18%. We finished fiscal year ’11 with a 13% increase in our earnings per share, and you see the fourth quarter results here on the screen.
This is our fourth quarter ended September 30 of this year. A few highlights to note there, as we finished that year 7% organic growth in the quarter, 6% organic growth in our backlog, so our backlog is moving up. Our organic growth is moving upward, and our margins are improving. So all in all, the trend lines are moving quite well due to that diversification that we talked about.
Balance sheet and liquidity, just a real quick point here. The balance sheet remains strong, about $450 million of cash on the balance sheet at 9/30 with in excess of $900 million available under our credit facilities. And the way we’re deploying that capital is twofold.
One is that we executed a stock buyback program. We authorized a $200 million share repurchase. We entered into an accelerated repurchase of $100 million of that, which we took those shares in right at the beginning of our fiscal year here in September. And we’ll have another $100 million authorized that we anticipate executing on at some point in the future.
We also are actively involved in the M&A market, as John mentioned, focused on deploying that capital, primarily outside the United States in emerging markets and natural resource-rich economies. And the markets we’re focused on are the ones you would expect, Brazil, India, China, Southeast Asia, and the mining opportunities in South Africa.
We feel very confident that we have the balance sheet to continue to execute on both fronts, the stock buyback as well as the M&A targets that we’ve talked about. Our book of business, about $15.6 billion of business that organically continues to grow. It’s not only approximately $16 billion of backlog, but you see on the right side of the screen here the backlog that we have in unconsolidated joint ventures and the IDIQ, or the indefinite delivery indefinite quantity contracts that we have with the US federal government, give us confidence in FY12.
Moving to FY12, we have, given our guidance at our last earnings call, we reiterated that guidance range of $2.45 to $2.65 for the fiscal year ending September 30, 2012, with all the of the assumptions remaining the same that you see listed on the page here.
So the bottom line here is that this global platform that allows us to provide services across the wide spectrum and diversified geographies, diversified end markets, and diversified sources of revenue. In emerging markets, I mentioned 40% of our business is in either emerging markets or natural resource-rich countries. It positions us quite well for 2012 and beyond and this gives us comfort in reiterating our long term guidance that we expect to continue to grow this business at 15% earnings per share growth rate for the foreseeable future.
So with that, I’d like to open it up to your questions.
Unidentified Audience Member
I think you have answered a lot of it, but longer term, one of the biggest tailwinds we had over the past several years was the fact that people globally used leverage to grow. You had low interest rates worldwide. And over the next three years, let’s say, it’s clear that at least some of this will start unwinding. And we’ve been seeing it. How should we think about your earnings growth in the next few years? And do you think 15% is sustainable given fiscal tightening in many of the regions and this global deleveraging?
Great question Andrew, and as you can see by our guidance, certainly at the midpoint of the guidance range, we’re not expecting 15% EPS growth in FY12. But we still feel confident in the longer term. And the reason we feel confident in the longer term is because of our continued and growing presence in certain end markets. If you look at the emerging markets that we talked about, the expectation for infrastructure growth in those markets is double-digit. And so to the extent we can continue to redeploy our assets into these higher-growth emerging markets, which I mentioned are about 40% of our business today, and growing quite nicely, the infrastructure growth markets are double-digit in those markets and that revenue growth, in addition to the opportunities that we create through our M&A strategy and our continued margin improvement give us the confidence to state that long term 15% growth rate.
Unidentified Audience Member
How should we think about the pace and size of your acquisitions given the announced share buyback? Should we think about it as an indication of M&A slowdown relative to the last few years?
No, Andrew, the buyback that we have, that’s the next tranche, is $100 million. Right now we have 12 potential candidates in the pipeline and we’re seriously speaking to six of them. So if anything, we’re seeing a continued increase in the M&A activity. And as Mike mentioned, the focus is on - we have two opportunities that we’re pursuing in Brazil. We have two in China. We have one in Taiwan, and we have one in Africa.
Unidentified Audience Member
On China, I guess based on my recent visit, one of the issues in China for you is getting the necessary permits to perform the kind of work that you can. Can you just talk about it? Where you are and just talk about how you can take your Hong Kong experience, where you pretty much dominate the market, and transfer it to mainland, and what needs to be done for us to see more cooperation between you and the local Chinese players. And I know how much time you’ve been spending in the region.
