Description

Investment Thesis 

Actividades de Construccion y Servicios, S.A. (ACS) is mispriced with material upside ( from current levels. An improved balance sheet, substantial spread between equity FCF and debt yields, and further scope for non-core asset disposals provides an opportunity for ACS to further simplify its overcomplicated group structure and drive further rerating. 

The Investment Thesis is based on the following rationale:

1. Attractive valuation based on underlying earnings and holding company cash flow – ACS has recently outperformed the market and sector, up +13% YTD. However, this follows multiple years of underperformance versus infrastructure peers; ACS is down almost 25% since January 2022 versus -9% for Eiffage, -11% for Ferrovial , and -7% for Vinci. 

The recent outperformance has done little to adjust the company’s conservative absolute valuation. ACS currently trades at a ~7.5% dividend yield, 0.2x EV/Sales and >10% FCF yield based on 2022/2023 forward estimates. Enterprise value yields are estimated between 10-15% and based on low-to-base case normalized cash flow assumptions. The company trades at significantly lower valuations than peers despite historically higher returns on invested capital. Current EV/EBITDA ~4x (2022E & 2023E) is well below historical sector average of 6.5-7.5x.

2. Ongoing corporate simplification to drive higher valuations – ACS’s group structure is complex, with the business split between multiple listed entities (ACS SM, HOT GY and, until recently, CIM AU) and a large unlisted holding (Albertis). The latter is 30% owned by ACS, and 20% by HOT. 

A leaner structure focused on core earnings drivers (construction and toll roads, similar to infrastructure peers Vinci, Ferrovial and Eiffage) could drive upside to both ACS’s earnings and valuation multiple. Transport infrastructure assets are monopolistic, high-margin and typically exhibit higher than GDP/inflation growth. These assets tend to generate higher through-cycle value than the lower margin, lower growth and fragmented contracting business. ACS’ lower quality business mix versus the more infra-focused peers partially explains the lower long-run performance, EPS growth and valuation multiple. Continued restructuring progress should be supportive of continued positive cash trends, higher dividends, and higher valuations. 

The remaining portion of Albertis’ is owned by Atlantia, the Italian infrastructure company recently subject to multiple takeover offers. ACS, GIP, and Brookfield made a preliminary non-binding proposal for Atlantia in which ACS would acquire a majority stake in the infrastructure segment. However, a transaction with ACS is likely unacceptable to the main shareholders of Atlantia (Edizione & the Benetton family at 33% ownership) given ACS’ offer would involve splitting up the group. Any hostile takeover by ACS is also likely to fail; a joint bid from Edizione and Blackstone seems more likely to succeed based on recent press reports. However, the current joint ownership structure of Abertis is likely unsustainable and should logically be simplified in the medium-term.

3. Recent simplification steps have yet to be reflected in valuation – ACS recently made progress on simplifying its corporate structure and repositioning towards a Concessions/Contracting model. Carve-out of the Industrial Services segment is complete, with Vinci's agreement to purchase ACS' Energy business for €4.9bn closing earlier this year. Most of the cash is likely to be reinvested into infrastructure projects, either directly or through concessions at Abertis. ACS should be able to re-deploy the proceeds at a mid-single digit FCF yield, increasing distributable holding level cash flow by up to 50%.

ACS is also making progress on simplifying the multiple listed entities. In February 2022, Hochtief (50.4% owned by ACS) issued an unconditional offer for the free float in its Australia-listed subsidiary CIMIC. HOT had previously held a 78.6% stake in CIMIC. The 66.67mn shares HOT does not already own cost ~€940mn and was completed in May 2022. 

4. Infrastructure packages in main jurisdictions and long-term projects to drive revenue growth – ACS strategic pivot to the U.S. (~50% revenue exposure) holds significant potential, based on a positive construction outlook under the Biden administration. Some argue that Abertis’ relatively short duration portfolio (~9 years) challenges the company’s long-term prospects given ~40% of ACS’ HoldCo’s dividend receipts come from Abertis. However, the loss of dividends from Abertis in early 2030s should be mostly replaced by significant FCF generation from the Vinci-ACS renewables JV.

