In this article I will lay out why I believe Tutor Perini (TPC) stock is overpriced at the current $19.24 per share. At first blush it appears to be a profitable value stock, trading at 0.53 of book value and 0.22 of sales. This has caused the stock to be acquired, and held up, by value investors as it fits well into the screens they use, shown in the prior sentence. I intend to show the company is in reality neither profitable and that the real tangible book value is well below the current market price. I will layout exactly how earnings and net worth have been inflated by aggressive accounting. Catalysts leading to more accurate accounting include shareholder lawsuits, an SEC investigation, a change in management, an active short campaign and a loss of business from its largest customer (the Federal government) who it is fighting for hundreds of millions of dollars of unbilled claims.
Tutor Perini (TPC) is a commercial contractor based in Sylmar, California. It has three segments; civil, building, and specialty contractor. Civil is large government projects, primarily rapid transit. Building is constructing commercial buildings of all types. Specialty contractor is electrical, mechanical, plumbing, HVAC, and fire protection systems construction. The revenue breakout in 2018 was civil 39%, building 40% and specialty contractor 21%. Over half of all customers are government entities. Over half of all projects are rapid or mass transit. Ronald Tutor has been the CEO since 2000.
Tutor Perini is not what it appears. The company has shown profits of $394 million over the past four years. I will show in this article, based on my analysis and opinion, that the true level of earnings is substantially less than reported and may be less than zero. Also, net worth is way overstated. Tangible net worth was $1.14 billion on December 31, 2018. When you look at how much higher the company’s receivables and costs in excess of billings are compared to their peers, and how long it has been outstanding, much of that probably needs to be written off. As a former commercial lender, I am very familiar with credit risk. What I am seeing here requires a large write off.
The difference with this article is it goes into much more detail and the situation has gotten worse. The most recent article shown above was by Michael Boyd. He stated the company
“ has a reputation for underbidding on contracts and then filing for change orders or other tack-on costs in order to drive up overall project cost for the customer. Low bids turn out to be not so low bids, so customers have a choice: roll over and pay the bill, litigate, or just sit on the payable and try to negotiate.”
The latter is what appears to be happening most often.
Costs in Excess of Billings and Accounts Receivable are Very High
Every year for the past three years the combined level of accounts receivable and costs in excess of billings have increased as shown in the chart below. This is despite a decline in revenues over the same period.
Source Tutor Perini 10-K’s and author's calculations as detailed below. The latest 10-K is here.
(1) Retainage payable to subcontractors is deducted from the total to be fair. (2) Days is days of sales. To determine you divide the asset account by annual sales and multiply by 365.
As shown above, accounts receivable has increased from 109 days at the end of 2015 to 143 days, currently. Most companies average under 90 days as does Tutor Perini’s peers which I will detail below. Management has repeatedly promised to get this number down but it keeps growing. Their promises go back many years. What is worse, Costs in Excess of Billings are growing even faster. They have increased from 67 to 94 days the past three years. This one is more troublesome because this represents work the company claims to have performed but has not been able to bill for. Much of this has been sitting unsettled for years, some over a decade. As a general rule, accountants write off or write down unbilled claims after a year.
Unbilled Costs and Unapproved Change Orders
The largest portion of Costs in Excess of Billings is Unbilled Costs and Unapproved Change Orders . The 2017 10-K explained these accounts as follows,
“ Costs and estimated earnings in excess of billings result when either: 1) the appropriate contract revenue amount has been recognized over time in accordance with ASC 606, but a portion of the revenue recorded cannot be billed currently due to the billing terms defined in the contract, or 2) costs are incurred related to certain claims and unapproved change orders. Claims occur when there is a dispute regarding both a change in the scope of work and the price associated with that change. Unapproved change orders occur when a change in the scope of work results in additional work being performed before the parties have agreed on the corresponding change in the contract price. “
In other words, it's all subject to negotiation, and many of the negotiations are going nowhere. Most companies write-off or write down items like this after a year and often earlier. The company does not mention any loss allowance for these items. In fact, the 10-K goes on to say the following,
“The amount of costs and estimated earnings in excess of billings as of December 31, 2018 estimated by management to be collected beyond one year is approximately $529.3 million.”
They do not expect to collect $529 million, or about half of it, for over a year! That amount is up from $443 last year, $415 million two years earlier and $353 million three years earlier.
CEO Ronald Tutor briefly addressed unbilled costs and unapproved change orders in the conference call last night as follows.
“We continue in negotiations on three major claims, have received significant offers on two of them, although not adequate. We continue to talk. We hope to bring those to conclusion over the next 90 days, but we have not been able to conclude any as of yet.”
He has said something similar for years yet the amounts keep going up. For example, here are his comments in the 2015 Q4 conference call.
