Aecon’s share price is aided by increased infrastructure spending, as the Canadian Engineering & Construction industry is booming
Juri Zguri | Ubika Research Analyst | June 7, 2016: With a healthy balance sheet and a history of increasing its dividend, Aecon Group Inc. (TSE:ARE) seems poised to benefit greatly from an expected increase in government and private sector infrastructure spending in the coming years.
Company Overview
Aecon Group is a construction and infrastructure development company that operates through four segments: Infrastructure, Energy, Mining and Concessions. The Infrastructure segment includes all aspects of the construction of both public and private infrastructure in Canada, and on a selected basis, internationally. The Energy segment encompasses a suite of service offerings to the energy sector, including industrial, construction and manufacturing activities, such as in-plant construction, site construction and module assembly. The Mining segment offers services consolidating its mining capabilities and services across Canada, including both mine site installations and contract mining. This segment focuses on delivering construction services. The Concessions segment includes development, financing, construction and operation of infrastructure projects by way of build-operate-transfer, build-own-operate-transfer and other public-private partnership contract structures. This segment contributes roughly 0.1% of total revenues.
Figure 1. Revenue Segments for FY2015
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Source: Thompson Reuters, Ubika Research
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Aided by Increased Spending, the Canadian Engineering & Construction Industry is Booming
Aecon operates in the engineering and construction (E&C) industry and derives virtually 100% of its revenue from Canada. As such, the Company is highly exposed to macroeconomic conditions. To be more specific, Aecon relies on GDP expansion and focuses on infrastructure and capital asset growth. One factor that has promoted demand and expansion in the industry at large is the current era of low interest rates. This allows for cheap money and thus continuous and less constrained big purchase spending (i.e. capital assets).
The most significant trend that has the construction industry booming is specifically-enhanced infrastructure expenditures by Canada’s new Liberal government. Led by Justin Trudeau, the Liberal party has promised massive spending additions throughout the next 10 years.
Figure 2. Increased Liberal Infrastructure Spending
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Source: Company Filings, Ubika Research
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By essentially doubling federal spending on infrastructure throughout the next decade, Aecon is exposed to many opportunities across Canada that specifically relate to: public transit, bridges, highways, and water treatment plants. In effect, the Company’s infrastructure segment is poised for growth.
The oil sector recovery is still expected to be slow in the second half of the year, as producers in the West are cautious to revamp capital expenditure plans in fear of another spike down in crude prices.
That being said, the stronger mining sentiment across the country, as well as nuclear power infrastructure, will provide more than enough to offset the fossil fuel energy weaknesses.
In terms of industry trends, the construction industry is moving towards larger, longer-term projects that provide a more significant backlog for Aecon. For example, Aecon has expressed preference to work with giants such as Suncor Energy (TSE:SU). This will provide the Company with more recurring revenue, further stabilizing its revenue stream.
Aecon’s stock has been performing relatively well compared to the market overall.
Throughout the past year, it has been largely affected by oil prices. Although energy makes up ~40% of the Company’s revenues, investors must not jump to the conclusion that all energy equals oil. A significant chunk of that 40% is nuclear energy infrastructure – a growing segment in Canada. That being said, the Canadian economy does tend to perform worse when oil prices are depressed, so investors have reason to dump a stock so closely linked with the performance of that country’s economy. With oil prices stabilizing at the US$50 mark, we believe Aecon’s stock price is poised to continue its upward trend.
Figure 2. Aecon’s Price & Volume Relationship from June 3, 2015 to June 3, 2016
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Source: Yahoo Finance, Ubika Research
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Investment Thesis Points
• Healthy Balance Sheet with Steady Cash Flows
Aecon has accumulated a cash balance of $214.37 million on its books. When compared to long-term debt of $263 million, and other debts of $76 million, a case can easily be made to show Aecon’s healthy cash and debt levels. To further relay this point, Aecon has conservative Debt-to-Equity and Debt-to-Total Capital figures of 48.39% and 32.61%, respectively.
• Stable Dividend History
Aecon currently sports a 2.62% dividend yield. This appeals to income investors, mainly because of its history of growing the dividend payout since 2011. The compounded growth rate (CAGR) since then is ~15%. The Company has stated it expects its cash interest expense (~$28 million in 2015) to decrease in FY2016, and capital expenditures to remain consistent. Coupled with the current booming industry environment, as well as successful operations that continue to provide a steady cash-flow stream, investors can continue to expect a healthy dividend.
Figure 3. Aecon’s Growing Dividend History
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Source: Company Filings, Ubika Research
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• Experienced Player in Public Infrastructure Space
As mentioned before, Canada’s Liberal government has enacted a plan to double infrastructure spending annually for the next decade. This, of course, provides a boost to all the players in the space. However, we believe Aecon is best positioned to capitalize on this. First, Aecon derives ~33% of its total revenue from infrastructure, whereas the competitors with the next highest figure is SNC-Lavalin (TSE:SNC) with just ~20%.
In addition, Aecon can leverage its experience with big-ticket public infrastructure projects in the past in order to gain lucrative contracts in the future. Currently, the Company has a large stake (~35%) in the Eglinton LRT project in Toronto, Canada, which is valued at over $5 billion. In the past, the Company has been involved in several historic federal landmarks, such as Toronto’s CN Tower.
Catalysts
The United States is a market that we believe is prime for construction work. Not heavily saturated or inflated, infrastructure in the U.S. is a target we believe Aecon may choose to pursue in the near future. CFO David Smales has already expressed interest in expanding its international footprint in the upcoming ~5 years.
From a valuation standpoint, Aecon trades at a discount to its peer-group average. For example, the Company’s LTM EV/Sales figure is 0.4, significantly lower than the peer average of 1.0. Additionally, Aecon’s EBITDA multiple is 5.8, compared to the peer average of 9.2. In terms of equity value multiples (specifically P/E and P/CF (LTM), Aecon trades in line with its peers at 18.7 and 13.2, respectively.
Risks
1. Large Project Risk
2. Contractual Obligations
3. Political & Regulatory Environment
4. Higher Lending Rates in Coming Years
