KBR (KBR) derives a a large part of its engineering and construction revenue from the oil and gas industry in North America, benefiting from the production increases and the growth in international emerging markets and in the U.S. and Canada, says Robert F. Norfleet, Managing Director and Senior Equity Research Analyst at BB&T Capital Markets.
“[A] name that we tend to like right now is the company KBR, as about 60% of their revenues are derived from what we call the hydrocarbons market, which includes gas monetization; that’s LNG, oil and gas, and petrochemical. KBR has long been a leader in building petrochemical facilities, LNG facilities, and various oil- and gas-related investments. We think KBR is benefiting now, and will benefit in the future, both from the growth in the international emerging markets as well as from the growth in North America,” Norfleet said.
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KBR has a strong presence in the LNG market, and they are one of the technology and expertise leaders in building different types of plants suited for the needs of their clients, Norfleet says. He adds that this company is poised to benefit from global growth.
“The company’s built one of two of the largest gas-to-liquid facilities in the world, they have a leading technology in building ammonia plants, they’ve built ethylene crackers and they have a very strong footing in the LNG market. So again, we think that KBR is another company that’s well-positioned to benefit both from the growth we’re seeing internationally as well as this trend towards increasing capital investment in North America,” Norfleet said.
Union Pacific Corporation (UNP) grows while increases pricing thanks to the shale drilling taking place in North America, with volume expected to grow and with the railroad returning capital to shareholders in the form of repurchases, says François Rochon, President and Portfolio Manager of Giverny Capital.
“The reason we bought Union Pacific is, and we talked about this in our annual letter, that we used to own BNSF before Berkshire Hathaway (BRK-A) purchased it. We like the fundamentals of the rail industry. This summer we went to meet the president of a big company, and he told me that he thought that BNSF and Union Pacific are almost a duopoly in the western railroad industry.”
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Rochon likes the cost structure at UNP, and the says the railroad has increased pricing by about 5% per year in the last five years, a number that is especially meaningful in this low-inflation environment. The company, moreover, is conscious of its shareholders.
“They repurchased close to $6 billion of shares in the last few years. If you combine the volume increases, margins improvements and the pricing gains with returning money to shareholders, we think they can grow their earnings per share at about 12% to 15% a year going forward. The p/e ratio is about 15 times, so we think it’s reasonable,” Rochon said.
Worthington Industries’ (WOR) exposure to nonresidential construction could rise to 20% in a better construction market, adding $0.40 extra earnings power, and the company is also seeing additional upside through its internal cost takeout program, says Arun Viswanathan, Senior Equity Analyst at Longbow Research.
“Worthington is currently at about 11%, but it could be 20% in the better market, which it was back in 2007, 2008. So in that case…we see about anywhere from $0.20 to $0.40 of extra earnings power to Worthington; that’s about 10%,” Viswanathan said.
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WOR has a flexible business model which makes the company less exposed to weak steel pricing, as WOR passes through price increases and decreases to its customers. Additionally, WOR is exposed to other strong markets and is continuing its internal cost takeout program that should give WOR additional upside in the future, Viswanathan says.
“They’re very spot-oriented, and then they do have exposure to strong markets other than construction as well…in case of Worthington, you have large exposure to auto, which is about 50% of their steel business is in autos,” Viswanathan said. “Worthington [also] has a particular program called Transformation, which has really helped their SG&A cost come down in the last couple of years, and we see that they are only about 40% through this program, so there is quite a bit of additional upside there.”
Quanta Services (PWR) is well-positioned to benefit from increased infrastructure construction in electric T&D and energy pipelines in both the U.S. and Canada, and exposure to increased North American energy capex drives strong revenue growth and margin improvement for PWR, says Noelle Dilts, Vice President at Stifel, Nicolaus & Co.
“In the U.S., we estimate that it has about 45% market share in transmission, and then we estimate the company has about 30% share of the long haul oil and gas pipeline market…The midstream market has shown strength over the past two years, while the long haul market has struggled. Quanta has a strong position in long haul, which is the piece of the market we expect to improve significantly in 2013,” Dilts said.
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PWR is also in a good position in Canada in electric transmission and pipeline, and exposure to these verticals drives strong revenue growth and margin improvement, adding to other characteristics that make PWR a solid player in the construction space, Dilts says.
“The company also has a strong balance sheet. They have minimal debt and recently divested their telecommunication business, which has resulted in a strong net cash position of $1.85 per share. I think the company is in a good position to make an acquisition,” Dilts said.
CarMax (KMX) changed the used-car retail industry by offering customers a big-company experience in a market dominated by moms-and-pops, and the company is now resuming its store expansion plans after having remained profitable even during recession years, says François Rochon, President & Portfolio Manager at Giverny Capital.
“They offer consumers a very good deal, and a very good guarantee. They buy their cars at a very good rate. So for the consumer, I think it’s a much better experience owning used cars. And even though they have 119 large super stores, they still have less than 3% of the market. It’s very fragmented, it’s a very big market, and we think they really have a very big competitive advantage,” Rochon said.
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Rochon says CarMax plans to increase new stores by 50% to 60% in the next five years, and he expects a growth rate of 15% to 20% for many years. He says Thomas Folliard, the CEO, has been implementing the right culture, and his growth plans are promising.
“We just thought that CarMax could continue to grow 15% a year for many years, and it has doubled since we bought it. So far we’ve been right on that. The stock had a little correction, down 67%, during the 2008 downturn, but it came back and it is about double what we paid, simply because earnings per share have doubled during that time frame. We think they will do that in the next five years also,” Rochon said.
Freeport-McMoRan Copper & Gold (FCX) consistently beats consensus EPS estimates and is poised to grow copper and metal sales in the double digits from 2012 levels and declining costs due to enhanced recovery capabilities due to higher grade, says Garrett S. Nelson, Vice President at BB&T Capital Markets.
