Description

While value investing is essentially a "bottom-up" approach, let me begin with a passage from Security Analysis which appears presently justified:

"When the general market is high there are always a number of individual issues that appear definitely undervalued by objective standards, and consequently even more attractive in contrast to the inflated level of other stocks.  The analyst may be tempted to recommend these as unusual opportunities.  But that is a time that calls for especial caution.  Not only may the "neglected security" continue neglected for the remainder of the bull market, but when the downturn comes it is likely to decline in price along with the general market and to fully as great an extent.  In a word, beware of "bargains" when most stocks seem very high."

While I do not see the present market as a "bull market" (nor do I care) and at no point is what follows based on relative valuation, the caution remains warranted.  Given the high level of "Author Exit Recommendations" recently and short sale ideas recently, perhaps my pessimism is shared by other VIC members.  Hedging systematic risk, while in "normal" times a good idea, would seem extremely important presently.  With that encouraging preamble, below is my investment thesis for Dycom Industries, Inc. ("DY" or "Dycom").

Note that when I began analyzing DY and constructing this write-up, the share price was roughly $8.80 versus today's closing price of $9.93.  While I still see compelling value, the share price has advanced 12.84%.

Introduction
Given that DY has not previously appeared on VIC, and is not likely a familiar name for members, a relatively detailed summary of the business follows. 

Dycom Industries, Inc. is a leading provider of specialty contracting services principally to telephone and cable companies.  The company was incorporated in 1969 (IPO in 1970) and is based in Palm Beach Gardens, Florida.  Through 30 separate subsidiaries, operations are conducted in 48 states and to a limited extent Canada.  As of February 2010, the business employed approximately 8,300 people.  Note that the company's fiscal year ends the final Saturday of July.   

Given average free cash flow ("FCF") of $58.32 million over the past decade (ten years ended July 25, 2009), a market capitalization ("MC") of approximately $401.32 million and enterprise value ("EV") of $400.74 million , common shares can currently be purchased at 10-year average FCF/MC of 14.53% and 10-year average FCF/EV of 14.55%. 

The company has generated $32.1 million FCF during the first 6 months of fiscal 2010, which ended January 23, 2010.  Assuming the second half of fiscal 2010 approximates the FCF generated in the first six months, the company is on pace to generate $64.2 million in the 12-months ended July 31, 2010, which would equate to a FCF/MC of 15.99% and FCF/EV of 16.02%.  

In addition to a high FCF yield, there appears to be an estimated $0.76 to $1.93 per share in excess working capital.

Additional Detail/"Qualitative"
Lines of Business
The specialty contracting business is divided (by the company) into the following three broad categories:

  Telecommunications Services

Telecommunications is divided into three primary areas:

From the most recent 10-K:
Engineering.  We provide outside plant engineers and drafters to telecommunications providers.  These personal design aerial, underground and buried fiber optic, copper, and coaxial cable systems that extend from the telephone company central office, or cable operator headend, to the consumer's home or business.  The engineering services we provide to telephone companies include: the design of service area concept boxes, terminals, buried and aerial drops, transmission and central office equipment, the proper administration of feeder and distribution cable pairs, and fiber cable routing and design.  For cable television multiple system operators, we perform make ready studies, strand mapping, field walk-out, computer-aided radio frequency design and drafting, and fiber cable routing and design.  We obtain rights of way and permits in support of our engineering activities and those of our customers, and provide construction management and inspection personnel in conjunction with engineering services on a stand-alone basis.

Construction, Maintenance, and Installation.  We place and splice fiber, copper, and coaxial cables.  In addition, we excavate trenches in which to place these cables; place related structures such as poles, anchors, conduits, manholes, cabinets and closures; place drop lines from main distribution lines to the consumer's home or business; and maintain and remove these facilities.  These services are provided to both telephone companies and cable television multiple system operators in connection with the deployment of new networks and the expansion or maintenance of existing networks.  For cable television multiple system operators, our services also include the installation and maintenance of customer premise equipment, including set top boxes and modems.

