Archive for June, 2009

Fundamental Analysis of Jacobs Engineering Suggests a Strong Infrastructure Play

by Ryan Johnson and Rob Weigand.

David Fessler wrote a recommendation in favor of Jacobs Engineering (JEC) on June 26, summarizing the many compelling macroeconomic themes that favor this stock right now:

  • The need for higher capacity transmission lines to move power from the midwest to the densely populated coasts.
  • Larger pipelines to move natural gas from Alaska and Canada to the lower 48 states.
  • Storage facilities for both oil and natural gas.
  • Liquid natural gas terminals in the U.S. and other countries.

Additionally, Fessler notes: “Jacobs has over 100 years of experience in the gasification and carbon-capture technologies, electrical transmission systems, and power and switching plants . . . [and] is active in the development of renewable energy projects, including wind farms, tidal power, hydro-power, tidal stream and waste energy plants.”

Some commenters on Fessler’s article asked for a complementary financial analysis of the stock — we provide a brief analysis below. As is the case with all the stocks we run through our process, we analyzed JEC’s financials for the past 5 years and forecasted their financials for the next 10 based on the following assumptions:

  • Average growth in revenues for the next 5 years of 20%, tapering to 6% by year 10, growing at 4% per year thereafter.
  • Ratios held stable at their historical averages in the forecast include COGS/Sales at 85.8%, SG&A/Sales at 9.7%, an effective tax rate of 36.0%, Cash/Sales of 5.5%, and PPE/Sales of 2.6% (pay particular attention to this last ratio in the analysis below).
  • JEC does not pay a dividend and we did not forecast a dividend initiation.
  • Beta of 1.5, cost of equity of 13.5%, and because they carry almost no debt, a weighted average cost of capital (WACC) of 13.4%.

Jacob’s 5-year historical compound revenue growth is 25.3%. Normally, with the global recession, we’d be concerned about a huge dropoff in revenues in 2009. With the resurgence of government spending and the compelling need for world spending on infrastructure, however, we’re confident that JEC will only grow slightly more slowly in the next 5 years (average of 20% per year).

JEC’s margins are low, but consistent with the rest of their industry, including McDermott (MDR), Quanta (PWR) and Fluor (FLR):


Although our forecast assumptions result in stable margins over the next 10 years, note that if JEC increases the mix of government-funded contracts in its portfolio, these will tend to have a positive effect on their margins (as governments wastefully pay higher prices than private-sector firms).

Jacbos’ ROA and ROE are not particularly high, but unlike many firms, their historical and forecasted ROIC is much higher — close to 20% historically and a little higher in our forecasts — due to their efficient balance sheet management (driven primarily by the low PPE/Sales ratio cited above).


The key point here is, even using a very high WACC hurdle for this firm (13.4%), their ROIC is well above the WACC, which is one of the principle drivers of long-term value creation. Add in the fact that JEC is likely to grow at 20% per year into that robust ROIC – WACC spread, and the stock is well below its high of $86 from last year (recently trading at $41), and the story on JEC begins to get interesting.


Jacobs has had good growth in Net Operating Profit After Tax (NOPAT) and Free Cash Flow (FCF) historically. After forecasting a slight decline in 2009, we predict that growth in these items is likely to resume over the forecast horizon.


The consistent growth in NOPAT and FCF means Jacob produces positive EVA (Economic Value Added) and MVA (Market Value Added). All JEC has to do to continue growing these value-creation metrics is grow revenues 5% slower over the next 5 years, taper down to 4-6% in 10 years, and maintain its other ratios at their historical averages.


Jacobs had an abrupt rise in its short interest in Summer-07, but short interest subsided in 2008-2009.


JEC’s Days to Cover ratio has been more stable because the increase in short interest was accompanied by a general increase in trading volume as JEC began attracting the attention of traders in 2007.


Insider selling in JEC is modest (most firms have cumulative insider selling over time as insiders diversify their holdings):


JEC scores a solid 10 out of 11 on the extended Piotroski Financial Fitness Evaluation Scorecard:


And their Altman Bankruptcy Z-Score of 5.2 is triple-A compared to most firms these days.


Using the forecast assumptions outlined above, we obtain a discounted cash flow price on Jacobs of $50 a share, vs. its current price of $41. Overall, we think Dave Fessler has it right and Jacobs Engineering merits a strong buy recommendation, based on the macroeconomic themes outlined in his blog posting and the fundamental analysis provided above. We’d love to hear what you think about this and other infrastructure plays.

Categories: Market Commentary

The Intelligent Consensus: It’s Too Early to Pull Back on the Stimulus Programs

by Rob Weigand.