5. Management is shareholder focused – ACS is generally regarded as a well-run contractor. Operating margins have been above peers, and FCF generation consistent in recent years. Financial performance of key subsidiaries Hochtief and CIMIC has particularly improved recently. HOT EBIT margins, for example, have more than doubled since the ACS COO took over in late-2012, and cash generation has improved even more significantly. Earnings quality and dividend cover have been solid in recent years as a result. 

6. The infrastructure segment offers inflation protection – Most of ACS’ earnings are inflation protected; mature toll roads tend to have strong cash flow generation, most of which is mechanically indexed to inflation (including the main European toll road concessions in France, Spain, Italy and LatAm). This should outweigh any potential weakness from wage inflation within the contracting business. Transportation infrastructure offers real asset exposure in the event of prolonged high inflation, slowing growth and low/negative real rates.

Mispricing likely exists due to jurisdiction (Spanish-listing despite majority US revenues), complexity, and historical business mix. 

Risks include any renewed lockdowns restricting toll road movements, cyclical exposure in the contracting business and Abertis’ relatively short remaining weighted average concession life. Lack of progress on structural adjustments could also weigh on the common stock. There is also a low probability risk that prolonged higher oil prices could also weigh on toll road traffic over time if motorists change habits and favour other forms of transport. 

Company & sector overview

Company overview – Actividades de Construccion y Servicios, S.A. (ACS) is an engineering and contracting company. The business originated from the acquisition of Construcciones Padrós S.A., a troubled construction business, in 1983. The company went on to acquire other support services businesses, eventually merging with Ginés Navarro Construcciones, S.A. to create Grupo ACS in 1997. 

ACS is now one of the largest construction companies globally. ACS provides Civil Works Construction, Greenfield Concession Development, Industrial Services (electricity, oil, and gas) and Environmental Services. ACS is based in Madrid, Spain and is active in about 60 countries. North America is the largest market, generating around 60% of revenue, followed by Asia/Pacific (21%) and Europe (20%). 

ACS is listed on the Madrid stock exchange and is part of the IBEX 35. Latest total enterprise value is ~€7.0bn with €7.8bn market capitalization, €12.5bn cash, €11.1bn total debt. The company reported revenues of €27.8bn and EBITDA of €776mn for FY2021. 

ACS has traditionally had three main cash flow drivers: Hochtief (HOCH, 50% stake), Abertis (ABE, 30% stake), and the recently divested Industrial Services division. ACS's group structure is complex, with the business split between three listed entities until recently (ACS, HOT and CIM) and a large unlisted holding (Abertis). The latter is 30% owned by ACS, and 20% by HOT. Atlantia owns the other 50% in Abertis, and a large minority stake (16%) in HOT.

ACS co-founded Abertis in 2002 when it merged Dragados' road portfolio (Aurea) with other Spanish concession operators. While peers Ferrovial, Vinci and Eiffage have relatively consistently maintained a concessions-contracting model and focused on growing their concessions footprint since the early/mid-2000s, ACS divested its Abertis stake in 2010 and pursued a more opportunistic capital allocation strategy (before buying Abertis back in 2018 with Atlantia).

This complexity arguably adds unnecessary layers of holding costs. The structure also reduces earnings/CF visibility, as ACS's share of profits needs to be assessed at each holding level. The close ties with Italian-listed Atlantia through joint stakes in Abertis and Hochtief also further complicates matters; Atlantia had been mired in legal dispute since the 2018 collapse of a road bridge in Genoa, operated by subsidiary Autostrade.  

On 1st April 2021, Vinci announced the signing of the agreement to acquire most of ACS's Industrial Services (IS) division for €4.9bn paid fully in cash (€4.2bn EV). IS was the largest ACS "core" division with nearly €661mn of EBITDA in 2020, and a competitor to Vinci Energies The deal includes additional contingent payments of up to €0.6bn (€40mn for each ready-to-build GW developed by the acquired business in 8.5Y post-closing). 

Recent earnings (Q1 2022) – Q1 results were solid with Revenues of €6.92bn (+8.4% yoy) and EBIT of €399mn (+21.6% yoy). Backlog increased by 4.6% yoy to €65.9bn. FX, notably the weaker EUR, helped results (see below). Seasonal FCF burn of ~€700mn was better than most sell side forecasts and -€0.9-1.0bn level of 1Q20 and 1Q21. 