Premise Wiring.  Premise wiring services are provided to various corporations and state and local governments.  These services are predominantly limited to the installation, repair and maintenance of telecommunications infrastructure within improved structures.  

  Underground Facility Locating Services

From the most recent 10-K:
 We provide underground facility locating services to a variety of utility companies, including telecommunications providers.  Under various state laws, excavators are required, prior to excavating, to request from utility companies the location of their underground facilities in order to prevent utility network outages and to safeguard the general public from the consequences of damages to underground utilities.  Utilities are required to respond within specified time periods to these requests to mark underground and buried facilities.  Our underground facility locating services include locating telephone, cable television, power, water, sewer, and gas lines for these utility companies.

  Electric Utilities and Other Construction and Maintenance Service

From the most recent 10-K:
 We perform construction and maintenance services for electric utilities and other customers.  These services are performed primarily on a stand-alone basis and typically include installing and maintaining overhead and underground power distribution lines.  In addition, we periodically provide these services for the combined projects of telecommunication providers and electric utility companies, primarily in joint trenching situations, in which services are being delivered to new housing subdivisions.  We also maintain and install underground natural gas transmission and distribution systems for gas utilities.

The following table displays how Dycom revenues have been divided amongst these three categories over the preceding five fiscal years:

 

Revenue by Customer Type	Fiscal year
	2009	2008	2007	2006	2005
Telecommunications	77.7%	76.2%	74.7%	72.9%	74.3%
Underground facility locating	16.7%	17.7%	18.9%	21.3%	21.6%
Electric utilities and other customers	5.6%	6.1%	6.4%	5.8%	4.1%
Total contract revenues	100.0%	100.0%	100.0%	100.0%	100.0%

Customer Concentration
Given the nature of the work the company performs, Dycom has a highly concentrated customer base with the top five customers representing the following share of total revenue from continuing operations:

 

Customer Concentration	Fiscal Year
	2009	2008	2007	2006	2005	2004
Top five customers	63.8%	64.4%	63.3%	60.9%	64.0%	59.6%
AT&T/BellSouth	18.2%	18.9%	19.2%	21.2%	16.6%	14.0%
Verizon	16.5%	18.4%	17.9%	18.6%	25.1%	3.7%
Comcast	14.9%	11.9%	11.6%	8.4%	11.3%	28.5%

Revenue by contract type
A large percentage of Dycom sales are realized through master service agreements and other agreements with customers that are for a period longer than one year.  The following table presents the percentage of revenues derived from long-term contracts, as a percentage of total revenues from continuing operations, for the past 5 fiscal years:

 

Revenue by Contract Type	Fiscal year
	2009	2008	2007	2006	2005
Multi-year master service agreement	69.5%	70.3%	72.8%	64.3%	54.3%
Other long-term contracts	17.2%	17.9%	12.1%	16.5%	34.5%
Total long-term contracts	86.7%	88.2%	84.9%	80.8%	88.8%

 
Note that in fiscal 2006, the lower percentage of revenue provided by long-term contracts was a function of damage sustained during the active hurricane season in mid-to-late 2005.  As a result, more of Dycom's revenue was generated via short-term contract as they were called upon to address damage that their customers had sustained.

Seasonality
Given that a significant portion of the work the company performs is outdoors, operations may be impacted by inclement weather.  Such work disturbance is most likely to occur during the company's second and third fiscal quarters.  Further, a disproportionate percentage of total paid holidays fall within the second fiscal quarter, decreasing the number of available workdays.

Outlook - Is Optimism warranted?
Please note that although I present the following items as reasons to be cautiously optimistic that the company's future prospects will exceed the level exhibited over the past year or more, the valuation presented does not assume improvement, but is rather based upon 10-year average FCF. 