Everyone generally agrees that the US and global equity markets have heroically priced in a remarkably optimistic scenario since the March stock market lows. An intelligent consensus appears to be emerging that government stimulus programs deserve some credit for this, as financial markets and the US economy are showing some signs of stabilization. John Hermann and Ron Insana had a spirited debate on this topic on CNBC on June 15. Hermann’s more optimistic, forecasting a slow but stable recovery as the stimulus programs help the global economy build momentum through 2011. Insana’s a bit more pessimistic, but does a fine job of thwarting Trish Regan’s “concerns” about government intervention while emphatically stressing that the Fed’s massive monetary stimulus efforts, both traditional and untraditional, must remain in place. You can watch the interview here:

The Shape of the Recovery

Dominique Strauss-Kahn, head of the International Monetary Fund, made comments similar to Insana’s, stressing in a recent interview that the worst of the global economic downturn may still lie ahead and that world governments should maintain or increase their stimulus efforts:

Worst of Crisis May be Yet to Come: IMF Chief

Paul Krugman just published an analysis suggesting that this is the third time we’ve witnessed a liquidity trap — the point in an economy where traditional monetary stimulus stops working. The first time was the Great Depression, and the second time was Japan in the 1990s. Both times government stimulus was prematurely withdrawn, and both times the result was a relapse into economic contraction:

Stay the Course

Of course, the consensus is far from unanimous. Those wild-eyed prophets at The Wall Street Journal see things differently. If you’re so inclined, you can watch reporter Jonathan Weisman fan the fears of socialism: 

Summers Says US Not in Danger of Becoming a Socialist State

Overall, considering that world leaders are navigating through completely uncharted waters, the intelligent consensus is that they’ve done far more right than wrong thus far. For an even deeper and more thoughtful analysis of what our economic future will look like, I recommend Mohamed El-Erian’s May 2009 article in which he coins the term “A New Normal.” El-Erian, who has one of the best track records of all the pundits, envisions a higher-savings, slower-growth, low-return, consumer-constrained future where government spending constitutes a greater share of GDP than we’ve become accustomed to in the last quarter century:

Secular Outlook: A New Normal

Finally, if you’re still with me and want yet another intelligent take on our economic future that’s slightly more optimistic than El-Erian’s, Jeremy Grantham’s May 2009 newsletter is a great read (as always). As is the case with many of the authors above, Grantham credits government stimulus programs for his “VL”-shaped economic recovery thesis:

The Last Hurrah and Seven Lean Years

Categories: Market Commentary

Bill Ackman, Dick Cheney, and the “Claim to Virtue” Strategy

by Rob Weigand.

[First, a brief disclaimer. Nothing in this article implies that Bill Ackman of Pershing Square Capital should be compared to former V.P. Dick Cheney, beyond strictly pointing out that they are both currently using more or less the same strategy to justify their recent behaviors — a strategy that’s so embedded in the Judeo-Christian and Western Scientific traditions that it’s often overlooked for being too obvious. The strategy is known as a “claim to virtue,” a concept elaborated on in the writings of the renowned psychiatrist Robert Jay Lifton. However, if you perceive that this article represents a personal attack on either Ackman or Cheney, or aspires to make some sort of political statement, you’re projecting. I assure you, no such intentions exist. But I believe that anyone who is motivated to figure out how the world works — something that applies to all investors — the following perspectives will be interesting.]

The final stages of Bill Ackman’s attempt at shaking up Target’s board have been chronicled in some excellent jounalism recently, including articles by the NY Times’ Joe Nocera, Reuters’ Felix Salmon and The Street’s Eric Jackson. The first two articles express puzzlement over what Bill Ackman has been up to with his usually successful activist strategy, as Target’s stock was never that big of a disaster. True, TGT has underperformed WMT in recent years, but over 5- and 10-year horizons both stocks have been mild disappointments (although both beat the S&P 500 over the past decade).

Joe Nocera and Felix Salmon really lay into Ackman over his erratic and puzzling behavior at the Target annual meeting. Evidently Ackman, who makes a good living by being a professional pain in the rear end, found it appropriate to abruptly don a halo and invoke both John F. Kennedy and Martin Luther King. Nocera quotes Ackman as he tearfully insists that he would “pay any price, bear any burden, meet any hardship,” as well as asserting:

I have a dream that directors will be elected on character and competence. I have a dream that one day the director nominating process will be transparent. I have a dream that our efforts here will be fruitful.

Nocera concludes that Ackman is “full of sound and fury, signifying nothing” (Shakespeare), while Salmon predicts he’s going to become an ever-greater object of ridicule. I’m going to respectfully disagree with these writers, both of whom I greatly respect, and devote the remainder of this article to describing why I believe that the strategy Ackman adopted as his defeat at Target became increasingly clear to him, known as a “claim to virtue,” may instead have been yet another shrewd move by someone who’s proved himself an astute student of both financial markets and human nature over the years. Ackman’s claim to virtue is quite simple — he hasn’t been a shareholder activist for money all these years, he’s been working hard to make the world a better place for you and me.