"I think with the goal being to reduce the unbilled receivables to a fraction of what they are currently by next year. I think the real impetus here in management is to take away control of cash flow from our subsidiaries, mandate resolves and to the extent practical, minimize litigation but more importantly collect billings, resolve changes and if they can't be take harsh steps with our owners to owners to enforce collections and resolves. So we never find ourselves in this absurd situation again"
Absurd was his words, three years ago. It is clearly worse now.
I did not see any examples of settlements. Costs in Excess of Billings ten years ago (at 12/31/08) was only 12 days, versus 67 days three years ago and 93 days now. The point is, this has been a business practice for at least 10 years. The fact that they are rejecting offers indicates losses are likely too on the half they do expect to settle in a year. The half they don’t expect to settle is particularly troublesome.
What is particularly disturbing is how much higher these accounts are from peer levels as shown in the chart below.
Source: Author’s calculations from Form 10-Qs and 10-Ks.
Tutor Perini’s accounts receivable are more than twice the peer average. Its accounts receivable plus Cost in Excess of Billings is three times the peer average measured in days and increasing. Costs in Excess of Billings is over five times the peer average measured in days and increasing.
Also concerning is that most of these receivables and Costs in Excess of Billings appear to be in the civil segment. Assets in the civil segment were 58% of all assets as of December 31, 2018, while this segment was only 39% of revenues. Since most of the company’s assets are accounts receivable and Costs in Excess of Billings, that means they are primarily from prior civil jobs. This is a real problem since the civil segment was 65% of operating income in 2018 and 78% in 2017. Clearly, they are puffing up profits in this area which leads to two problems. First, is the concern that the reported profits don't correspond to tangible shareholder value. The second is they risk losing their apparent most lucrative business.
Summary of Issues
1. Accounts receivable are twice the peer average and increasing. Accounts receivable are well above the 90 day level that is normally considered high
2. Accounts receivable have increased over the past three years despite already being high and despite a decline in revenues. They have increased from 109 to 143 days of sales in the past three years.
3. Costs in Excess of Billings are extremely high. It is over five times the peer average.
4. Costs in Excess of billings contains mostly work done over a year ago where payment has not been agreed on. Close to half is not even expected to be collected within a year. It's just sitting there and increasing every year.
5. The increase in Cost in Excess of Billings has accelerated in the past year. It went up by $209 million in 2018. It went from 72 to 94 days during 2018. The peer average is 14 days.
6. The peer group does not even have accounts called Unbilled Costs and Unapproved Change Orders. They may be included in Costs in Excess of Billings as they are too small to break out. It seems only Tutor Perini has this problem.
7. What is amazing is despite these items being way above peers and increasing, there have been little in the way of announced write-offs the past three years.
8. The level of Costs in Excess of Billings has been increasing rapidly for a decade. This is a pattern and practice exclusive to Tutor Perini that appears tied to the CEO.
9. What is also concerning is the limited lawsuits by the company. The lawsuits mentioned in footnote 8 of the 10-K are for a small portion of this amount and mostly for jobs 10 years old or older. How hard are really trying to collect? The longer these things go, the less chance of collection.
10. I believe the lack of significant lawsuits is because the Federal government is the customer on close to half of the company’s projects, and a significant majority of Costs in Excess of Billings. They risk losing that customer if they push too hard. That puts them in a real tight spot. To reiterate how precarious this may be, the company has entered into joint ventures for two of its largest recent projects, both $1.4 billion. This is not something they did much in the past.
11. All of these unsettled claims and underbidding while trying to make it up in other ways, likely gives Tutor Perini a reputation of being hard to work with and can make future business harder to get.
12. Revenues have declined the past three years by over 10% despite a strong economy.
13. Costs in excess of billings are all considered current assets despite the fact the company doesn’t expect to collect $529 million of it within a year. They have actually had little success collecting what they do expect to collect within a year in the past. Most of Costs in Excess of Billings should be non-current assets. As a result working capital used by investors is way overstated.
How did Tutor Perini get here?
Clearly the answer is they have been underbidding jobs then trying to fight for add-ons, change orders and claims to get to profits.
But where are the accountants? Their independent auditor is Deloitte & Touche. They have had the same independent auditor since 2002. That’s a long time. Certainly, time for a fresh look. I believe that Deloitte has some serious explaining to do regarding this situation.
Billings in Excess of Costs are Also Very High
There are more concerns. The opposite of Costs in Excess of Billings is a liability account called Billings in Excess of Costs. As a general rule construction companies have both and they somewhat offset. Billings is Excess of Costs is billing for work that has not been started. A look at Tutor Perini versus the peers is below.
Source: Form 10-K’s, Billings in Excess of Costs in days is BIEC divided by annual sales X 365.
Billing a few weeks ahead of work is common as it allows the contractor to buy the material. Billing an average 47 days ahead of doing the work is very unusual of and smacks of desperation. This account like the others mentioned above has gotten much higher over the past three years as shown below.