I. Backlog
As detailed in the "2nd Quarter Fiscal 2010 Results Presentation", dated February 24, 2010, on slide 5, the company's backlog appears to have bottomed as of the end of fiscal Q1 2010.  The table below provides detail:

 

Backlog
(Dollars in millions)
	Total	12 Month
Fiscal period	Backlog	Backlog
Q3 2008	1,409	820
Q4 2008	1,313	765
Q1 2009	1,150	715
Q2 2009	1,131	726
Q3 2009	1,118	679
Q4 2009	935	582
Q1 2010	819	517
Q2 2010	1,078	684

 
It is important to note that Q3 of fiscal 2008 roughly equates to the February through April period of 2008, i.e. the period basically represents the company's first full quarter in the (official) recessionary period.

II. Contract Awards

The company reported that "strong contract awards and extensions" had been "secured during the quarter", which is exhibited by the approximately $259 million increase in "Total Backlog" from Q1 2010 to Q2 2010.  While the presentation did not provide detail as to the expected revenue to be derived, the following contract awards and extensions were achieved during the most recent period:

Current Contract Awards and Extensions 
   
 

Current Contract Awards and Extensions
Customer	Area	Description	Term (in years)
AT&T	Central Florida	Master Service Agreement	3
Comcast	California	Master Service Agreement	3
Verizon	Northeast	Other Long-Term Agreement	1
Comcast	Nationally	Various Long-Term Agreements	1
Charter	Nationally	Various Long-Term Agreements	1
AT&T	Georgia	Locating	3

III. Reduced Headcount

Finally, in response to the declining volume of business, Dycom Industries, Inc. began, as did most companies, an initiative to rapidly cut costs.  The most telling exhibit, also from slide 5 of the aforementioned presentation, is the total number of people employed by the company:

Total Employees
 
 

Total Employees
Fiscal period	Employees
Q3 2008	10,786
Q4 2008	10,746
Q1 2009	10,355
Q2 2009	9,407
Q3 2009	9,426
Q4 2009	9,231
Q1 2010	8,951
Q2 2010	8,360

  
As the above table details, the most drastic measures were taken during Q2 2009, which approximates the period from October 2008 through January 2009, a rough period in American business to say the least.  While yet to show meaningful improvement in "General and Administrative" expenses, Dycom should, at least in theory, be a much leaner company than it was prior to the economic downturn.  By eliminating 2,426 employees, or 22.49% of the Q3 2008 workforce, it is expected that SG&A costs should fall in coming periods.  As mentioned above, any cost benefits which result from this reduction in headcount have not been factored into the valuation presented below.

IV. General/Miscellaneous
In the most recent investor presentation given at the BB&T Capital Markets Conference on March 24, 2010 (which can be found at www.sec.gov under an 8-K filed the same day)the company referenced a number of relatively optimistic comments made recently by notable clients.  The slide number and related information is presented below.

Slide 9 - Telecom Spending

"We are taking our U-verse build, which is our IPTV build, the broadband capability that we have been deploying, and we are going to get to 30 million homes by the end of next year.  We are actually moving that build out to cover more of our small business locations.  We have a fairly aggressive plan to get the U-verse build in front of a lot of small businesses, integrate the high-bandwidth product with a mobile product, and we think it is going to be pretty powerful."
- Randall Stephenson, AT&T Chairman, CEO AND President (March 2010)

Slide 10 - Cable Capital Spending

"[...] we have been aggressively rolling out All-Digital and Wideband.  These are initiatives that are central to our strategy, and so we are investing about $1 billion in these two projects between 2009 and 2010, and we've made rapid progress deploying these technologies and new products that follow the rollout."
- Brian Roberts, Comcast Chairman and CEO (February 2010)

Fundamental/"Quantitative"

I. Earnings and cash flow

 Earnings
The following table provides income statement information for Dycom for the previous 10 fiscal years.  As mentioned on the first page, the company's fiscal year ends the last Saturday of July:

 

