Arcosa, Inc.: A Low Leverage Bet On America's Infrastructure

Summary

• ACA is well positioned to take advantage of any stimulus that could be passed to lower unemployment.
• Its low leverage and strong sales growth give it room to run.
• I'm bullish long term, but I'm waiting for a pullback to the $35 level.

Arcosa, Inc. (NYSE:ACA) Overview

A late 2018 spin-off of Trinity Industries (TRN), the Arcosa split created two purer play companies with TRN focused on railroads, while Arcosa focuses on construction and shipping. In their short time as an independent company, ACA has achieved impressive sales growth both organically and through prudent acquisitions largely funded with cash from operations. Each of their segments has been classified as essential, but they are certainly not immune to the cyclicality of the construction business. Both CEO Antonio Carrillo and CFO Scott Beasley have held these roles since the spin-off and were senior members of Trinity Industries prior to the separation.

Business Dynamics & Financials

ACA operates in three segments - construction products, energy equipment, and transportation products.

	Construction	Energy	Transportation
Q1 '20 Revenue	$149.4M	$223.2M	$117.0M
Y/Y Rev Change	41%	7%	20%
Q1 '20 EBITDA	$32.1M	$35.2M	$18.7M
Y/Y EBITDA Change	49%	-5%	55%

Click to enlarge

Source: ACA 1Q20 Earnings Slides

Construction Products - While growth in the construction products segment appears impressive, most of it was non-organic as the Cherry acquisition added roughly $44M to sales and $9M of EBITDA to the aggregates and specialty materials sub-group. At a purchase price just under $300M, 10x EBITDA seems reasonable given the expected growth in the Texas market. Furthermore, the acquisition was funded through debt, $250M at LIBOR+1.5% (currently ~2.5% after COVID-19 induced drop), and $100M at 4%. In the current interest rate environment, this was a smart investment paying under 4% interest while earning close to 10% especially given the potential for growth in the investment and a low leverage balance sheet at 0.5 Net Debt to EBITDA. Expect this segment to experience some weakness in 2Q, potentially 3Q, as COVID-19 will be a near-term headwind as spending drops, potentially offset in the medium/long term by any infrastructure spending by the government to kick-start the economy. Mr. Carrillo offered some guidance "we started the second quarter pretty strong. We're not seeing in the aggregates piece any delays, yet, any signs of stress."

Energy Equipment - Sales for this quarter can be further broken down into a $176.4M Wind Towers business and a much smaller $46.8M storage tank business primarily for the oil and gas industry. As of 3/31/20, wind towers had a healthy backlog of $476M, and management expects minimal impact related to COVID-19. On the other hand, the storage tank business will experience a mixed impact as low oil demand places a strain on storage capacity. The backlog for this sub-segment is small, primarily due to the smaller lead time compared to a wind project, so it is subject to great variability. Finally, a positive for this segment as well as the transportation business are low steel prices as stated by the CEO, "we're buying steel at half the price that we were buying a year ago could help us get some additional business."

Transportation Products - Barges accounted for roughly 80% of sales while rail components, largely a holdover from the TRN split make up the rest. With a backlog of $348M in sales from barges, exceeding total sales from 2019, there should be minimal impact from COVID-19, while lower steel prices are positive for profitability. Rail related demand has declined significantly, but a decline in this offset should be more than offset by growth in barges as highlighted by Mr. Carrillo, "both the liquid and dry cargo barges more the dry cargo have aging fleets. And those fleets have to be replaced."

Opportunities

We'll take a look at what I believe to be the top opportunities for the industry, the company, and a wildcard.

Industry - At the moment, low material costs - whether that's steel, oil, copper - make infrastructure project more economical. Infrastructure suppliers like ABM have the opportunity to leverage low raw material costs in a bid to begin projects ASAP before costs go up and projects become more expensive. Particularly, if raw material costs start to rise, clients will be incentivized to lock in projects over the fear of rising costs in the future.

ACA - ACA's low leverage relative to peers provides them with the flexibility that competitors may not have. They are less likely to issue expensive debt in a tight market and may have the opportunity to purchase distressed assets or companies in a downturn. They have already laid out the vision to look for strategic acquisition growth in the areas of natural and recycled aggregates, specialty materials, and utility structures.

