Arcosa: Plenty Of Value In This Discounted Spin-Off

|
About: Arcosa, Inc. (ACA)
by: JP Research
Summary

Arcosa has shown good progress in meeting its strategic objectives since the last year's spin-off.

The Energy Equipment business is expected to ride the US and Canada’s transmission infrastructure push while adopting a lean approach to improve margins.

Transportation Products is a near monopoly for Arcosa, and it is expected to benefit handsomely as the business comes out of its cyclical trough.

With a strong balance sheet, revenue growth, and expected margin expansion, Arcosa is worth a look at current valuations.

Following its spin-off from Trinity, Arcosa (ACA) has gained an independent line of sight and a renewed focus to concentrate on its three key business segments: energy equipment, transportation products, and construction products.

Management had highlighted the strategic priorities for each segment: to grow construction products organically & inorganically, to expand energy equipment' margin and to ride a positive business cycle in its transportation products business. Since November 2018, management has fulfilled these objectives.

The company has already acquired ACG Materials in December 2018 to add ~50% revenue to its construction business. The company has adopted a lean approach in its energy equipment business and targeting to improve margins by 50-100bps annually.

On the transportation products front, the company is expected to benefit from a natural uptick in internal transportation (barges) business as well as a gap in the market created by the number 2 player shutting its operations.

Overall, management has been reliable thus far and with a debt/EBITDA ratio of ~1x and close to $100M in cash, the company has a strong balance sheet. Despite these positives, the stock trades at a discount relative to its peers and may be worth a look at these levels.

Spin-off and Path Forward

Arcosa was spun-off from Trinity Industries in November 2018. The spin-off allows Arcosa to focus on rapidly growing infrastructure sector through its three distinct business segments. As Trinity and Arcosa can independently pursue their business strategies in their respective areas, capital allocation has improved and become more nimble. Management has outlined clear strategies for its businesses and is on track to fulfill its promises.

Business Segment

Segment Size(FY18)

Long-term Strategy

Progress and Outlook

Energy Equipment

$780.1M

  • Improve EBITDA: Currently lowest (10.5%) among 3 segments and company average (12.8%).
  • Simplify Portfolio: Exit loss-making businesses.
  • Pursue Growth: Tap into robust demand from the US and Canada's electric transmission revamp plan.
  • Adopted Lean in the transmission business to improve margins by 50-100 bps annually
  • Company has exited two loss-making businesses since the spin-off.
  • US and Canada expected to spend $31B annually to replace aging infrastructure in electric transmissions.

Transportation Products

$391.4M

  • Pursue organic growth, especially as liquid and dry barge market recovers.
  • Near monopoly in barge business. Has 60-70% market share, with 2nd largest player, Jeff Boat, shutting operations. The exit presents a good opportunity to capture the sudden gap in the market.

Construction Products

$292.3M

  • Pursue organic and inorganic growth
  • Acquired ACG soon after the spin-off, which both expanded and diversified the product-mix.
  • Expected to reduce cyclicity of Arcosa revenues.

Source: Quarterly reports

We present a business-wise commentary in the following sections.

1) Energy Equipment:

This segment comprises of 3 sub-segments :

Utility Structures (~37% contribution): At 11% EBITDA margin, this segment has room for improvement, especially against Valmont, which has ~14% EBITDA. Management has adopted Lean principles to improve margins, which had previously worked in Wind Turbines business. This business is expected to gain significantly from the USA and Canada's push to revamp its aging transmission infrastructure to alleviate congestion issues and improve grid reliability. Both the countries are expected to spend ~$31B annually over the next few years, and Arcosa is expected to gain significantly from this spend.

Wind Towers (~37% contribution): This segment operates at EBITDA margins of 19-20%, significantly higher than the industry average (GE Renewables, Vestas and Siemens Gamesa) of 12%. Lean implementation has been successful in this segment, but we expect steady state margins to be 700-800bps lower. Production Tax Credits (PTC's) are expected to phase out by 2020, which will also impact wind tower demand. Arcosa's customers (turbine manufacturers) have been experiencing low margins themselves, so they are expected to negotiate for lower prices in towers aggressively.