	Fiscal Year
	2009	2008	2007	2006	2005	2004	2003	2002	2001	2002
Sales	1,106,900	1,229,956	1,137,812	1,023,673	986,627	872,716	618,183	624,021	826,746	806,270
COGS	894,885	1,011,219	915,250	835,889	785,616	673,562	482,877	478,971	615,239	600,489
Gross margin	212,015	218,737	222,562	187,784	201,011	199,154	135,306	145,050	211,507	205,780
SG&A	98,732	98,942	90,090	80,868	78,960	74,580	68,774	67,446	73,518	65,478
Bad debt expense- nonrecurring	0	0	0	0	767	776	1,285	21,550	58	0
Operating income	113,283	119,795	132,472	106,916	121,284	123,798	65,247	56,054	137,931	140,303
Non-operating other income	6,564	7,154	8,647	6,382	11,970	15,636	2,981	1,460	2,673	(2,758)
EBITDA	119,847	126,949	141,119	113,298	133,254	139,434	68,228	57,513	140,604	137,545
Depreciation and Amortization	65,435	67,288	57,799	47,955	46,593	42,066	39,074	38,844	40,117	31,759
Goodwill impairment	94,429	9,672	0	14,835	28,951	0	0	47,880	0	0
EBIT	(40,017)	49,989	83,320	50,508	57,710	97,368	29,154	(29,211)	100,487	105,786
Interest income (expense), net	(14,482)	(12,405)	(13,843)	(10,078)	924	(188)	1,301	2,620	4,496	3,448
EBT	(54,499)	37,584	69,477	40,430	58,634	97,180	30,455	(26,590)	104,983	109,233
Income tax expense (benefit)	(1,405)	13,180	27,275	22,250	34,320	38,547	13,306	9,508	43,573	44,201
Earnings from continuing operations	(53,094)	24,404	42,202	18,180	24,314	58,633	17,149	(36,098)	61,411	65,032
Loss from discontinued operations	(86)	(2,726)	(318)	0	0	0	0	0	0	0
Cumulative effect of change in accounting principle	0	0	0	0	0	0	0	(86,929)	0	0
Net income (loss)	(53,180)	21,678	41,884	18,180	24,314	58,633	17,149	(123,027)	61,411	65,032

Bad debt expense in the year ended 2002 totaling $21.55 million is primarily attributable to the June 25, 2002 Ch. 11 bankruptcy filing of Adelphia ($18.5 million) and the July 21, 2002 Ch. 11bankruptcy filing of WorldCom.  The two companies represented a combined 14% of DY revenues during fiscal 2002.

As should be apparent from above, numerous non-cash charges have consistently influenced the reported earnings (loss) of Dycom.  Perhaps the only meaningful information from above not included on the statement of cash flows is sales, COGS, and SG&A.  Given this lack of consequential data, I have omitted a column related to the company's first six months of 2010.  During this period, ended January 23, 2010, the company posted sales of $475.447 million, COGS of $370.908 million and SG&A of 47.401 million.  The gross margin during the period was 17.78%, which is comparable to the 18.12% gross margin exhibited in the six months ended January 24, 2009.

 Cash Flow
The following table displays summarized statements of cash flows for the previous ten fiscal years:

 

