Description

Disclaimer:

The information contained herein (the “Information”) represents the views of the author as of the date submitted based on public information published or disseminated by the companies referenced below, including, but not limited to, through SEC filings, investor relations materials and public conference calls, or other third parties as of such date.  Securities of the companies discussed herein may have been, are currently, or in the future may be, portfolio holdings or short positions of the author or clients of the author’s firm.  The Information does not constitute investment advice or a recommendation, and it is not an offer to buy or sell or a solicitation of an offer to buy or sell any security or other asset or to participate in any trading or investment strategy.  Furthermore, while research conducted by the author is based upon public information, not all relevant facts and information may have been considered in developing the Information and such Information is subject to change.  The author has no obligation (express or implied) to update any or all of the Information or to advise you of any changes to the Information; nor does the author make any express or implied warranties or representations as to the completeness or accuracy of the Information or accept responsibility for errors.  You should not rely on the Information, in whole or in part, without conducting your independent verification as to its accuracy.  The Information contains forward-looking statements, including observations about markets and industry and other trends as of the date hereof. Forward-looking statements may be identified by, among other things, the use of words such as "expects," "anticipates," "believes," “strives,” “targets,” or "estimates," or the negatives of these terms, and similar expressions. Forward-looking statements reflect the views of the author as of such date with respect to possible future events. Actual results could differ materially from those in the forward-looking statements as a result of factors beyond the control of the author and you are cautioned not to place undue reliance on such statements.  The Information may not be reproduced or disseminated in any manner without the express written consent of the author.

Business:

• I believe this is a very high quality company with structural tailwinds, MSD+ organic grower, asset light human capital business, strong management, 76% US market exposure; record ~$23B backlog of contracts reported as of 3/27/20 (+12.5% YOY) and ~$57B pipeline provides multiyear visibility
• Current mgmt team transformed the portfolio of the business over last 3-4 years via (i) operational improvement/professional mgmt, (ii) a ~$3.3B acquisition of company called CH2M in late 2017 (very accretive, achieved full budgeted synergies, added key complementary verticals), (iii) mid-2019 ~$3.3B divestiture of their cyclical, lower margin legacy Energy & Construction (E&C) business (segment was called Energy, Chemicals & Resources (ECR))
  
• Now is a pure play service/design/engineering/Government IT consulting firm with strong market positions in growing end markets
  
  • Talent base of ~55K people (engineers, architects, data scientists, IT, etc.)
    
  • Fully exited its legacy fixed price/low margin/high risk construction business; Jacobs is now comprised of largely low risk contracts that are structured as cost-plus reimbursable agreements; customers are paying for value-add and intellectual property
    
• Aerospace, Tech and Nuclear (comprised ~45% LTM net revenues, ~30% LTM EBITDA as of 3/27/2020):   renamed Critical Mission Solutions (CMS), stats below as of 2Q20
  
  • ~89% US govt work, ~96% structured as reimbursable or fixed price hourly labor, generally 5-10 year contracts, ~95% recurring; largely supporting long term critical programs that have funding support; classified/security cleared workforce is key asset/barrier as is required for certain govt projects
  • Key project examples:  run operations at Missile Defense Integrated Operations Center for DoD and Kennedy Space Center for NASA, provide cybersecurity and drone support for intelligence community, decades of nuclear remediation work for DoE
• Buildings/Infrastructure/Advanced Facilities (comprised ~55% LTM net revenues,~70% LTM EBITDA as of 3/27/2020):  renamed People Places Solutions (PPS), stats below as of 2Q20
  • #1 global design firm (based on 2020 ENR rankings); ~64% US, ~41%/~59% private/public sector, ~90% reimbursable or fixed price labor, largely multiyear duration contracts, diverse base of thousands of projects
  • Key end markets:  transportation (~29%), water (~20%), environmental/PFAS/built environment (~33%), advanced facilities (e.g. pharma, life sciences, semiconductors, etc.) (~18%)
  • High visibility due to combination of a large backlog + subset of recurring operational work (run the facilities they build under long term contracts, an example would be large water treatment plants)
• The company has excellent disclosure and decks on its IR site with extensive information on its various business lines, types of contracts/customers, etc.; furthermore, the 2019 Investor Day was a great event and showcased the business and importantly, management’s strategic approach

Thesis:

