- United States energy infrastructure is rated a "D+", according to the American Society of Civil Engineers' most recent report card.
- Trillions of dollars will likely need to be invested over the coming years - both to make up for the current shortfall and allow for new technologies such as 5G.
- MasTec is a solid, growing operator in the infrastructure construction space.
- With a strong track record of growth and an attractive valuation, MasTec seems to be a good pick for the long haul.
Thoughts On Infrastructure Investing
The need to construct and rebuild critical infrastructure in the US is palpable, and many people understand there is great potential for money to be made investing based on that simple fact. However, one serious question remains: what is the best way to invest based on such a broad topic?
The fragmented nature of the construction and engineering market fundamentally contributes to my idea that there will be no clear-cut "winner" in infrastructure investment. Instead, I believe the best bet for long-term investors is to focus on a company with a nationwide footprint in the space and a solid operating track record that is trading at an attractive valuation. Such a company not only stands to benefit from any acceleration of investment in the area, but also a consistent track record protects it from more speculative risk over the long-term.
After conducting some research into the area, MasTec (NYSE:MTZ) stands out as holding serious potential to be a long-term winner in the infrastructure construction industry.
Company and Leadership Story
MasTec was formed by Jorge Mas Canosa in 1994 through a combination of Burnup & Sims and Church & Tower, two construction firms with extensive histories in communications infrastructure. Upon creation of the combined entity, Jorge Mas Canosa assumed the position of chairman of the board, with his namesake son, Jorge Mas, becoming president.
To this day, the family is still heavily ingrained in the company's operations; Jorge Mas has since taken over his father's former position as chairman while his younger brother, Jose, has assumed the role of CEO. As of the 2020 Proxy Statement, the two brothers remained beneficial owners of more than 23% of MasTec's shares outstanding.
This clear alignment of management's interests with shareholders is the first notable thing about the company. Over the course of MasTec's 26-year history, the brothers have been actively involved in some leadership role the entire time and have shown a strong and sustained commitment through their retained ownership interests. Furthermore, the company's impressive operating results speak volumes about upper management's experience and expertise in the industry. Since 2007, when Jose Mas became CEO, the company has diversified into several new markets and grown revenues and earnings more than six-fold.
Source: May 2020 Investor Presentation
Opportunities in Infrastructure: Energy
In its 2017 Infrastructure Report Card, the American Society of Civil Engineers ("ASCE") evaluated the current state of overall American infrastructure and determined it to be a D+. Energy infrastructure, MasTec's largest business currently, was also rated a D+.
A large portion of the current US energy system was constructed in the 1950s and 1960s with an intended life span of 50 years. More than 50 years later, much of it still needs to be replaced or upgraded, and there is projected to be a $177 billion electricity gap between 2016 and 2025. Significant power outages have risen from 76 in 2007 to 3,571 in 2015, which reinforces the fact that there are serious problems facing the current US system of electric transmission and distribution. All together, this contributes to a definite need for infrastructure upgrades to meet new safety standards and a growing demand for energy, driven by population growth and higher levels of technology.
MasTec is involved in electrical transmission and projects concerning the energy grid, but much of MasTec's current business is the construction and maintenance of oil and gas pumping facilities and pipelines. Despite the current weakness in the oil and gas industry, the outlook seems to be strong, and CEO Jose Mas eased many of my worries with several statements. First, the company holds a $2.6 billion backlog in oil and gas projects, a >$600 million increase from year end. I believe this large backlog is because CapEx has been deferred in order to preserve 2020 cash flow. Over the next few years, however, MasTec should reap the rewards of construction picking up again.
Second, oil pipelines, which will be increasingly hard to construct due to new regulatory standards and climate change pressures, contributed only 6% of oil and gas revenue over the last three years. This shows that much of the company's emphasis is on natural gas pipelines, which will likely continue on an upward trend over the long-term due to the clean-burning properties and overall efficiency of the gas.