	Fiscal Year
	2009	2008	2007	2006	2005	2004	2003	2002	2001	2000
Net income	(53,180)	21,678	41,884	18,180	24,314	58,633	17,149	(123,027)	61,411	65,032
Depreciation and amortization	65,435	67,288	58,612	47,955	46,593	42,066	39,074	38,844	40,117	31,759
Other adjustments to reconcile net income	87,516	6,180	352	13,621	25,951	(9,632)	5,190	148,379	768	775
CFO prior to ? in working capital	99,771	95,146	100,848	79,756	96,858	91,067	61,413	64,195	102,295	97,566
Changes in working capital	26,865	9,143	7,613	22,518	(9,426)	33,151	(36,415)	1,068	30,939	(21,564)
Net cash provided by operating activities	126,636	104,289	108,461	102,274	87,432	124,218	24,998	65,264	133,235	76,003
Net capex	(25,326)	(62,331)	(62,331)	(47,330)	(48,365)	(28,648)	(13,174)	(9,508)	(34,435)	(38,121)
Other cash used in investing activities	(60)	232	(62,241)	(65,682)	14,407	(140,153)	18,301	(1,893)	(70,890)	(31,121)
Net cash used in investing activities	(25,386)	(62,099)	(124,572)	(113,012)	(33,958)	(168,801)	5,127	(11,402)	(105,326)	(69,242)
Proceeds from (repayment of) long-term debt	(13,629)	(13,496)	1,373	143,350	(4,329)	(3,368)	(79)	(68,133)	(5,581)	(2,890)
Issue (repurchase) of common stock	(2,915)	(25,159)	0	(186,235)	0	0	0	(1,150)	0	0
Other cash used in financing activities	(2,067)	(329)	6,332	(2,171)	2,534	4,632	1,792	990	2,453	3,836
Net cash provided by (used in)   financing activities	(18,611)	(38,984)	7,705	(45,056)	(1,795)	1,264	1,713	(68,294)	(3,127)	946
Net increase (decrease) in cash and     cash equivalents	82,639	3,206	(8,406)	(55,794)	51,679	(43,319)	31,838	(14,432)	24,782	7,707

 

Taking the numbers above, the 10-year average "net cash provided by operating activities" equates to $95.281 million while 10-year average "Net capex" is $36.957 million, resulting in 10-year average free cash flow ("FCF") of $58.324 million.  We will revisit this in the "Valuation" section below.

During the six months ended January 23, 2010 and January 24, 2009 Dycom exhibited the following cash flow generation/use:

 

	Six months ended
	Jan 23,	Jan 24,
	2010	2009
Net income	(442)	(67,405)
Depreciation and amortization	30,707	33,429
Other adjustments to reconcile net income	2,717	82,455
CFO prior to ? in working capital	32,982	48,479
Changes in working capital	23,891	26,731
Net cash provided by operating activities	56,873	75,210
Net capex	(24,746)	(16,473)
Other cash used in investing activities	0	(233)
Net cash used in investing activities	(24,746)	(16,706)
Proceeds from (repayment of) long-term debt	(722)	(4,510)
Issue (repurchase) of common stock	0	0
Other cash used in financing activities	(184)	(2,025)
Net cash provided by (used in)   financing activities	(906)	(6,535)
Net increase (decrease) in cash and     cash equivalents	31,221	51,969

If we assume that full year results will approximate twice those exhibited in the first six months of fiscal 2010, then the company is on pace to generate $64.254 million in FCF.  Note that although FCF is at a depressed level relative to fiscal 2009, generation of $64.254 million is slightly above the 10-year average FCF calculated above.

It should be noted that such an assumption (i.e. the doubling of six month results) would be fairly accurate historically, as fiscal Q2 and Q3 are the slowest quarters of the year given that much of the work is conducted outdoors.  The second half of fiscal 2009 (approx. February 2009 through July 2009) was somewhat extraordinary given massive capex cuts by the company's customers.  

II. Capitalization

The following table presents a summarized view of data related to the capitalization of DY:

(in millions, except per share data)  
   
 

(in millions, except per share data)
Company	Dycom Industries, Inc.
Exchange: ticker	NYSE: DY
Current market price (04/16/2010)	9.93
Common shares outstanding	40.42
Market capitalization (based on diluted shares)	401.32
Plus: debt outstanding (1/23/2010)	135.35
Less: cash (1/23/2010)	135.93
Resulting enterprise value	400.74
Book value incl. goodwill and intangibles	391.02
Book value per diluted share	9.68
Tangible book value	180.29
Tangible book value per share	4.46

While tangible book value is technically $4.46 per share, I am tempted to include the approximately $48.175 million in finite-lived intangible assets, listed on the balance sheet at January 23, 2010, that will be amortized in the future and provide cash flow via tax deductibility.  If this amount were considered to occupy a "grey area" and thus be open for consideration as tangible, tangible book value would increase to $5.65.

