Is it weird that I think of an infrastructure construction company every time I hear this Boogie Down Productions classic?
Making Me Look Smarter Than I Am
The very first stock I wrote about here at Seeking Alpha, back last October, was MasTec (MTZ). They are making me look much smarter than I am.
The elevator pitch:
- Diversified infrastructure construction: shale oil/gas; 5G/fiber rollouts; wind/solar construction.
- Their customers in these industries have huge CapEx spends this year, and probably through to 2021 if not longer.
- Management is executing, with no signs of stopping.
- They keep curb-stomping expectations, including my own.
So, for Q2, they are guiding to $1.8 billion in revenue and $1.11 EPS. My math gets to $1.14. My guess is they demolish both those numbers. Standard disclaimer: Only time will tell!
- Me, three months ago
Time did tell: $1.60. Also, not the first time:
Zacks. It should no longer be a "surprise".
I used to recommend waiting for a dip on MasTec, as they were frequent, deep and temporary, cued by a smaller dip in the market. But I'm not so sure anymore. MasTec just wants to go up now.
The Force is strong with this one.
The Story So Far
In my original October report on MasTec, I went into a little detail on the company's history, but here's the Reader's Digest Version.
MasTec is an infrastructure construction company based out of Miami. The company was founded by Jorge Mas Canosa, a somewhat legendary figure in the 1960s generation of Cuban refugees (he was at the Bay of Pigs and lived to tell the tale). Their roots are in telecom buildout, but now, their customers are split between wireless/wireline, oil/gas, power generation, power transmission and in-home installation. The company is currently run by Mas Canosa's sons, Jose, the CEO, and Jorge, the Chairman. Together, they own about 20% of the outstanding shares.
Infrastructure construction is a volatile business, both in terms of contracts, and how and when those contracts get paid. Quarterly revenue and earnings are very noisy data sets (management prefers "lumpy") and are not as useful as in other industries. So, we'll be sticking with the TTM numbers for the most part.
The first half of 2018 was one of the down periods, and the stock price reflected that, despite how things look for MasTec down the road. MasTec's management has displayed an ability to manage the quarterly ups and downs of their business quite well historically. MasTec bottomed out under $13 during the oil glut that accompanied the initial shale oil boom. While they did see downward trends in their revenue and earnings in 2015 and 2016, the boom in oil production in previously inaccessible fields is obvious good news for MasTec, and they recovered quickly once the WTI price scraped itself off the floor.
Then, the dreaded double top at $55 in H1 2018. First, it took a February swoon with the rest of the market. After recovering from that, a couple of bad headlines hit. First were reports that they were having trouble collecting on their invoices for the much-delayed Rover pipeline (they collected in October). Then came a court-ordered delay on another project, the Mountain Valley pipeline. This is not unusual.
Quarter to quarter, revenue and earnings are volatile. Contracts are large and mostly get paid at or near completion. Pipeline projects especially are often met with delays, force majeure, rerouting, local NIMBYs, and unforeseen regulatory hurdles. These two projects had a bit of all that.
The good news about all of this is that it mostly just pushes the revenue into later quarters, while many related costs and working capital are already accounted for. Delays also raise the overall value of the contract, increasing long-term margins. For example, they bid out their oil and gas projects anticipating 12-13% gross margins, but heavily delayed projects typically come in at 15-16%. This quarter had very high margins in oil/gas, which was part of their big earnings beat.
But the real story is the variety of opportunities in 2019 through 2021 in areas where they have a very significant corporate footprint and competence.
- 5G rollout
- Fiber rollout
- FirstNet first-responder cellular network
- Shale oilfield takeaway capacity alleviation
- Canadian tar sands takeaway capacity alleviation
- Mexican transition from coal to LNG for power generation
The capital spends by MasTec customers will be huge at least through 2021, but I think much longer. Last quarter, I spilled a lot of ink on the 5G/Fiber part of the equation, but this quarter, I want to focus on the oil and gas segment, which is really driving 2019 performance so far. I'll update on 5G briefly. My 2018 full year review has details on these other bullets.
The 2019-2021 Scenario
They may run out of places to put it all. 3D Animation Production Company
- Beginning in Q3, communications revenue grows rapidly from the 5G radio buildout accelerating, but really from the big fiber backbone being laid down for it. Fiber should peak at some point when these projects wrap up next year, after which the 5G radio climbs will dominate. This will go on for years, though the install-to-home subsegment will decline at about 15% a year to offset that. Total revenue growth rate here is about 13% when you add it up, and margins should expand back to where they were once the hiring and CapEx slows down.
