Buy Jacobs Engineering Group on Improving Architectural Spending
Brendan is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Few professionals have brighter hopes in the near future than architects. The Architecture Billings Index recently rose for the fourth consecutive month to a new post-recession high. It appears that architecture is back after languishing for years during the Great Recession. It is expected that a large amount of pent-up demand exists for architectural services and one company that should benefit is Jacobs Engineering Group (NYSE: JEC).
But why pick Jacobs when several other architectural firms are available on the market? The figure below is a bit crowded, but makes the case for Jacobs over other available firms. Two other firms are KBR (NYSE: KBR) and the Shaw Group (UNKNOWN: SHAW.DL).
Until recently, the Shaw Group had the most desirable valuation in terms of price/sales (red line vs. blue and orange lines in Figure 1). However, the firm was purchased by CB&I, thus the price has risen accordingly. Jacobs is the clear winner in terms of gross profit margin, while the valuation of all three firms is now similar. As my greatest criticism of this investment thesis is the low margins obtained by most of the firms, picking the firm with the best profit margin appears to be a good strategy. Jacobs appears to have a durable comparative advantage that has allowed them to achieve better margins and should allow them to best translate revenue growth to earnings growth if my investment thesis plays out.
Figure 1: Comparing Margins and Price/Sales for Jacobs, the Shaw Group and KBR
In this economy investors are eagerly searching for revenue growth and if the past is any indication rising construction spending should bode well for strong revenue growth from Jacobs (Figure 2). Add to this that while the firm may not appear that cheap, it is trading at the very bottom of its valuation multiples over the past 15 years in terms of price/book, 10 Year CAPE, EV/EBITDA and price to sales (1.4x, 19.3x, 7.2x and 0.497x).
Figure 2: Prior Revenue Increases for Jacobs to Lag US Construction Spending, which is Trending Higher.
Slow going for several years has caused the market to price in rather pessimistic expectations for the firm. Jacobs earned $2.94/share in 2012 versus, $2.60 in 2011 and $1.96 in 2010. While profitability has increased, the market has not rewarded the firm with a higher valuation. If Jacobs is able to follow through and deliver a 15% increase in earnings with revenue growth it is expected that the market would finally reward the firm and a price target of $50/share or 14.6x forward earnings expectations seems reasonable.
After reading through the most recent 10-K filing, it also appears that the firm is most exposed to subsectors of the economy likely to benefit from an increase in construction spending (Figure 3).
Figure 3: Jacobs Engineering Revenues by Sub-Division.
It is expected that Mining and Oil & Gas Upstream are most likely poised for slower growth in the near term. Both mining and oil companies have responded to slower growth by cutting their CapEx spending, but Jacobs is less exposed to these areas compared to sectors that are expected to have better growth in the near term. Refiners (21.8% of revenue) have been doing very well in recent times. Government spending programs (20.8% of revenue) should provide stable or increasing growth with money flooding into municipalities through the bond market and deferred government spending on infrastructure is badly needed in the near term. Infrastructure and Buildings (combined 17.7% of revenue) should provide the best revenue growth, while Chemical and Polymers (15.6% of revenue) firms have also done quite well recently and should continue to do so given the low price of natural gas liquids.
In total, the future of Jacobs Engineering group is likely brighter than the market is currently discounting. With the current selling related to the fiscal cliff, it seems like a good time to buy for around $40/share. Craig Martin, the CEO of Jacobs, owns 0.5 million shares or $20.6 million, while Noel Watson, a director at the firm, presently owns 0.86 million shares or $35.5 million. I agree with these insiders, the upside reward appears to outweigh the downside risk for Jacobs Engineering Group.
The post above was written by myself and expresses my own opinions. It should not be construed as a soliciation to buy the mentioned security. Please perform your own due dilligence before taking a long position and carefully weigh the risk and reward.
I am presently short 20-July-2013 $43 puts in order to lower my cost-basis below $40/share, however, if the price of JEC falls below $40 simply buying the stock is likely the best trade.
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