While not discussed in the "Earnings and Cash Flow" section directly above, finite-lived intangible assets will provide roughly $6 million in amortization expense, and thus cash flow, for the next few years.

Outstanding Shares
The below table presents a reconciliation of the outstanding common shares, adjusted for potential future dilution, presented above: 

 

		Wt. Avg.
Common stock:	Shares	Exc Price
Outstanding (February 26, 2010)	39,128,111
Potential dilution (from 10-Q filed March 1, 2010):
Stock options	1,034,248	8.55
Restricted share units (RSUs)	196,919	11.10
Performance RSUs	55,746	12.25
Total equivalent shrs outstanding	40,415,024

  

Excluded from the above table are 2,654,170 stock options with a weighted-average exercise price of $23.19 and 248,446 Performance RSUs with a weighted-average exercise price of $21.00 per share.  Note that as of January 23, 2010 a total of 2,045,723 stock options were currently exercisable; these shares featured a weighted average exercise price of $27.87 per share.  Given the conclusion reached below, dilution resulting from the exercise of the excluded shares would occur at a price well above conservative intrinsic value. 

Share repurchase program
The Board of Directors authorized the repurchase of up to $20 million of DY common shares on February 23, 2010, replacing the previous authorization which was set to expire February 28, 2010 under which $16.9 million remained available.

Long-term debt and available borrowings
During October 2005, Dycom Investments, Inc., a wholly-owned subsidiary of DY, issued $150.0 million of 8.125% senior subordinated notes due October 2015.  During fiscal 2009 the company successfully repurchased $14.65 million principal of this issue for $11.3 million.  As of January 23, 2010, the principal amount outstanding under the Notes amounted to $135.35 million. 

At January 23, 2010 the company had $153.4 million of borrowing availability under its $210 million revolving Credit Agreement.  There were no outstanding borrowings and $43.9 million is reserved for outstanding letters of credit related to the company's insurance program.  This agreement expires September 12, 2011.

III. Valuation(s): Tying it all together
**Disclaimer: I have chosen to use to a perpetuity formula coupled with conservative discount rate(s).  While the use of a perpetuity formula may be imperfect, I would argue that it is far less misleading than an individual believing they can forecast earnings and cash flow years into the future.  The only assumptions I have made is that 1) DY remains a going concern and 2) that future results approximate the ten-year average.  These assumptions do not strike me as aggressive, given the company is not involved in the production of a short-lived finite resource, nor facing patent expiration.  Without this "disclaimer", inevitably a message would be posted questioning the use and accuracy of a perpetuity formula, thereby asserting that the employment of estimates which simply appear precise would be more appropriate.

CFO, Net Capex and FCF

 

CFO, Net Capex and FCF
(dollars in millions)
		Net
Fiscal Year Ended	CFO	Capex	FCF
2009	126,636	(25,326)	101,310
2008	104,289	(62,331)	41,958
2007	108,461	(62,331)	46,130
2006	102,274	(47,330)	54,944
2005	87,432	(48,365)	39,067
2004	124,218	(28,648)	95,570
2003	24,998	(13,174)	11,824
2002	65,264	(9,508)	55,755
2001	133,235	(34,435)	98,799
2000	76,003	(38,121)	37,882
10-year average	95,281	(36,957)	58,324

While there has been a certain degree of variability due to working capital investment and liquidation during the period presented, the 10-year average of $58.324 seems a good approximation of the average to expect over time.  Note that the median of the high and low FCF over the past 10 fiscal years is $56.567 million, inline with the average.

Note that excluding 2003, a year in which required substantial investment in working capital (and was subsequently "returned" in 2004), the lowest level of FCF exhibited in the previous 10-year period is the $37.882 million.  Even at this level of FCF, relative to current market price this represents a FCF yield of approximately 9.3%.  