- Oil/gas continue to grow rapidly and expand margins. One thing that has kept the stock down in the last two years is the idea that they cannot keep up this phenomenal performance in the oil/gas segment since H2 2016. They did, and short of another WTI price collapse, they will do more in the future. They have filled up capacity through the end of 2020. We are closer to the beginning of this than the end.
- Power generation construction continues its very steep growth, but I can't imagine it will keep going the way it is, up 85% in the TTM YoY. They are guiding to 35% YoY revenue growth, which would put them at $1.8 billion in 2021, from $841 million in the TTM.
- Electrical transmission will likely continue its weather-related up and down. However, on the outside chance that the elusive $2 trillion infrastructure bill becomes a reality, and it contains significant investment in the grid, I might do something stupid, and get a second mortgage on the house and put it all into MasTec. None of this is likely to happen, so the house is safe for now.
A Quick Data Note
As I said, we will mostly be sticking with TTM numbers due to the noisy quarterly numbers. But there is another thing here, MasTec's effective tax rate, which has been in huge flux. The quarterly rates:
The bill passed in mid-December 2017, and some of the changes regarding depreciation were retroactive for that year. Not having enough time before the new year, the IRS gave companies some rough guidelines for their 2017 taxes. Of course, everyone took the maximum benefit they could, and MasTec got about $100M in refunds in Q4 2017 for a -180% effective rate - literally off the chart. Later, the IRS issued the official rule, and everyone who overshot (i.e., everyone) had to pay more in 2018, as MasTec did with their 52% Q4 2018 rate. In any event, as you can see, we are still in flux here. So, we will be using EBT as our primary earnings measure, and EBITDA for segments.
MasTec blew out the quarter, mostly by excessive overperformance in Oil and Gas, and also their fast-growing Power unit. Communications growth is lagging right now, but I expect that to change soon.
Starting with revenue and earnings, we can see it's been a good year.
There's some nice growth in revenues that has blown up their EBT. But the EBT margin has not followed. Why?
MasTec is making heavy investments in building out their capacity for the 5G rollout, and the equipment leases show up on the interest payments line.
TTM June 2018 = 100
Other margins continue to perform well and expand:
TTM June 2018 = 100
Let's look at the source of TTM revenues from each segment:
So, a few things:
- Despite the recurrent bear story to the contrary, Oil and Gas keeps overperforming.
- Communications is seeing a dip in revenues as a proportion of the total.
- Holy smokes, Power Generation and Industrial is growing like a weed.
Comparing to last year's TTM revenues gives you an idea of the astounding growth:
As you can see, Communications and Electrical Transmission are only up slightly, but Oil and Gas and Power Generation are blowing out. Switching to segment EBITDA, we can see the effect of the larger Oil and Gas margin.
What we're seeing is the same sort of thing you would have seen if you were watching their Oil and Gas segment back in 2014-2016. When fracking opened up all those shale oil and gas fields, the WTI price collapsed, and MasTec's revenue and stock price went along with it.
Everyone took five minutes to figure out what the heck was going on, and new business dried up. But this was an obvious opportunity, not a bad thing for MasTec. They made heavy investments in building up capacity during that period, crushing their margins while revenue was dipping as well. But the payoff came in those giant Oil and Gas growth rates you see in the charts above. They spent the capital and were ready for the opportunity when it came.
So, a couple of similar things are going on in Communications right now. We have an exogenous factor - consumers replacing cable and satellite TV with streaming - pounding one of the subsegments of Communications, DirecTV home installation. This subsegment has been dying the death of 1,000 cuts as consumers transition from cable/satellite to streaming services. MasTec is trying to replace this with installs of home security and smart home devices, but I remain skeptical that can make up for the millions of DirecTV installs they have done.
I asked about this, and why it wouldn't be better to sell the subsegment and use the proceeds to finance all their new CapEx. Investor Relations VP Marc Lewis was kind enough to respond, even while on vacation on a Sunday:
Install to the home and customer fulfillment are both good businesses. The last 2 decades, DirecTV has been a great customer there...and still is. That business is low capex, quick cash conversion, it's very scalable up and down because our technicians get paid piece work...plus the work is diversified among hundreds of thousands of individual work orders each month...so all in all, it is very low risk. So, if we can replicate that with other customers we'd love to do just that and enhance the offering.