Source: US EIA
The above graphic shows the recent sharp rise of exports of US natural gas. McKinsey extrapolates this trend into the future in its 2019 North American Gas Report; it projects US and Canadian gas exports to reach 20 billion cubic feet per day by 2030 compared to ~5 billion cubic feet per day in 2019. As exports increase and the US establishes itself as a top global exporter of LNG (liquefied natural gas), the existing pipeline system will need to be augmented or upgraded in order to meet the growing supply. As a major player in every productive basin in the US, MasTec should be able to account for a substantial chunk of the necessary construction.
70% of 2018 US natural gas exports were via pipeline (as opposed to ship, truck, etc.), of which 67% went to Mexico. As Mexico continues to develop and its energy needs rise, MasTec sees the country as a promising opportunity for expansion. Having already constructed two major gas pipelines in the country and as one of the largest pipeline contractors in North America, the company should be able to capitalize on the need for a larger connected system in Mexico.
Opportunities in Infrastructure: Communications
While communications was not directly rated by the ASCE, the industry requires upgrades for a different reason: the upcoming 5G rollout. Between 2012 and 2017, more than $1 trillion was spent on building up 4G infrastructure. Between 2019 and 2025, around $1.3 trillion in CapEx from mobile operators is expected to occur related to 5G deployment. Furthermore, Sylvain Fabre, a Senior Research Director at Gartner, elaborates:
National 5G coverage will not occur as quickly as with past generations of wireless infrastructure. To maintain average performance standards as 5G is built out, CSPs will need to undertake targeted strategic improvements to their 4G legacy layer, by upgrading 4G infrastructure around 5G areas of coverage.
Essentially, successful 5G deployment will require a larger CapEx outlay by the major CSPs (communication service providers) over a longer period of time. This dynamic plays well into MasTec's position in the wireless communications infrastructure industry. As a leader and reputable operator, the company can continue to collect construction contracts over an extended build-out period and achieve solid revenue gains over the long run.
Additionally, AT&T's development of FirstNet poses a significant opportunity due to its existing customer relationship with MasTec. AT&T is expected to invest $40 billion alongside the federal government's $6.5 billion for a wireless network dedicated exclusively to first responders in all 50 states. With MasTec's nationwide operations, this represents a significant opportunity for expansion.
Much of the company's potential is reflected by its immense backlog. Currently, the communications backlog stands at ~$4 billion, which is indicative of expanding commitments by CSPs as well as network additions. Moreover, most of the 5G rollout is expected to occur beginning in late 2020, which may have been delayed by COVID. However, this CSP CapEx can only be deferred for so long, and MasTec should continue to show strong results as the pace of 5G construction picks up.
Opportunities in Infrastructure: Power Generation
Although a smaller segment relative to MasTec's operations in oil and gas and communications, power generation should be a fast-grower in the future. As installation costs of renewables such as wind and solar continue to drop, adoption will increase, and construction will, of course, follow. MasTec has proven itself as a capable contractor in all aspects of wind farm construction and, as wind assets age, has eyes to become a leading operations and maintenance provider. It also hopes to expand into solar and other renewable projects as well as heavy civil constructs. With the company's currently limited scope, there is substantial room for expansion in this area.
Currently, the combined backlog for power generation and electrical transmission projects stands at a record $1.7 billion. Returning to the earlier mentioned pitiful energy grade by the ASCE, electrical transmission upgrades should continue to grow due to the overall deterioration of present systems. When considered alongside power generation revenue growing 56% in FY 2019, it all contributes to a rosy outlook for the company.
For FY 2019, MasTec reported total revenue of $7.2 billion, 4% growth from the year prior. Earnings for the year were $394.1 million compared to $259.2 million in 2018 thanks to margin expansion and revenue growth. Most recently, Q1 2020 revenue contracted 6% YoY due to severe weakness in the oil and gas segment. Earnings came in at $36.2 million, a 16% decrease.
With a long-term view, however, this present weakness can almost be completely disregarded due to the extremely attractive valuation (which I will discuss later) and the overall opportunity in infrastructure construction. On the Q1 call, Jose Mas consistently reiterated the outlook for 2020 and 2021 remained strong despite some delays and difficulties posed by COVID. His experience and consistent success at the helm leads me to believe this is not merely blind optimism, but a capable leader with an eye to the future.
