Design for Growth
By Stewart Scharf
This week's S&P Focus Stock of the Week is URS Corp. (URS ), ranked 5 STARS by Standard & Poor's, its highest investment ranking.
This leading architecture and engineering services company, which focuses on infrastructure projects for the transportation, industrial process/petrochemical, building and facilities, water/wastewater and hazardous waste markets, is well-positioned to benefit from increased federal spending on transportation (25% of revenues), as well as strong demand for energy (5%) and water resources (10%) projects. URS specializes in planning, design and construction services for both domestic public (16% of revenues federal; 33% state and local) and private (40%) customers, with the majority of its revenues generated from contracts valued at less than $1 million, which limits its risk exposure.
The company has pursued an acquisition growth strategy to broaden its operations over the past few years, including the purchase of Dames & Moore in 1999 ($1.1 billion in revenues). Since fiscal 1995 (Oct.), revenues have increased from $180 million to $2.2 billion in fiscal 2000. Looking ahead, S&P anticipates revenues to advance in the low-to-mid single digits into fiscal 2002, as soft global economies (11% of revenues international) and a tight labor market for engineers offset growth in public infrastructure projects.
Future comparisions for new orders are difficult as the company lacks the large, multi-year contracts that it received in fiscal 2000. However, with backlog (we project modest growth to over $1.6 billion in fiscal 2001) having advanced at a faster rate than capacity in recent years, there is minimal concern regarding new orders.
Mitigating economic-induced pressure on organic revenue growth near-term will be improved profitability levels enabled by acquisition-related synergies. A new accounting system is expected to be in place by late calendar 2002, further enhancing accounts receivables levels with days sales outstanding (DSOs) declining. This should generate additional cash for debt paydowns, which will further reduce interest expense.
Although the company's acquisition strategy has led to a greater leverage ratio (recently 68% debt-to-capital), S&P believes URS will reduce this level to about 55% by late fiscal 2002, as its strong cash generation will be used to pay down debt rather than for additional acquisitions. However, when its leverage ratio returns to a more acceptable level, URS may seek a growth-by-acquisition strategy once again, albeit of the smaller variety than those of recent years.
ROOM TO RUN.
Given the company's focus on margin improvement and debt reductions, along with positive trends in its respective markets and the bulk of its services provided in the early stages of projects, we see potential for significant capital gains. Although URS's depressed valuation partially reflects its high debt level, the shares appear undervalued at only 10 times S&P's $2.45 EPS estimate for fiscal 2001, a 40% discount to its peers and nearly 50% below the projected p-e for the S&P SmallCap 600 Index.
With an improving operating strategy and a sound management team, which orchestrated the company's reorganization in 1990, we see EPS growing more than 12% in fiscal 2002 to $2.75, making for an attractive PEG ratio (p-e-to-EPS growth rate) of 0.75, a ratio well below that of the broader market. S&P discounted cash flow analysis implies an intrinsic value range for URS of $30 to $35.
Scharf is an equity analyst following engineering & construction stocks for Standard & Poor's