Lots of in-home services, delivery and customer services in trials that might be able to fill the gap for DirecTV.
I learned one important lesson about what can be done during my 17 plus years with MasTec. If you want something done there three ways to do it. First, do-it-yourself. Second, order a subordinate to do it. Or third, tell Jose that it can't be done. Jose is driven to make things work, particularly when he believes in the business model. People were saying the same thing about the power-gen business several years ago. Jose said it will get better. He was right then, and I think he'll be right on this one as well.
I so love that last paragraph so much, I'm going to put it on a plaque and mount it. I just love how patient Jose is. Standard disclaimer: time will tell!
But the ramp-up on 5G is also proceeding a little more slowly than they anticipated. They have been guiding for some time to H2 2019 as the big ramp-up in the 5G rollout, but now, they are seeing it proceed a little slower than we had all hoped. So, despite still showing double-digit YoY growth in the wireless and wireline subsegments, it's a little below where they had hoped and my own projections. But this just pushes out the carriers' CapEx spends a bit, so we may have to wait a little longer for the big jump here.
Andy Kaplowitz (from Citi)
You made a comment in the prepared remarks that you'd like to your wireline and wireless business grow faster despite growing double digit, as the growth of wireline and wireless not that what you thought it would be in 2019, or is really the slow ramp up of Communications solely because of the decline in install-to-the-home?
Jose Mas (MasTec CEO)
When we think about Communications, we've always said we expected ramped to be second half of 2019 event. We've - I think we've been extremely consistent on that for a long period of time.
Has it pushed out a little bit maybe more into 2020? The answer is, yes. Right. I think, we do have some customers that are still trying to figure out exactly how they're going to deploy certain things we've got obviously some of the Verizon permitting issues, have been very - they've been prevalent and spoken about by many people. So we're seeing some of that as well.
So I think we're months maybe behind where we originally thought, which in the overall scheme of things isn't significant. But yes, we're probably a little bit lighter in the second half of 2019 than we originally thought. But it doesn't change our long-term outlook of what we expect to happen in both wireline and the wireless markets.
So, like in 2016, with the Oil and Gas segment, MasTec is still making big investments in their Communications segment. They've hired about 250 new tower climbers a quarter for three quarters now, and they are hoping to keep doing that through the end of the year. Each new hire costs about $30-40k in training for this highly skilled and dangerous job, so that's a significant spend just there. Additionally, they have added $226M in new equipment in the past year, mostly through leases, most of it in H1 2019. So, before we dig for Oil and Gas, let's take a quick look at the state of 5G in the US.
More Towers! The State of 5G
If everything you knew about 5G came from carrier ads, you would think that today you could go out and buy a new 5G phone and stream 40 simultaneous angles of a baseball game in 4K, all while your self-driving car takes you home from work. Hooray?
The reality today is much bleaker than that.
"5G" is a marketing term adopted by the wireless industry to describe a group of technologies, mostly centered around "millimeter-wave" radio. "mmWave," as the industry refers to it, is a big chunk of the spectrum at much higher frequencies than were previously used, from 24-100 GHz. The wireless industry saw two advantages to this portion of the spectrum:
- Higher data speeds than the sub-6 GHz bandwidth (LTE, AKA "4G"), about 100x the theoretical peak per channel. The key word is "theoretical."
- It was available.
Why was this giant chunk of the spectrum still available in the 21st Century? Because it sucks. The signal does not travel far. Higher frequencies also have penetration problems. They can be knocked down by just about anything, including your hand, which is problematic when the main use-case is a device you hold in your hand. mmWave frequencies are not only knocked down by solid objects, but by rain, fog, and a small slice around 60 GHz is absorbed by oxygen.
So, there will be no mmWave outside of cities, because of the distance issues. The plan here is for upgraded multichannel LTE on all those towers - 5G Lite. But inside of cities, your chances of getting a 5G signal are not great because of the distance and penetration issues. It's pretty clear you will not be getting the signal indoors unless you are standing next to a window. So, most of the time, even city dwellers will be on 5G Lite until the density of radio towers is much greater. But even if the carriers put a small cell on every rooftop, it still does not solve the penetration issues.