The “claim to virtue” strategy is at least as old as the Judeo-Christian roots of Western Civilization. It’s often used as a justification when someone wants to take possession of something that doesn’t belong to him or someone wants to do great harm to another (or both). A few quick examples. In the Old Testament, Deuteronomy 21:11 rationalizes the appropriation of attractive women after victory on the battlefield: “And seest among the captives a beautiful woman, and hast a desire unto her, that thou wouldest have her to thy wife.” (In this case the claim to virtue is the “fact” that the advice is being handed down by God himself.) Or, take Genesis 1:28, for example, which uses the same “but God said to do it” justification for appropriating natural resources, as man is exhorted to “fill the earth and subdue it; and have dominion over the fish of the sea, and over the birds of the air, and over every living thing that moves upon the earth.” In both past and present times this exact justification has been used as an excuse for colonial conquest, deforesting, overfishing, etc.

Now, of course Ackman didn’t claim that he was shaking up Target in the name of the Almighty, but he did attempt a decisive strategic move to the moral high ground with his quoting and paraphrasing of Kennedy and King. In my opinion, this was a based on a split-second calculation on his part as he astutely perceived he would win no seats on Target’s board — he shifted to the best possible position left to him in an attempt to mitigate the humiliation inherent in his high-profile defeat, and set himself up to raise more funds for future ventures, which he will do, and do bathed in the glory of his own high-mindedness. We’ll come back to the full brilliance of this positioning in just a moment.

Nocera and Salmon’s puzzlement stems from the fact that Ackman’s positioning of himself as a socially-concerned corporate activist is almost completely implausible to anyone with basic common sense. Modern applications of the “claim to virtue” justification always reflect some aspect of implausibility, however, often in the extreme. And, sad but true, the American Capitalist tradition is rife with these sorts of implausible justifications. Philosophies like Manifest Destiny were at first used to justify the slaughter of 60 million buffalo and 20 million antelope to make life tougher on Native Americans, and later the philosophy was used more directly to justify the mass genocide of these people. It was still God’s will in this case, but this time in the name of progress and profit. Pretty implausible from a modern perspective — but only because modern claims to virtue have become increasingly subtle. The implausibilities get harder and harder to argue with. Next, notice one more thing: no history scholar ever got a contract to write a textbook reporting these sorts of things. Or the fact that George Washington crossed the Potomac during a Christmas Even cease fire and murdered drunken Hessian mercenaries. Facts like these get sanitized by the time the next generation sits down for its history lessons. That’s how the for-profit world works.

Everyone’s noticed that Dick Cheney has been busy lately. For such a reticent and press-shy V.P., Cheney has devoted enormous energy to a prolonged speaking tour. But he knows exactly what he’s doing. Cheney is re-writing his entire legacy around a simple claim to virtue: I wanted to keep the country safe. So I had to approve enhanced interrogation techniques. It’s not torture when you’re trying to keep the country safe. And we had to invade Iraq. No invasion is unjustified when you’re trying to keep the country safe. In my opinion, Cheney is making a smart calculation that’s eventually going to pay off. No mass market history textbook is going to dig deeply into the enormous mess Bush and Cheney created. Right now, about 30% of the country views Cheney favorably. With time, that number is likely to go up, as the implausible justifications, repeated again and again, become faintly plausible — just another point of view that must be considered if one wants to be “fair and balanced.” Eventually, no history scholar is going to get a contract to write a chapter called “The Bush and Cheney Debacle.” The facts will need to be sanitized because textbook publishers won’t take the risk that 30-40% of children’s families in any particular school district will take offense.

Bill Ackman just made a similarly shrewd calculation with his invocation of Kennedy and King. Ackman doesn’t care what I think of him. Or you either, probably. Unless one of us has $5 million or more to invest. Ackman only needs 30% of the smart money to like his latest move, wiping away those crocodile tears in front of the press in Minneapolis. If that 30% liked it, or just remembers it favorably later, there will still be a new pool of money available to him when he gets his next great idea. And, tempered with the humility maturity can bring, it will probably be a damn good idea, and we’ll all wish we had invested in it, or saw it ahead of him. Another $1 or $2 billion of personal profit later, and no one will remember that Bill Ackman looked a little silly on a cool June day in Minneapolis. The facts will get sanitized, and Bill Ackman will be pestering corporations and making heaps of money while you and I are . . . watching and commenting.

Categories: Market Commentary