Matrix Service Company (MTRX) is a long-term growth story in the market for engineering, fabrication, and maintenance services. Growth has been impressive, driven by both organic achievements and bolt-on dealmaking.
The slump in industrial production and energy-related capital spending has pressured shares, now trading at levels just half that of the 2014 peak. While the current year looks to be disappointing given the recent profit warning, current earnings remain decent, earnings potential is large and the balance sheet is strong.
Rapid Growth, Improved Diversification
A decade ago Matrix was a $650 million company comprised out of a construction service as well as repair & maintenance services segment. The company avoided much leverage which served the company well through the crisis, but shares nonetheless fell from $25 in 2008 to just $6 a year later.
The company took advantage of its strong capital position as it started to make bolt-on acquisitions coming out of the recession. Past cash flow statements reveal that the company spent $15 million on deals in 2009, $4 million in 2011 and $9 million in 2013. In 2014, the company made a major move with the $88 million purchase of KNAC, followed by minor deals in 2015 and 2016.
All in all, some $200 million was spent on acquisitions since 2009, including a more recent purchase, which will be elaborated further on in the remainder of the article. This spending and organic growth resulted in revenues doubling to more than $1.3 billion last year. More importantly, the company managed to deliver on this growth without causing any dilution of the shareholder base as the balance sheet remains very sound.
The Current Stance
Over time, Matrix has started reporting under 4 segments: electrical infrastructure, oil gas & chemical, storage solutions and industrial. These businesses generated $1.31 billion in sales for the year ending in June of 2016, a 2% fall compared to the year before.
Storage solutions is the largest segment and generated $564 million in sales, 12% more than in 2015. This segment makes up 40% of sales and growth was driven by the project to built crude gathering terminals for the Dakota Access Pipeline. The segment is the real backbone with operating margins of nearly 6%. Segment profits of $33 million are responsible for nearly all of the $41 million in total operating earnings.
Electrical infrastructure generates $349 million of sales. Segment sales were up 35% in 2016, now making up little over a quarter of total sales. The strong growth has been driven by work on the Napanee Generating Station project, although this has not been very lucrative with operating margins coming in at just 3% of sales.
Oil gas & chemical is struggling for obvious reasons as sales fell by a sixth to $250 million last year. The negative leverage resulted in a modest loss of $3 million. That being said, we might have very well seen the bottom for this division.
Industrial revenues were cut nearly in half to $150 million last year and reported relatively flat margins. The severe cut in sales resulted from depressed iron and steel markets, although these markets are improving as of late. The near completion of a large fertilization project hurt sales as well.
Modeling The Future
While Matrix operates in cyclical businesses, it has delivered on solid results over time. The company has doubled sales over the past decade while it avoided shareholder dilution and continues to operate with a very strong balance sheet. This financial prudence and diversification across different segments allows Matrix to run the business well in the long run, despite dramatic swings in margins.
Over the past decade GAAP margins have ranged anywhere between 1 and 7% of sales, averaging at roughly 4%. Despite the fact that sales have doubled over the past decade, and no dilution has been incurred, shares have been trading flat over the past decade, and it should be mentioned that investors do not receive any dividends.
The lack of capital gains has been disappointing for investors who have had to deal with a lot of volatility. Shares traded at $25 in 2008, fell to a low of $6 a year later, and have steadily risen to a high of $35 in 2014. Ever since shares have been cut in half again.
What Is Happening?
In November of last year, Matrix posted its first quarter results for the fiscal year of 2017. These results revealed that sales were up by 7% to nearly $342 million, despite a book-to-bill ratio of merely 0.76 times. This growth was driven by the strong performance at the storage solutions segment. Overall margins came in at 4.2% for the quarter, down half a point compared to the year before, resulting in earnings of $0.35 per share.
On the back of these results, the company reaffirmed the full year sales guidance of $1.30-$1.45 billion, and earnings of $1.10-$1.40 per share. This strong guidance and prudent balance sheet allowed the company to pursue the acquisition of Houston Interest in December. This $46 million deal should add over a hundred million in sales, and has already been closed in December.
In February, second quarter results were released for the quarter ending in December. Results were very soft, prompting the company to cut the full year sales guidance to $1.20-$1.30 billion, a $125 million cut in the guidance compared to the initial outlook. Worse, Houston Interest will contribute to the second half of 2017, with the revenue contribution seen at around $50 million. That implies that the core business has seen a $175 million shortfall in expected sales, being a huge cut.
Adjusted earnings are now seen at $0.75-$1.05 per share, a $0.35 per share reduction from the midpoint of the guidance. While the guidance is disappointing, earnings power of $0.90 per share yields a 20 times multiple as the balance sheet remains very strong. Even after taking into account the acquisition of Houston Interest, net debt stands at just $6 million.
One optimistic sign is that order intake for the quarter amounted to $310 million, for a book-to-bill ratio of 0.99 times. This indicates that sales pressure might be relatively short-lived, as management became more upbeat about activity going forward.
Factoring in A Recovery
Obviously this year is not going to be easy, yet signs are green for the longer term on the back of a recovery in energy markets, infrastructure, construction and industrial production.
Using preliminary sales guidance for this year, while factoring in the purchase of Houston Interest, one should not be surprised to expect a $1.5 billion sales run rate from 2018 onward.
The company indicated that it sees significant improvements in 2018 over 2017, yet it failed to quantify the amount of improvement. Growth should be driven by improved economic conditions, infrastructure spending, a recovery in oil prices, as well as further construction activity of LNG facilities and investments into the smart grid.
I furthermore have to congratulate management on sound capital allocation strategies, as the company announced a $25 million buyback program in February of 2016, when shares were at the lows. This is a big plus in my eyes, as management really considers the share price level when pursuing buybacks, unlike most companies.
If historical average margins of 4% can be achieved, the outlook arguably looks different. If sales recover to $1.5 billion in 2018, operating profits might hit $60 million, for after-tax earnings of $37 million after taking into account taxes and interest charges. That would be equivalent to $1.35-$1.40 per share.
That said each point in terms of margins impacts earnings by $0.35-$0.40 per share on a $1.5 billion revenue base. If margins spike to 5%, earnings of $1.80 per share are within reach. That makes the valuation arguably look compelling. Combined with the current balance sheet strength, I could easily see shares trading at +$30 in such a scenario.
For now headwinds are prevailing and revenues are seen at just $1.25 billion. The $0.90 earnings per share midpoint implies that EBIT is seen around $37 million, and margins of 3% lag the historical average on the back of softness in certain end markets and sales deleveraging.
That said, the multiple at this difficult point in the cycle comes in at 20 times which seems reasonable given the future growth drivers. It should furthermore be said that the guidance includes $2 million in deal-related costs resulting from the Houston transaction, equivalent to roughly $0.05 per share after taxes.
On the back of the cut in the guidance, shares have lost a fifth of their value over the past week, and are now trading at pre-election levels. Do not get me wrong - the cut in the guidance was bad, particularly given the acquisition of Houston Interest, but sales and projects are lumpy in this business. Taking into account that order intake is improving rapidly, and that 2018 is projected to be better, the future arguably looks brighter.
That said, the short term will be uneven as the Dakota Access project will end this year and the Napanee Generating Station project will be completed next year. This will create a drag on the storage and electrical business, but hopefully new projects as well as a recovery in industrial and oil gas & chemical projects should offset the drag on revenues.
Given the forward looking nature of the market, and the clear improved prospects following 2017, I think that current levels provide an opportunity for those with a longer term horizon. This makes me a buyer on dips in the $15-$17 region.
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.