Description

Dycom Industries, Inc. is a provider of specialty contracting services, including engineering, construction and maintenance services to communications (telecom and cable) companies and utilities throughout the United States and Canada. DY operates in 3 end markets: telecommunications, underground facility locating, gas utilities & other. Telecom is the biggest driver of the business, responsible for ~89% of revenue. The segment provides engineering, construction, and maintenance services to telecom companies and cable operators in connection with the deployment, expansion, or maintenance of new and existing networks. Underground facility locating includes locating telephone, cable television, power, water, sewer, and gas lines. The gas utilities & other segment performs construction and maintenance services for those customers.

The stock has re-rated during COVID as broadband has become an integral utility powering work/school from home. The stock is trading near its 5-year high from an EV/EBITDA basis around 9x. Expectations are for the company to return to growth in their FY2022 and margins to expand. The stock is rated Buy by all eight sell-side analysts that cover it.  It’s viewed as a pure-play on major telcos investing in fiber to support faster and faster broadband and mobility backhaul for 5G.

However, the KPIs that the company presents show a different story.

The company’s reported backlog has fallen YoY for six consecutive quarters.  Next twelve month backlog has been negative YoY for nine consecutive quarters.  The company tried to explain the 3Q21 backlog weakness (-15% YoY and -16% QoQ) by saying that $740mm of backlog had been booked subsequent to quarter end (11/24/20).  Yet, in 3Q20, the company mentioned that in excess of $1.5b of backlog had been booked subsequent to quarter end (11/26/19).  So it would seem that they’re on track for another material YoY decline in bookings.  

All this is also coupled with a multi-year long deterioration in DSOs.  While no secret as the company readily reports this figure, investors in telco suppliers should see it as a flag.  Given the extreme customer concentration (top six = 81% of revenues for FY2020), extending terms is usually the first “give” in a contract negotiation that signals the customers have the leverage and can be followed by more painful conversations around pricing.  In FY2018, revenue from VZ/T/CMCSA/LUMN represented 72% of revenues and 69% of receivables and contract assets.  In FY2020, it was 74% of revenues and 79% of receivables and contract assets.  This coincides with DSOs moving from 84 days in FY2018 to 115 days in FY2020 (and 129 days at end of 3Q21).

Earnings are tomorrow morning.  The company doesn’t guide annually, only quarterly.  Expectations for 1Q22 revenue are -5%, not heroic.  However, FY22 revenue estimates are for 3% growth, implying decent revenue growth in 2H22.  These expectations seem high given the trend in backlog and the amount of money that VZ and AT&T have just spent on the C-Band spectrum auction.  It seems that capex at those two customers will now shift more to enabling that valuable spectrum vs. laying fiber.  VZ/T represented 38% of LTM revenue.

Given the weakness in backlog and DSOs, high exposure to VZ/T that must shift capex dollars to spectrum rollout, and expectations that have steadily increased in a COVID world, I think DY is a short here.  

Sell side is at $344mm of EBITDA for FY22 (up 10% from FY21) on 3% revenue growth.  I think revenue could be flat to down and margins flat.   Using $315mm of EBITDA and a more tempered 7.5x multiple as investors realize the shift in focus by the company’s two largest customers, I get to a $54/share price target.

A note on RDOF.  I understand that RDOF will be used by CHTR and other broadband companies to edge out to rural areas and that may benefit DY.  It replaces CAF II, which was $1.5b per annum.  What we know currently is that Phase 1 of RDOF awarded $900mm a year for 10 years to the winners, which was lower than the $1.6b per annum expected.  The savings have been rolled over to Phase 2, but the fact that less was awarded than anticipated in Phase 1 suggests that costs have come down.

“These results suggest that the cost of fully addressing the broadband availability gap may be much less than many currently anticipate.  To be sure, average per location support awarded via Universal Service Fund (USF) programs has consistently gone down – from $2,400 in the Connect America Fund Phase II (CAF-II) model-based framework, to $2,000 in the CAF II auction to $1,700 in RDOF Phase I, with some large winners winning at substantially less.  For example, Charter, which has said it is seeking to expand its HFC footprint, won support for over 1 million locations at an average of $1,156/location.” (https://www.attpublicpolicy.com/fcc/the-rdof-auction-results-and-implications-for-u-s-broadband-policy/)

This could imply that when Phase 2 of RDOF is all said and done, there will be less funding per annum given out than CAF II.  Plus, CAF II funding was based on a cost model, while RDOF was a reverse auction.  CAF II recipients were thus incentivized to inflate costs to boost revenue, while RDOF recipients will be hypersensitive to actual costs as that would impact their projected returns.  It also implies that cost to build has come down drastically since CAF II, which should be negative for DY.

Catalyst

Catalysts - negative earnings revisions lead to multiple contraction

Key risks - backlog reverses trends, DSOs contract leading to better FCF, multiple expansion