Additionally, this company is considered solely as a long-term investment due to the difficult-to-predict timeline of infrastructure spending. When you zoom out from the sequential year statistics, the company's record stands out as strong. Revenues have grown at a ~9% CAGR over the last five years, and earnings have grown at an astounding 27.6% annual rate over the same time.
MasTec is also a strongly cash-generative company. It has generated positive free cash flow each of the last eight fiscal years, with $458.8 million most recently in 2019, 18% growth from the year prior. For Q1 2020, it generated $151 million in free cash flow on $203 million operating cash flow. It used ~$119 million of this free cash flow to fund share repurchases, and all the while, net debt decreased sequentially.
Overall, the company is steadily growing revenues, earnings, and cash flow, and it is doing so conservatively while continuing to reinvest in the business and aggressively repurchase shares.
The company is in strong financial shape with plenty of liquidity, low debt levels, and a strong cash base. As of Q1 end, the company has a net leverage ratio (net debt divided by TTM EBITDA) of 1.6x and a current ratio of 1.7x. Total debt stood at ~$1.4 billion and total liquidity at ~$946 million. Given the company's strong cash generation, ample liquidity, and no near-term maturities, the debt level is nothing to worry about.
MasTec does have over $1.4 billion in goodwill and other intangible assets on the balance sheet from consistent acquisitions over the years. Despite the potential for liability in the future, I do not believe this is a significant negative factor because many other construction companies - Quanta Services (PWR) and EMCOR Group (EME) as two quick examples - carry even greater amounts of goodwill. Overall, I foresee no short-term or long-term financial problems coming from the balance sheet.
MasTec currently trades at around a $2.9 billion market cap. TTM P/E stands at only 8.0x and EV/EBITDA at 5.7x. In terms of free cash flow, it is valued at only 6.3x FY 2019 FCF.
Even looking at analysts' consensus for 2020 earnings, it is trading at only 10x forward earnings, a far cry from its peers. All the while, it remains best-in-class in terms of efficiency. MasTec's Return on Equity is 24.8%, much higher than even its closest competitor's (EMCOR Group) 17.1%. Its Return on Capital is also higher than average, at 10.3%, and its Return on Assets is best-in-class, at 7.0%.
No matter which way I approach it, MasTec appears to be substantially undervalued relative to its long-term prospects.
With that being said, there are always risks in any investment, and MasTec is no different. First, as mentioned earlier, the large amount of goodwill on the balance sheet exposes the company to some liability if the carrying value of any of its units is deemed to decrease.
Second, MasTec relies on several customers for a majority of its revenue. AT&T (T) is responsible for around 24% of the company's total revenue, with several others, including Verizon (VZ), Energy Transfer (ET), Enterprise Products Partners (EPD), and Comcast (CMCSA) responsible for over 4%. All totaled, the top 10 customers were responsible for 62% of total revenue in Q1. Although this does expose MasTec to some concentrated credit risk, I think this may actually be a positive. All of the top customers are investment-grade and cannot afford the negative effects of a failure to make good on contracts. Additionally, even though some of the pipeline players are experiencing near-term weakness, for the most part, it is an extremely solid financial group, and ET and EPD stand out as well-positioned midstream companies.
All told, I believe the merits for an investment in MasTec far outweigh the risks.
MasTec boasts a dedicated and capable leadership, strong operating results, and best-in-class efficiency. It is not a matter of if infrastructure spending rises in the future but when, and I believe MasTec will be a long-term winner. COVID-19 has posed little risk to the company's future prospects, yet the stock has dropped over 30% since the beginning of the year, providing an excellent buying opportunity.
With the growing need for pipelines, the upcoming rollout of 5G, and the overall deteriorating state of infrastructure, MasTec has abundant opportunity looking forward, yet it is valued as a stock experiencing rapid decline. I believe if investors purchase at the current depressed levels and hold for at least five to ten years - if not entire decades - outsized returns should occur over the long run.
This article was written by
Analyst’s Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in MTZ over 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.
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