As previously mentioned, assuming the second half of the fiscal year approximates the six months ended January 23, 2010, Dycom is on pace to generate $64.254 million in FCF during fiscal 2010, or FCF yield of approximately 15.8%.

Net Capex
The company estimated during the investor presentation in late February that a total of $40-50 million would be spent in the upcoming 12-month period.  It is important to note that management stated that they were "opportunistically" pursuing capex, thus indicating that the current capital budget was in excess of maintenance capex.  Given this admission, I have chosen to pursue valuation using the 10-year average of $36.957 million versus a more conservative $50 million.  While such an estimate appears low relative to net capex in fiscal 2007 and 2008, I think the high level of sales, and management's inability to see the economic turmoil directly ahead, likely allowed comfort with a higher capital budget than was necessary. 

Present Value of Perpetuity

The following table presents three separate discount rates and the resulting perpetuity value:

 

PV of Perpetuity
(dollars in millions)
10-year average CFO	95,281
10-year average capex	(36,957)
10-year average FCF	58,324
Perpetuity value at:	Total	Per shr
15.00%	388,827	9.62
12.50%	466,592	11.55
10.00%	583,240	14.43

Excess working capital
It appears as though DY, given the current level of sales, has an excessive level of working capital.

 

WC/Sales
(dollars in millions)
Fiscal Year Ended	WC	Sales	WC/Sales
2010*	220,789	950,894	23.2%
2009	217,177	1,106,900	19.6%
2008	173,617	1,229,956	14.1%
2007	165,185	1,137,812	14.5%
2006	172,514	1,023,673	16.9%
2005	223,167	986,627	22.6%
2004	173,555	872,716	19.9%
2003	234,739	618,183	38.0%
2002	186,185	624,021	29.8%
2001	224,420	826,746	27.1%
2000	209,669	806,270	26.0%

* 2010 sales are annualized

DY ended fiscal Q2 2010 with total working capital of $220.789 million and, assuming the first two quarters can be relied upon as indicative of what too expect this fiscal year, the company is on pace to have total sales of approximately $950.894 million in fiscal 2010.  This places the hypothetical WC/Sales ratio at 23.22%.  What follows is a brief summary of measures taken by Dycom in the past to address excess working capital, as well as the capital structure:

- After ending fiscal 2003 with a WC/Sales ratio of 37.97%, the company acquired UtiliQuest ($116.1 million) and First South ($55.7 million) during fiscal 2004.  The UtiliQuest purchase was financed using cash and $85 million in borrowings (which were repaid within the same fiscal year), while First South was acquired using "cash on hand".
- Ending fiscal 2005 with a WC/Sales ratio of 22.62% the company acquired Prince ($65.4 million) in fiscal 2006 and also completed the repurchase of 8.76 million shares via a "Dutch Auction" at $21.00 per share ($186.2 million including expenses).  The Prince acquisition was completed with cash, while the repurchase was funding via $183 million in borrowings, i.e. the company altered the capital structure.

These examples are included to demonstrate that in the past management has paid close attention to the level of working capital and the capital structure.  See the "Risk" section below, as while the willingness to address excess working capital is positive, it raises a few pertinent questions.

To summarize excess working capital:

 

Excess Working Capital
(dollars in millions)
Annualized 2010 Sales	950,894
Current WC	220,789
	Resulting	Excess	Excess WC
WC needed as a percentage of sales	WC	WC	per shr
15.00%	142,634	78,155	1.93
17.50%	166,406	54,383	1.35
20.00%	190,179	30,610	0.76

Note that should excess working capital be "digested" by an increased level of sales, the resulting per share value would likely be considerably higher than that indicated above.  However, given agreement with the statement that "the future is something to be guarded against, rather than profited from", my conclusion treats excess working capital to be just that, and not as having a casual relationship with sales and FCF generation.