“Freeport is unique in possessing one of the best volume growth profiles in the industry. This year, they expect to increase copper sales by 18% and gold sales by nearly 40% over 2012 levels, and they’ll grow volumes even further in 2014 largely due to the fact they’re moving into an area of the pit at their cash cow Grasberg copper and gold mine in Indonesia, where the ore grades are significantly higher,” Nelson said.
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FCX announced its plans to acquire Plains Exploration and Production (PXP) and McMoRan Exploration (MMR) in early December, leading to some criticism of the mining company. Nelson says, however, the miner has a track record of beating consensus EPS estimates for 15 of the last 16 quarters, and he expects the dilution of these acquisitions to be relatively modest.
“The acquisitions and various organic growth projects on the copper side should help mitigate the various labor, geopolitical, and asset and commodity concentration risks for the company, particularly at Grasberg, although it was difficult for some shareholders to take that longer-term view when they announced the acquisitions. The stock actually declined 16% the day Freeport announced that, and a number of analysts downgraded the stock. But we argued that the selloff was an overreaction and stuck with our ‘buy’ rating. As it turns out, the stock has rebounded since, and that day marked its low point,” Nelson said.
Granite Construction (GVA) is positioned to benefit from positive movement in the construction market as project demand increases and pricing improves, resulting in potential upside for GVA, says Jack Kasprzak, Managing Director and Senior Equity Research Analyst at BB&T Capital Markets.
“Granite Construction is a highway and bridge construction company. They perform the actual construction work, and we think they are very well-positioned with the way the markets are moving right now. If this trend continues, and all three main end markets improve, one of the things that should happen is capacity should be soaked up, which translates into improved pricing for projects,” Kasprzak said.
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Kasprzak says that pricing has been under pressure over the last several years because of the environment; however, he now expects the number of bidders per project to decrease as demand rises, improving pricing and benefiting companies such as GVA.
“When I say pricing, I mean the bidding on various types of projects should go up. You had seen a sharp increase in the number of bidders over the last several years because of limited demand, which drove down pricing. If that reverses, and we see more projects so the number of bidders on any one project starts to decline, pricing should improve and there should be some pretty nice margin potential upside at Granite Construction,” Kasprzak said.
Steel Dynamics (STLD) is one of the lowest-cost steel producers, remaining competitive even in a lower pricing environment, and its investments into the company have allowed STLD to produce more today than before the financial crisis, says Shneur Gershuni, Executive Director at UBS Investment Bank.
“The company spent a lot of money throughout the recession and into the early part of the recovery making investments in their company. I think that both their trough and their peak earnings power is higher today for any given steel price because of those investments they made. Their ability today is stronger than when it was even pre the financial crisis,” Gershuni said.
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STLD has diversified products at their structural mill and has made investments in special bar quality products, allowing the company to produce more higher value-added product today than before and solidifying STLD‘s position in the steel market.
“So for example, they have a structural mill. Previously, that would just go up and down with construction cycles, but now they have made investments to diversify the products like rail and absorb latent capacity there. They have made investments in special bar quality, or SBQ…to develop these types of specialty products that command premium prices for and so forth,” Gershuni said.
Plains All American Pipeline, L.P. (PAA) is among the larger master limited partnerships, being a candidate for a core holding for investors looking to increase their exposure to MLPs, an asset class benefiting from low interest rates and investor desire for yield, as well as the growing demand for energy infrastructure in North America, says Gregory A. Reid, Managing Director at Salient Partners, L.P.
“Among the larger-cap companies that we have larger positions in, here in Houston we have Plains All American Pipeline,” Reid said. “We view Plains as a very solid core holding. The yield is around 4% today, and we expect to see about 8% to 10% growth out of that company in the next several years annually, so that would be something that would be a core holding.”
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Although PAA does not offer the highest total return among MLPs, Reid says this stock can act as an appropriate part of a balanced portfolio that has exposure to the tailwinds affecting this sector.
“You are probably not going to have as high a return on Plains because it is fairly low yielding — less than 4% today is a fairly low yield on that security — but something we feel would be an appropriate core holding. It is a pretty large part of the index as well, the Alerian MLP Index; I think it’s around 6.5% of the index currently,” Reid said.
Royal Gold (RGLD) expects to grow earnings through its gold mining projects in Canada and Chile in a way that is not dependent on the price of gold. Garrett S. Nelson, Vice President at BB&T Capital Markets, rates this miner a “buy,” and he says pullbacks in the price of gold present investors with a more attractive entry point, especially as developed nations continue increasing their money supply.
“Royal Gold is poised to realize extraordinary earnings growth over the next few years with the impending start up of a couple of mines in which they have very large royalty interests — Thompson Creek’s Mt. Milligan mine in Canada and Barrick Gold’s (ABX) Pascua-Lama mine in Chile. Importantly, this earnings growth is not dependent on gold prices, although higher gold prices would certainly help produce additional royalty revenue and act as an additional tailwind for the stock — the growth is driven by volume and the incremental royalties they’ll collect when those two mines start up,” Nelson said.
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Nelson says RGLD has very low overhead, with less than two dozen employees, allowing the company to generate EBITDA margins greater than 90%. He adds that management has a track record of successful favorable and accretive royalty agreements.
“The cash flows from Mt. Milligan and Pascua-Lama should help fund additional royalty agreements and dividend increases down the road. The stock is down from a 52-week high of just over $100 to levels where the valuation is very attractive. Also, historically this is a stock that’s outperformed both physical gold prices and senior gold producer equities by a wide margin, so we view RGLD as the best way to play gold that’s available to investors,” Nelson said.