• While acquisition/divesture/restructurings have made numbers bit messy + FCF has been lumpy due to deal integration, restructurings, deal taxes/fees, etc., I believe all of these one-time costs are now behind us; FCF conversion has been inconsistent with all the moving parts, but nature of the business lends to ~90-100% FCF conversion; I believe, as company starts to show clean FCF numbers, stock should continue re-rating
• Stock started to re-rate as business has transformed but is still covered by legacy E&C community; generally has traded at discount compared to pure Govt IT competitors (BAH, CACI, LDOS, SAIC, MANT) and cheap vs. several pure engineering/design firm competitors (TTEK, PSN, WSP CN); sell side coverage is shifting to IT/Biz services analysts and the company is seeking to change its GIC code which could help index/ETF inclusion
• Excellent and deep management who own ~$100M (at current stock price * 1.2M shares, based on last proxy) and have shareholder aligned incentive plan
• Management’s 3yr plan ending in fiscal year 2021 (September):
  • Target organic growth CAGR of 2-3% in CMS and 4-6% in PPS; drivers include end market growth + growth in backlog + project RFP pipeline visibility; organic growth in both segments have outpaced these targets since being established
  • Target margin improvement of 100-150bps in CMS and 110-140bps in PPS; drivers are gross margin in backlog (which is up >200bps) + an additional cost restructuring plan + operating leverage
  • Combined equals CAGR of 8-10% operating profit growth in CMS and 10-12% in PPS
  • Company set an earnings target of $7-$8 per share for fiscal 2021, get there via combination of organic growth, M&A and buybacks; if more weighted to buybacks company wants to stay <2x levered, if go more the M&A route would go >2.5x leverage
• Interesting angle is company may be well overcapitalized due to the large above-mentioned divestiture; has material dry powder for buybacks and continued M&A
  • Net debt ~1x; have an estimated $2B of dry powder (based on 2.5x debt capacity, cash on hand and Worley stock (WOR AU) to be monetized); in addition, the company should generate ~$700M of FCF per year (assuming ~$5+ per share in earnings and ~100% FCF conversion)
  • This $2B of estimated dry powder is after having already bought back ~$1B of stock and completing 2 bolt-on acquisitions (~$900M for KeyW and ~$325M for Wood Nuclear)
  • Buyback authorization recently increased by $1B to $1.4B
• COVID:  commentary below based on most recent earnings call and management presentations at sell side conferences since; company also provided good disclosure of how well the business performed in last recession
  • CMS segment provides mission critical essential work for the government and the PPS segment also provides essential services to the public and private sectors and supports multiyear large projects across various end markets; according to the company, it is being paid in normal course, is signing new deals and building the backlog, it and its competitors have not experienced contract cancellations or deferrals of any materiality
  • The PPS segment had the least disruption as much of this work (design, engineering, etc.) is doable remotely and in many cases the work is already dispersed around the world depending on where the expertise is located; a subset of the CMS segment had more disruption as much of this work is highly technical and done on site (i.e., missile command, nuclear cleanup, SCIFs (Sensitive Compartmented Information Facility)); this work is again essential, under long term contract and was not canceled but rather postponed until new social distancing and other protocols were established; the company expects to be largely back up and running in 2H20
  • Unlike many companies, to date, guidance was NOT pulled largely due to the visibility/recurring nature of this business; pre-COVID, the company was on track with its prior 2020 Adjusted EBITDA guidance range (midpoint $1.1B, +12% YOY)
  • In response to COVID, the management team made the admirable choice to not fire or furlough a material portion of its workforce, but rather recognized that its employees and culture are its greatest assets; mgmt chose to retain their talent as a people/intellectual capital business rather than cut to make shorter term numbers; they also identified $100M cost savings to help offset the effect of keeping the staff intact
  • The result, again fully inclusive of the cost of keeping the staff substantially intact, is a new midpoint of 2020 EBITDA guidance of $1B; notably, if attained, this would be UP 2% YOY; furthermore, the company guided to expectations of further growth in EBITDA and FCF in 2021
  • If the downturn is longer/worse than anticipated, the company still has the flexibility to cut in that scenario if necessary as the cost structure is highly variable 

Summary:  (i) excellent business and management team, (ii) double digit organic operating profit growth + use of balance sheet = several ways to materially increase earnings power; (iii) company earnings power target of $7-$8 per share intact but likely pushed back a year from fiscal 2021; assuming a high teens P/E multiple and 12-13x EBITDA multiple implies a stock price of $120-$130, up 40-50% +over a 1-2 year horizon               

Catalyst

M&A announced; new project wins announced; GIC codes/index changes; clean FCF proven; infrastructure bill optionality