Wait, This Isn’t Minecraft! (JEC)

[Also see the SeekingAlpha commentary here]

One of my favorite video games is Minecraft. No doubt most of you have heard of or played it (if not, stop reading ASAP and go play it!). For those who haven’t, it’s basically a sandbox game that gives you a lot of freedom to build anything your heart desires. Skyscrapers, forts, castles, it’s all possible. And like many investors, I try to find ways to bring my interests and likes into the investing world. So going along with the theme of construction, I chose an engineering consulting firm for my next stock analysis, Jacobs Engineering Group (JEC).

Quick Background:

From Scottrade:

Jacobs Engineering Group Inc. is a technical professional services firm. The Company provides a diverse range of technical, professional, and construction services to a number of industrial, commercial, and governmental clients. The Company provides four categories of services: Project Services; Process, Scientific, and Systems Consulting services; Construction services, and Operations and Maintenance services. The Company focuses its services on clients operating in the industries and markets: oil and gas exploration, production, and refining; chemicals and polymers; programs for various national governments, including aerospace, defense, and environmental programs; buildings; infrastructure and telecommunications; mining and minerals; pharmaceuticals and biotechnology; power; pulp and paper; Technology and manufacturing, and food and consumer products, among others.

The company was founded in 1947 by Joseph J. Jacobs. It employs 66,300 people in over 30 countries, and is currently headquartered in Pasadena, California. JEC is a component of the S&P 500 and a Fortune 500 company. The company has received numerous accolades, including Forbes‘s 100 Most Trustworthy Companies.

JEC’s peer group in the construction services sub-sector include Fluor Corp (FLR), Chicago Bridge & Iron (CBI), and KBR (KBR).

For more basic information, check out the company’s website and the 2014 annual report.

Fun fact: An investment of $10,000 on September 1995 would be worth $69,290.01 today. This yields a annual rate of return of 10.5%, outperforming the S&P 500 during that timeframe. (Source: FAST Graphs)

Investment Criteria:

Let’s run JEC through our preferred stock screening criteria:

• I may only invest in technology companies in sub-sectors I understand: Iffy
• The company must have a ‘narrow’ or better economic moat, based on Morningstar’s judgment: Unknown (Not Rated)
• The company must have a quality rating of ‘B’ or better (‘A’ or better preferred), according to S&P’s credit ratings: Yes (B)
• Earnings must be on a consistent and significant uptrend: Yes
• FAST Graphs must show undervaluation based on the Normal P/E ratio (the blue line): Yes
• Expected return is 8% or more over the next few years, according to FAST Graphs: Yes (33.67%)

Other Bonus Ratings:

• S&P Capital IQ: 4-star Buy
  • Scale is 1-5, 1 being ‘strong sell’, 5 being ‘strong buy’
• Thompson Reuters StockReport: 5 (optimized score of 5)
  • Scale is 1-10, 10 being best, 1 being worst
  • Optimized scores weight insider trading and price momentum heavier than other criteria

Financial Overview:

The more astute observers among you may have noticed I ranked JEC with my growth stock criteria. That’s because JEC does not currently pay a dividend. Management explains their rationale in the 10-K:

Our policy is to use cash flows from operations to fund future growth, pay down debt, and, subject to market conditions, repurchase common stock under a stock buy-back program approved by our Board of Directors. Accordingly, we have not paid a cash dividend since fiscal 1984. Although our Board of Directors periodically reviews and considers the merits of paying cash dividends, we currently have no plans to pay cash dividends in the foreseeable future.

The company’s total debt/equity ratio is 0.2, half that of the peer group, indicating the company is financially healthy. YCharts tells us an interesting story about the share count. It started at 124.9 million in April 2010. This count increased consistently until June 2014, at 133.01 million. The company has significantly bought back shares since, so the total number of shares currently outstanding is 128.3 million. The company has had four 2:1 splits since 1990, in 1990, 1991, 2002, and 2007.

JEC has a current P/E ratio of 17. Morningstar states that the company has a forward P/E of 11.7. Based on what I see so far, I suspect that the lower P/E will be a result of a higher price and flat earnings. As you can tell in the FAST Graphs chart, JEC is in undervalued territory, but is starting to recover. JEC’s gross, operating, and net profit margins are all lower than the peer group’s: 16.70% vs 19.82%, 4.22% vs 6.00%, and 2.80% vs 4.29%. These numbers are a bit skewed, as my source also considers some unrelated-ish technology companies, which generally have much higher margins. But when compared to “true” peers like FLR, JEC is more in line with the average, if still slightly below.

When viewing FAST Graphs, we see that JEC has an estimated earnings growth rate of 7.9%. Even better, JEC has a three year estimated annual rate of return (AROR) of 11.95%. FLR is nearly tied with a three-year AROR of 11.94%. CBI, due to being in even deeper value territory, has an AROR of 31.00%. KBR wraps it up with a 18.23% AROR. This indicates that JEC will underperform the peer group until 2017.

Risk Factors:

•  Customer concentration – Like with most companies, over-reliance on one customer can cause serious issues if that customer suffers economically. Thankfully, JEC is working to avoid this issue. According to the 10-K, the company’s largest customer is the US government. But over the past 5 years, total revenue earned from Uncle Sam has declined from 25.4% in 2010 to 17.8% in 2014, which is a solid attempt at diversification. JEC also notes that “[i]t is uncommon for a commercial customer to contribute 10% or more” to JEC’s annual revenues.
• Workplace safety – Construction is by necessity a very dangerous field. Workers can get hurt or killed, and construction projects could get damaged significantly. If something bad were to happen, the financial and reputational hit could be massive. Since many of the projects JEC works on require minimum safety standards, any major issues could result in JEC losing the contract.
• Cost overruns – Although companies like JEC have experienced people working to estimate costs as accurately as possible, no one’s perfect. Any major overrun could hurt or eliminate JEC’s profits on a given contract. If that happens continuously, Bad Things could happen.

Final conclusion:

This is a tough call. My impression is that there are a bit too many unknowns for my liking. The moat is unknown according to my trusted source. According to others (see here and here), JEC has no-to-narrow moat. Based on what I know of the construction industry, I see no real reason to disagree. I personally lean towards narrow moat due to the reputation and breadth of the company, but there’s no denying that JEC operates in a very competitive industry. Combine that with the lower margins and lack of dividend, and I think I am going to pass. However, I really like the valuation and earnings trend, so I will still keep an eye on the company. Earnings have been rocky since the Recession, but if the economy does well in the future, JEC will probably benefit. If the share prices declines a few more dollars (possible due to the company’s oil & gas exposure), or if the company keeps decreasing share count or initiates a dividend, I may start nibbling. We shall see. Until then, I won’t be rushing to buy JEC.

Would you consider investing in a growth company like JEC? Also, how can I improve future analyses?

Disclosure: None

All data is accurate as of market close, 03/09/2015. My stock analysis archive page has been updated accordingly. Please read my disclaimer here before choosing to invest. Company logo image source is available here. Data source is FAST Graphs or company materials, unless otherwise indicated.

Tags: growth-stock-analysis, Jacobs Engineering Group, JEC