Sector overview – Construction activities performed well in 2021 and the  beginning of 2022.  The industry should be able to pass on the expected near-term increases in energy and labor costs. However, the increasingly tight construction workforce could become a concern in the medium term and potentially more disruptive for the industry. The contracting businesses should also benefit from expected increased infrastructure spend in Europe, North America and Australia.

Infrastructure funds and industry majors such as ACS, Vinci, and Eiffage are currently able to finance high, real-yielding infrastructure assets at negative real rates. Transport infrastructure assets was historically viewed as attractive relative to other real assets given traffic growth ahead of GDP. This assumption was challenged, of course, by the COVID-19 pandemic and movement restrictions. The post-pandemic recovery has been uneven, particularly air traffic, but road traffic has recovered in most areas.

Valuation

ACS is best valued using SOTP given the publicly listed stakes, recent sale of Industrial Services, and expectations of further simplification. Dividend and free cash flow yield to the HoldCo is also logical given the pass-through to ACS shareholders.

Market implied valuation – ACS trades at a ~7.5% dividend yield, 0.2x EV/Sales, ~4.0x EV/EBITDA and ~8-10% FCF yield. Enterprise value yields are likely between 9-15% based on low-to-base case normalised cash flow assumptions (€900mn or more).

Backing out the Hochtief list stakes market implied at and valuing the Abertis ~€35bn (10-11x EV/EBITDA 2022E) suggests market implied EV/FCF yields of ~8% for the concessions and remaining services businesses, including ~10% HoldCo discount. Between 2022-24, ACS’ main subsidiaries will upstream €600-800mn in annual dividends to the ACS HoldCo. This equates to a distributable FCF yield of 8%-10% over the forecast horizon on the last close share price. On a fully consolidated basis (i.e.100% of subsidiaries earnings instead of just their dividend payouts) our estimates imply an even higher yield of 12%-14%. 

Absolute valuation – ACS’ intrinsic value is likely between €30 per share to €45 per share, assuming conservative 10% FCF (EBITDA-capex) yield.  Upside could be even higher if corporate simplification benefits were realised. Each separate part of the business appears conservatively valued by investors. 

NPV based on FCF to the parent suggests similar upside even under reasonable assumptions. 7% discount rate (versus 2.6% YTM on ACS 2025 maturity bonds) and 8x exit multiple suggests fair value ~€35 per share (+30%). This assumes ~€300-400mn dividends are upstreamed from Hochtief, ~€300mn from Abertis and €275-295mn per annum EBITDA at Dragados (US construction).

Relative valuation – ACS has underperformed infrastructure peers by ~20% since the beginning of 2020 and trades at discount to the peer group on most metrics. Dividend yields remain more than double the peer group (Eiffage 3.3%, Ferrovial 2.4%, Vinci 3.1%). As mentioned, the longer-run share price performance of ACS has been decent compared to other contractors (roughly flat since 2010), but weak compared to higher-quality peers Vinci/Eiffage/Ferrovial. The latter either have much simpler structures (Vinci, Eiffage), or have recently been rewarded by the market for simplifying (Ferrovial). Both stocks are valued at a premium to ACS. Vinci is much more geared to higher-quality infrastructure assets. Eiffage is more comparable to ACS in terms of business mix but trades closer to 6x EV/EBITDA.

Risks

Input cost inflation – Rising input cost inflation and/or lower activity levels could thus result in earnings downgrades. 

Cyclical variations – While ACS has generally performed better relative to contracting peers, contracting earnings and cash flows can be subject to large cyclical variations.

FX – Key subsidiaries such as HOT, CIM, Dragados, and Industrial Services have large USD and AUD exposure. FX hedges should be weighed by earnings’ FX exposure.

Abertis concession duration and rating – Abertis has a relatively short remaining concession life (~9 years). ABE’s dividend payout is also subject to credit rating constraints. Payouts could be reduced if the credit rating falls below investment grade. This outcome is unlikely; halving the ABE dividend in 2020E, ACS's parentco cash flow would be sufficient to cover the dividend.

Catalyst

Further group simplification and asset disposals, activist involvement (screens well on various metrics), profitable reinvestment of cash proceeds, shareholder returns