On top of that, the state of 5G consumer hardware is still in the advanced prototype stage. I've only been able to play around with the Samsung Galaxy 5G. When you can actually get a 5G signal - almost nowhere - it's great. That is, for about 10 minutes until the 5G chip overheats and the phone falls back to the 4G chips inside. The phone also works very poorly in warm environments, again quickly overheating the 5G chip. The Wall Street Journal reviewer kept an ice chest around, just so she could cool the phone and actually, you know, review it. It's a giant, expensive mess of compromises built around a power-hungry heat monster of a 5G chip, and a giant battery required to power it.
So, the rollout of 5G is proceeding very slowly, because the carriers are really struggling with the distance and penetration issues, and how this translates into products built around mobility. They will keep doing what they always do when they run into implementation issues: more towers, more cells, more money. It's worked for them before.
Whenever the big ramp-up does begin, this is going to continue for years. Right now, there is no end in sight, and the carriers are making it up as they go along. All of this is good news for MasTec.
The T-Mobile (NASDAQ:TMUS)-Sprint (NYSE:S) merger and the addition of a new player, DISH, adds a new dimension to this, and MasTec is anticipating increased demand for construction services as a result. We'll dig deeper of the effects of the merger on the industry and MasTec next quarter.
Everything's Big in Texas
Big Tex is building some big pipelines. TheNewAnimaniacsFan2001
We're going to zero in on Texas to keep the Oil and Gas discussion focused, but similar things are happening all over the country. Neither of the two pipelines I've already mention is even in Texas, so there's a lot more to it.
For our discussion of what is happening in Texas and other high-producing shale formations, here is the key chart:
This is the average monthly spread between Brent Crude - the global benchmark for light, sweet crude oil - and West Texas Intermediate - the US benchmark for the same. Since the recovery from the 2014-2016 price collapse of WTI, the spread between the Brent price and the WTI price is widening; WTI is much cheaper, by over $6 a barrel most months in the TTM, and sometimes in the double-digits. If you were a refiner, which would you choose?
The explosion in production has created a problem. Midland, the center of the action in West Texas, is landlocked and does not have nearly the pipeline capacity to get it all out. The same is true for most of these new production areas.
You may have noticed in that chart that the WTI benchmark price is set in Cushing, Oklahoma not Midland. Cushing is a small town in northern Oklahoma, closer to Kansas than Texas. It is home to about 8,000 people, and just about as many pipelines and storage tanks. Generally speaking, it connects the refineries and storage facilities on the Gulf Coast with the Midwest and other parts of central time zone.
So, when WTI began spiking, it was still going up to Cushing via the Centurion Pipeline, rather than its more natural route to the Gulf Coast, where it can reach the entire world.
The pace of construction has been stupendous, both for crude oil and natural gas. As soon as a pipeline is opened, it is at full capacity and they are already engineering the next expansion. The larger pipeline companies have CapEx spends in the multiple billions per year, and continue to show double digit revenue growth year after year.
The economics of the pipeline business in these new shale formations is sort of like building a high rise in a high demand central urban area. You have to borrow a lot of money. It takes a long time to build, and that loan costs you every day. If you go over-schedule, you may have to borrow more. But once you open the doors, it's just a cash cannon.
The very strong incentive is to do what it takes to come in fast. Hiring a company who has gotten the job done for you in the past is a good start.
MasTec's biggest Oil and Gas customers in the quarter were EQT (EQT), Energy Transfer Partners (ET) and Phillips 66 (PSX) (PSXP). EQT is not from Texas, but they were the largest, so we'll keep them in for variety's sake.
Here's their consolidated CapEx spends since Q4 2016, when the WTI price was finally getting off the mat.
Does that look like it's slowing down any time soon? These companies are shaving their CapEx spends a bit, looking to be more efficient with their capital than before in reaction to investors' and creditors' complaints, but not slowing down on projects in the slightest. The three companies mentioned all have a big mix of major and smaller projects through 2021, and they hinted at more to come.
MasTec's end? CEO Jose Mas:
As we look ahead into 2020, we have now significantly committed our capacity to our customers with a number of projects going into 2021. We are actively working with our customers on their future needs, and we continue to have very strong visibility for multiple years out.