Wildcard - In the aftermath of COVID-19, there will be pressure on governments to reduce unemployment with one possible avenue being infrastructure spending. Estimates from 2016 "suggest that improving U.S. infrastructure to an "adequate state" requires a total investment of approximately $4.6 trillion from 2016 to 2025" according to the Arcosa 2018 Investor Day Presentation. Low interest rates provide the perfect environment to spend on projects with long-term benefits.

Risks

I'll take the same approach as opportunities by looking at the top risks for the industry, the company, and a wildcard.

Industry - While high unemployment could provide an impetus for government infrastructure projects, COVID-19 is stretching state budgets thin, so it's hard to imagine any but the most important infrastructure projects going forward. The federal government with an ability to issue new money could provide a source of project funding, but that would take time and might only make sense after lockdown orders have been lifted, and we see how much unemployment is here to stay.

ACA - Wind towers and utility structures have a solid 2020 backlog, but with longer lead times, lower bookings around the project now would lead to lower sales in 2021. This may be offset a bit as lower steel prices may convince clients that the economics make sense despite the uncertainty. When pressed on the issue, Mr. Carrillo could not commit too much beyond 2020 other than to state, "There's a little more uncertainty on wind, but we will have a wind business in 2021 and it will be profitable."

Wildcard - Management has set a long-term target of 2-2.5x Net Debt/EBITDA target, up from 0.5, and while that puts them in line with the industry, the airline industry just proved that an entire industry can be wrong. As ACA increases leverage, it will be important to separate out organic sales growth to understand the company's operational performance. Be careful to avoid a potential growth trap if the market assigns too lofty a valuation to the company if growth is fueled by leverage.

CEO & Management Team

Over the long term, the CEO and Management team have the power to either create or destroy shareholder value, so I think it's important to listen to at least one conference call and examine their history to get a feel for their character as well as possible strengths and weaknesses.

Both the CEO and CFO were involved in the conceptualization of the Arcosa spin-off from Trinity, so they should understand the business they're leading better than anyone. The majority of the acquisitions to-date have been smaller and funded with cash from operations. The Cherry acquisition is the exception but made sense given leverage well below the industry standard and attractive loan rates. They've laid out a long-term vision that places a bigger emphasis on ESG initiatives, a strategy that has paid off well for others and can often be a cost-effective way to increase the appeal of infrastructure projects. I would have liked to hear the heads of the individual segments on the call to get a better feel for decisions being made at a more granular level but not many companies choose to do that.

It's encouraging to see CEO Carrillo make an open market purchase of 15k shares on March 19th in the middle of panic selling by the rest of the market. He spent $451k, increasing his total share count to 215,258, that's roughly $9M at $41.62/share (the price as I write this article), about 4x his annual salary. It's good to see management with skin in the game, and it's perhaps even better to see a CEO that can look past the panic in the market and seize an opportunity. Source: ACA Insider Trading Activity (Arcosa)

Overall, it's rare to see such a comprehensive quarterly presentation breaking down results by sub-segment and giving clear guidance for each. They lay out the competitive advantages ACA has in each sub-segment and lay out a long-term vision with potential opportunities.

Conclusion And Recommendations

I wish I knew about this company 3 weeks ago when it revisited March lows in the low $30s. I believe this company has a lot of potential and am bullish in the long term, so long as they keep their leverage under control with prudent acquisitions. I see clear resistance in the chart at the current price near $41, and $47 represents an all-time high. With so many other stocks offering a significant margin of safety, I'm not going to chase a stock when there's a reasonable chance it could pull back to $35 in the near term.

Analyst’s 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.

Comments

[jamiemacph]

Thanks for the write up! Under followed stock imo, particularly during this streak for industrials. I bought into ACA in October ‘19 with a similar thought pattern (minus Cherry acquisition which hadn’t happened yet) and have been quite pleased with execution since

[A Pragmatic Investor]

You maybe waiting a while for that pullback.
As you noted, it is moving without any serious infrastructure talk.
I own through the Trinity spin-off, it has not been super exciting ... but did not expect it to be.
At this rate of movement, it will hit $50 before your target price.
For me it is a hold, others will have to wait.

Long ACA.