Others (Storage Tanks, ~26% contribution): Arcosa is one of the leading manufacturers of pressurized and non-pressurized storage tanks in North America. Demand for these tanks is expected to remain strong within the residential, commercial and agricultural sectors. Moreover, exiting the loss-making cryogenics business should enable the company to focus more on its core storage business and return to high growth.

2) Transportation Products:

This segment comprises of 2 sub-segments :

Barges (~57% contribution): Arcosa enjoys a near monopoly in the US inland barges industry. It is the largest player with 60-70% market share, which is expected to increase as the 2nd largest player, Jeff Boat (~20% share), winds up its operations. The segment is experiencing both headwinds and tailwinds currently. On the positive front, the industry is expected to return to the positive end of the cycle, while on the negative front, declining coal production and reducing demand for transporting crude by barge may impact the growth.

Components (~43% contribution): As Trinity continues its operations in the legacy rail business, it entered into a long-term agreement with Arcosa to supply steel axles and couplers. Arcosa, being independent of Trinity now, has the opportunity to expand this business to other companies, including both railways and other industries.

Overall, Transportation Products is recovering from a cyclical trough with 2018 EBITDA at $54M (~14% EBITDA%) a shadow of the maximum EBITDA achieved in 2015. The barge business is undergoing a cyclical upturn, with book to bill now above 1.0. A continued recovery back to 2015 levels should further contribute to EBITDA.

Source: Investor Presentation

3) Construction Products:

Arcosa completed the acquisition of ACG in December 2018, which will give the dual benefit of growth and portfolio diversity to Arcosa's revenue streams. The construction products segment is expected to grow by 58.5% in FY2019, with ~50% growth attributed to ACG acquisition and ~8-9% growth being organic. This acquisition has also diversified and expanded Arcosa's product mix as well as reduced its revenue cyclicality.

Source: Investor Presentation

Valuation

As of June 5, 2019, Arcosa is trading at ~$35.50/share, which gives it an EV of $1.9B and EV/EBITDA multiple of 8.6x.

Share Price

$35.50

Shares Outstanding (NYSE:M)

48.3 M

Market Cap ($M)

$1715 M

Outstanding Net Debt ($M)

$185.5 M

Enterprise Value ($M)

$1900.5 M

FY2019E EBITDA ($M)

$220 M

EV/EBITDA (NYSE:X)

8.6x

Source: Investing.com and own research

At current prices, it is trading at a ~12% discount as compared to its peers.

Business Segment

Peers and their EV/EBITDA(X)

Average 2019 EV/EBITDA(X)

Segment Weightage in FY2019 (%)

Arcosa 2019 EV/EBITDA(X)

Energy Equipment

Valmont: 9x

Worthington: 9x

9x

46.3%

9.8x

Transportation Products

Kirby Corp: 10.2x

Westinghouse Air Brake: 8.5x

9.3x

26.9%

Construction Products

Vulcan : 13.9x

Martin Marietta : 12.5x

Summit Materials : 8.2x

11.5x

26.9%

Source: Own research

The market seems to be treating the spin-off negatively while ignoring the independence and upside that this spin-off brings to the table. Given the upside potential across its businesses and the highly stable balance sheet with FY2018 Debt/EBITDA of ~1x, we think Arcosa is undervalued at these levels.

Conclusion

Arcosa has a golden opportunity to tread its path post-spin-off from Trinity. It can focus on its three core segments and grow within these along with expanding its margins. It has a strong balance sheet to fuel inorganic growth ambitions and weather the cycles. Furthermore, management is solid and has delivered on its promises thus far. At current valuations, we think Arcosa is worth a look.

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.