An emerging aspect, as it seems in so many industries, is water. The type of fracking they do in west Texas and Oklahoma uses 7 times as much water as crude produced - 7 barrels of water for every barrel of crude. Currently, most of that water has to be trucked in. Some stays underground, and some is wastewater that has to be properly stored and disposed.
Currently, the oil/gas water-hauling business is $13 billion a year in revenue. Pipelines cut out 30% of that, so there is a potential $9 billion business for someone to build in water pipelines, mostly concentrated in Oklahoma and West Texas.
MasTec closed their acquisition of Kingsley Construction in Q1, an oil/gas water management construction company in Texas. They expect this small subsidiary to grow fast, and so do I.
The Part Where I Whine About Pipeline Companies
Because sometimes, only Jean-Luc Picard can properly express my frustration.
I've already discussed some of the challenges faced in building pipelines. But another challenge is the general level of competence I see in some of these midstream companies.
I mentioned the Mountain Valley Pipeline, which was briefly shut down for regulatory reasons in 2018, and just again last week on a short 2-mile section, for a very similar regulatory reason. You'd think they'd learn. This particular shutdown won't be of much material issue for MasTec, but I find it frustrating, because it's not just EQM Midstream (EQM), whose pipeline Mountain Valley is, that can't seem to get out of their own way.
This was an exchange from Energy Transfer Partners' Q4 earnings call:
Shneur Gershuni (from UBS)
Just switching to the CapEx side, you had multiple years where you've spent in the $5 billion plus range for CapEx. There have been delays along the way, some of it regulatory, some of it not. You have a $5 billion capital program this year. You're needling some projects for the out years as well too. Has there been any changes in practices that Energy Transfer is learning from the past to execute better? How are things being planned on a go-forward basis? Just wondering if there's - just wondering if there are things taking place where CapEx could potentially come in more on time and more under budget. Just any color around that would be greatly appreciated.
[Brief pause, while management caught their breath]
Kelcy Warren (CEO and Chairman of ET)
Yes, we're all staring at each other, figuring out who is going to answer this, and I'll start. And it's probably several people, but yes, we've learned all kinds of lessons. And we've made mistakes and we are correcting those mistakes and we'll not make those mistakes again. So yes, we've learned a lot. Every place is not Texas. [emphasis added]
Here is a grown man, 63 years of age, a billionaire even, who has spent his entire adult life in the oil and gas midstream business, and he didn't know Texas' regulatory regime is unique until just last year? I know pretty much nothing about the oil business, but he could have paid me $50 to be a consultant, and I would have told him.
Full Picard face-palm.
But MasTec Still Has to Execute, Right?
That subject heading is Jose Mas' stock self-check when he realizes he's gotten a little out over his skis in his excitement at the range of opportunities he sees out there for MasTec right now. They have clearly been executing, so it's a bit of false modesty.
We are already into this, but there is still time to get on board this rocket ship. Unless the WTI price collapses again, or the Brent-WTI spread narrows dramatically, the revenue growth is going to keep happening for years.
Starting with their 18-month backlog, we see it keeps growing and outpaces TTM revenues. Backlog numbers are another noisy data set, so we will be using the average of the trailing 4 quarters.
The TTM average backlog stands at a company record (though it is down a little QoQ). The two main segments are seeing double-digit growth, and the two smaller segments are growing at a fantastic rate. It stands at 106% of TTM revenues, up from 104% last year.
Moving on to guidance, MasTec tends to be very conservative here, and they keep blowing away expectations as we saw in the intro. For Q3 they are guiding to $2.15 billion in revenues and $1.62 EPS. My math gets to $1.64. I'll say the same thing I said last quarter. My guess is they blow both of these out of the water.
MasTec has been better at estimating their annual numbers. They bumped up their revenue guidance to $7.7B and $5.04 EPS, which would beat their best-ever 2017 EPS by 19% and last year's by 55%. Look for this guidance to inch up over the rest of the year.
I used to recommend waiting for big, temporary dips in MasTec's price before buying. Here's the chart I would show:
See all those giant highlighted dips, cued by much smaller dips in the broader market? Those were the buying opportunities. But after August 5, I'm not so sure anymore. Let's look at that chart again:
The market was crushed, down over 3.5% and the big board was a sea of red. MasTec was up much of that awful day, and finished down only 9 bps. So my recommendation now is to get a half or a third of a position, and try and get a better price for the rest.
Good hunting! See you next quarter.
Disclosure: I am/we are long MTZ. 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.