The way it works, to do any type of work in China, you need a license. So they have a class A license if you want to do structural work, a class A license to do architecture work, environmental work. We have a class A license for architecture. So we bought a Chinese company, we’re considered a Chinese company in China, and we can do architecture work. Right now we’re in negotiations with a company to secure a license for water, wastewater, and environmental work. Now, if we don’t get the class A license, what we’ve done, and what we are doing, is we have partnerships with local design institutes. So they use their license, we provide the expertise, and we share in the profits. That’s something that’s good for a while, but the better thing is to secure your own class A license. And so, as I said, we’re looking at two companies, one in the building and engineering side, and one in the environmental side.
Unidentified Audience Member
So those would allow you to obtain more licenses?
Yes. Now, in the region, Hong Kong and China, we have about 4,500 people. And as Andrew mentioned, we’re the number one firm in Hong Kong by a long ways, and we’re developing a major presence. We’re located right now in Beijing, Shanghai, in Southeast Asia, in Singapore.
Unidentified Audience Member
One of the issues investors have had with you is free cash flow, and do you expect to reach 100% net income conversion this year? And what gives you confidence or visibility, particularly on days receivable? What has been happening there?
The short answer to your question is yes, we expect our cash flow to exceed net income in FY12 as well as into the future beyond that. What’s happened, Andrew, it’s really straightforward. We’ve seen this in every recession for the last 20 years. During tough times clients pay a little slower than normal, both private sector and public sector clients. We saw that in this past recession, and most importantly, at the end of this year, we saw our days start coming back down again as we would have expected. And so DSOs dropped about eight days at the end of this year in the PTS segment. We did have one large receivable from the US government at the end of the year that was about $85 million due to the closeout of a contract that we fully expect to get paid either this quarter or early next quarter. So overall the trend line looks really good on cash flow.
Unidentified Audience Member
So you think the government is going to pay? You don’t think there’s anything going on with the government’s ability or willingness to pay on time?
No, there’s a standard procedure that at the end of a contract they withhold the last payment until they close out the auditing of it. Just this one contract was a 10-year contract, so when they hold even a small, couple percent of that contract, because it was a 10-year, large contract, that number is $100 million. It was $120 million. They paid us about $40 million of it, and we’re still sitting on about $80 million. But the good news there is - I hesitate to say it, but - it’s a good credit risk client. [laughter]
Unidentified Audience Member
Another concern we hear for you guys is how can you maintain margins? How do you think you can maintain margins in the MSS business with tight budgets and more fierce competition for work with the government agencies? Are you seeing government being a thriftier spender? Or just watching what they pay more? Or is it getting more competitive?
In our sector, pricing leverage or pricing risk doesn’t move that much, Andrew. I remember three years ago, four years ago, sitting here with you among others and saying, boy the market’s so hot, why don’t you have pricing power to extract more money out of the government? And I remember saying at that point in time that the margins you get from the City of New York or the Department of Defense have been the same margins for 40-50 years, both in good times and bad times. And our gross margins have been relatively constant for the same client. Where we see improving margins is coming from two areas, both economies of scale, or operational leverage, as well as a change in the shift.
So let me address two of those. One is if you look over the past four years, we’ve increased our EBITDA margins against net service revenue by 250 basis points because we’re just driving more revenue through the same-sized platform. So we’re picking up margin improvement on the bottom line, we’re not picking it up on the top line. When you get to a change in shift, as we’ve been moving over the past few years into higher margin services like construction management and program management, we realize much greater margins in that sector. And so our margin improvement is coming through a mix shift, coming through a geographic shift, because we earn higher margins in places like Asia, so it’s coming from a geographic shift, but a service shift and then pure operating leverage.
Unidentified Audience Member
What do you guys think is going to happen, we’ve seen a lot in the press with the new highway bill, and we’ve heard a lot of sort of conflicting information from, you know if you talk to lobbyists. What do you think is the baseline scenario for highway spending in the US and how long do you think we have to wait, realistically, to get a comprehensive highway bill in this country?
You know, only over the past several weeks, maybe a month, we’ve been hearing some more positive talk from Washington in terms of the reauthorization, and there seems to be an interest in getting something done in 2012. Matter of fact, I’m going to Washington on Thursday to speak to Chairman Mica about it and see what the reality of it is. I mean, it’s bogged down in the political maze that we see in Washington, but there are signs that there may be something moving. Now, if it does move, we’re going to get a continuation, which isn’t the worst thing in the world. It’s better than not having anything. But what’s happening with the continuation is agencies are not able to plan well in advance. So the amount of funds are not bad. I think it’s $40-50 billion a year being spent on transportation, but as that gets divided up, state and local governments cannot make plans for a program for three, four five years.
Unidentified Audience Member
Well, I think we’re out of time. And with that, I want to thank you for coming.
Thank you very much.
Thank you Andrew.
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