Source: Form 10-K’s, BIEC in days is BIEC divided by annual sales times 365.
Debt is Going Up
The negative real free cash flow has resulted in an increase in net debt despite showing relatively strong profits the past three years. The increase in net debt is shown below.
Source: Form 10-K's
So, despite apparent strong profits the past three years, no dividends, no acquisitions, no stock buybacks and relatively low Capex, the amount of net debt (debt minus cash) has gone up. It has gone up because Tutor Perini keeps increasing accounts receivable and Costs in Excess of Billings.
Where Did the Profits Go?
As shown above, Tutor Perini claims $349 million of net income over the past three years. However, despite those apparent strong earnings, net debt has increased. The increase occurred despite a low level of Capex, no dividends, no stock buybacks and no acquisitions. This shows the true picture of the company, it is actually losing money. The profits went to build up Costs in Excess of Billings and accounts receivable, primarily the former which is more troublesome. The lack of dividends, acquisitions and stock buybacks indicates a company with a weak balance sheet kept on a short leash by lenders.
So How Big is the Hole?
To see how much receivables and Costs in Excess of Billings may need to be written down we again compare them to the peer averages.
Source: Prior tables.
What this calculation shows is that, measured against the peers in terms of days, Tutor Perini has $1.72 billion more accounts receivable and costs in excess of billings than its peer. Certainly not all of that is a loss. The bigger risk is in the Costs in Excess of Billings area as those are just claims not approved by their customers. Much that has been in that category for years and not expected to be collected in the next year. Most accountants charge off or write down money receivable that is over a year old with no terms. As of December 31, 2018, $529 million of Costs in Excess of Billings was not expected to be collected in the next year. Based on the numbers above, my guess is the hole is at least $500-$750 million. That exceeds all profits the last four years. That is why I do not believe this is a profitable business.
Tangible net worth was $1,138 on December 31, 2018. An adequate write-off could bring net worth down close to zero.
I am shocked that there has no apparent write-off of these items in any of the periods I looked at, especially since the balances are accelerating.
There are financial covenants for the $350 million line of credit. The leverage ratio is adjusted EBITDA divided by outstanding interest bearing debt. This ratio is 3.25 starting March 31, 2019. There is also a Fixed Charge covenant of 1.25 to 1. That is an EBITDA to interest coverage ratio. An accurate accounting of EBITDA would likely cause a violation of one or both covenants. The company previously violated its covenants in 2016 and received a modification at that time as shown on page F-16 of the 2016 10-K here..
Risks / Backlog is Increasing
The most bullish item about Tutor Perini right now is a recent increase in its backlog. The backlog was $9.3 billion on December 31, 2018, up 28% from one year earlier. This included the $800 million Minneapolis Southwest Light Rail Transit project, contracted last quarter. The question of course is, these guys have a long history of underbidding jobs. Now all of a sudden, they have lots of jobs. Have they bid it accurately? Can they handle the work? With all the add-ons, change orders and claims in the past you have to have some doubts. Limbach (LMB) is a good example of a contractor that recently took large losses when they got more work than they could handle.
Tangible net worth is shown as being $1.14 billion on December 31, 2018. If the company is able to collect most of its unbilled costs then the stock is trading close to tangible net worth, which provides some downside support.
For a Short position, there is always the risk of a sale of the company. I consider this risk quite low due to all the work an acquirer would have to do to sort through all the unbilled costs and how uncertain most of them are.
The upside risk is $25.80. This is based on the following. Tutor Perini is guiding for net income of $2.15 in 2019 at the midpoint. The five peers I mentioned earlier are trading at an average PE ratio of 12 currently. Multiplying $2.15 by 12 gets to $25.80.
My estimate of losses needed in the Costs in Excess of Billings and accounts receivable is $500 to $750 million. This exceeds all profits recognized the past four years. Despite the apparent profits, lack of dividends, low Capex, no stock buybacks and no acquisitions, net debt has actually increased over that time. Debt does increase for profitable companies but rarely when there is low Capex, no dividends, no acquisitions and no stock buybacks. The fact that none of those things occurred is evidence of the weak financial condition the company is in. Tutor Perini has had little or no profitability for years and has an increasingly weak balance sheet. It is not in immediate danger of bankruptcy but is clearly overvalued.
To determine a price target, I took the current tangible net worth of $1.14 billion and subtracted $625 million, the midpoint of my write down estimate. The leaves $515 million in tangible net worth, or just over $10 per share. I recommend a short position with a price target of $10. Despite having a short ratio of 16.9 as of February 15, I had no difficulty shorting this stock. My broker (TD Ameritrade) is not charging interest so long as I have the cash to cover the position.
Disclosure: I am/we are short TPC. 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.