Valuation: Conclusion
While I have likely presented far too many valuation alternatives above, hopefully doing so will allow the reader to reach their own conclusion (if they choose to pursue looking further into the company).  Here is a summary:

Estimated Range of Intrinsic Value   
   
 

Estimated Range of Intrinsic Value
Current market price	9.93
	Low	Mid	High
PV of perpetuity	9.62	11.55	14.43
Excess working capital	0.76	1.35	1.93
Intrinsic value (IV)	10.38	12.90	16.36
Increase (%) to IV	4.53%	29.91%	64.75%

As is likely apparent, the discount rates used to calculate the perpetuity PVs were subjectively chosen based upon the free cash flow yield I would be comfortable accepting.  Although I am a pessimist by nature, I am comfortable with an estimated intrinsic value of approximately $13.58.  This amounts to the perpetuity value using a 12.5% discount rate of $11.55 per share, plus the $1.93 in excess working capital if one assumes that 15% WC/Sales is adequate.  Should the market price come to reflect this amount, it would represent a 36.76% gain from the current price.   

While it should not be used as an "anchor", during the five years ended January 2008, the market price remained consistently between $20 and $30 per share. 

Risks
Almost irregardless of the security or company, I presently find the astonishing disconnect (in my opinion) between capital markets and the underlying economy the single largest risk.  Either the economy is going to stage the immaculate recovery which most are hoping for or capital markets are going to begin to discount a subdued (or even deteriorating) economic backdrop.  Regardless, at some point the two will converge.  As somewhat indicated in the very first section of this write up, complete disregard of the macro-backdrop may prove to be hazardous. 

The two most prominent company-specific risks identified are as follows:

- Customer concentration
While certainly not a desirable business characteristic, it would appear to be a largely unavoidable aspect of the industry. 

Providing partial mitigation to this is Dycom's "decentralized approach to marketing, operations, and ongoing customer service, empowering local managers to capture new business and execute contracts on a timely and cost-effective basis."  As previously mentioned, the company operates through 30 separate operating subsidiaries and with the (claimed) result being that:

"A customer's decision to engage us with respect to a specific construction or maintenance project is often made by local customer management working with our subsidiaries.  As a result, although our project work is concentrated among relatively few customers, our relationships with these customers are generally broad and extend deeply into their organizations...Our markets are served locally by dedicated and experienced personnel.  Management of our subsidiaries possesses intimate knowledge of their particular markets and we believe our decentralized operations allow us to be more responsive in addressing customer needs.  Our sales and marketing efforts are the responsibility of our management and that of our subsidiaries.  These marketing efforts tend to focus on contracts with managers within our customers' organizations." 

- Current excess working capital is deployed via acquisition or similar unproductive method. 
This represents a significant risk and one that history suggests a shareholder must be concerned, as management has engaged in ill-advised M&A activity in the past, as well as expensive share repurchases.  While troubling, perhaps management will be more conservative and not "empire build" given the lessons of the past number of years - goodwill and intangible asset impairments.  Regardless, such a risk is applicable to the overwhelming majority of businesses with a relatively healthy balance sheet / capital position in a hopeful (hopeless?) attempt to find top-line growth. 

Catalyst

Catalysts
There is not (in my opinion) an identifiable catalyst to correct the apparent undervaluation which persists.  DY is simply an undervalued business.  It is not mispriced due to corporate complexity, a new or recent development, or a transformative restructuring plan.  Patience as an equity holder and the company continuing to generate free cash flow, should ultimately allow price and value to converge.

That being stated, two potential catalysts are::
- Deployment of excess working capital to security holders via dividend or (more likely) share repurchase
- There was approximately $7.2 billion included in the 2009 fiscal stimulus earmarked for the purpose of bringing high-speed internet connections and "information-age jobs" to parts of the country lacking both.  These funds apparently began to be awarded in early 2010.  It is unknown what effect these measures will ultimately have on DY, yet it is hard to see how they will impact the company negatively.