CIBC UpgradeEQUITY RESEARCH
April 20, 2022 Earnings Revision
E&C / Heavy Equipment Q1/22 Preview
WSP, STN, SNC, FTT, TIH, ARE, BDT, NOA, WTE
Our Conclusion
In this report, we provide our Q1/22 preview for the E&C and heavy
equipment sectors and highlight key emerging themes. We have a positive
bias towards STN/WSP (pure-play engineers able to pass through higher
costs at a time of rising backlog/demand levels) and FTT (historic valuation
discount to TIH and a proxy play on elevated crude/copper prices). While we
remain constructive on the mid- to longer-term outlook for Canadian
construction names (ARE/BDT backlog levels set to rise through H1/22), we
expect Q1/22 results (including SNC’s LSTK projects) to be weaker Y/Y due
to ongoing supply chain issues/cost inflation and/or the lack of CEWS.
Key Points
Construction Spending Positive During Periods Of High Inflation: Going
back to 1964, U.S. construction spending growth has generally been positive
during times of sustained high inflation or rising rates.
But What If There Is An Economic Slowdown/Stagflation? While
concerns of an economic recession are growing (not our base case at this
point), historically high E&C backlog levels, increased levels of global public
infrastructure spend (including the multi-year US$1T U.S. plan that kicks in
more meaningfully from H2/22) and pent-up project work due to COVID-19
provide a fundamental cushion for the names in our E&C coverage.
Supply Chain Disruptions Pose Risk To Construction-focused Firms:
As per industry surveys, ~75% of E&C firms indicated project delays and
~79% of firms indicated that supply constraints are having a serious impact.
Engineers Well Positioned To Pass Through High Wage Inflation: The
U.S. engineering unemployment rate has fallen to just 1.8%, and private
sector wage rate growth has risen to 5%. Given high demand for design
services, WSP, STN, and SNC (its engineering segment) are well positioned
to pass on higher costs to clients through higher project pricing (i.e., we
forecast relatively flat margins in 2022 vs. 2021).
Forward Indicators Indicate Demand For Design Services (WSP, STN,
SNC’s Engineering Segment) Remains Strong: Latest Architecture
Billings and Dodge Momentum Index readings suggest continued growth.
CAT Machinery Supply Crunch Improves In Q1/22: CAT’s March 2022
consolidated factory activity rose about 18% vs. a year ago, driven by
off-highway trucks, graders and excavators (a positive development for TIH
and FTT).
Prefer FTT Over TIH On Valuation: Though TIH is arguably more
defensive/less cyclical compared to FTT, the commodity backdrop for oil and
copper remains constructive and, thus, we believe that FTT’s near-historic-
high valuation discount (~11x P/E discount) to TIH is not warranted.
Heavy Equipment (FTT, TIH)
Finning International Inc. (Outperformer, $50 Price Target)
Investment Thesis: Despite supply challenges, we believe the combination of higher revenue (robust new equipment backlog levels, supported by a robust oil/copper commodity backdrop and continued product support growth momentum) on a lower cost base should continue to lead to double-digit EPS growth in 2022E and 2023E (and we expect FTT to generate strong earnings/free cash flow as a result of this operating leverage). While the
constitutional convention in Chile does pose a risk to the mining sector in that country, we expect a resolution within Q2/22 or Q3/22. We raise our forward estimates slightly (2023E adjusted EPS increases by ~3%) to reflect improving CAT equipment supply and the stronger-for-longer crude price environment. Our price target increases from $47 to $50 and we maintain our Outperformer rating. From a valuation perspective, FTT is trading at a 2023E P/E of ~14x, an ~11x near-historic-high multiple discount to TIH.
Q1/22 Preview: We forecast Q1/22 adjusted EPS of $0.48 (vs. consensus of $0.50), implying a solid 37% Y/Y increase. We forecast sales to grow by 17% Y/Y, driven by higher new equipment sales (reflecting FTT’s solid backlog across Canada, South America and the U.K.) and the continued recovery in higher-margin product support sales. We forecast adjusted
EBITDA margins to improve slightly vs. a year ago (despite a higher mix of equipment sales), driven by operating leverage across all regions and initiatives to reduce fixed costs. Our focus for the quarter will be on the extent of product support recovery, management commentary on the outlook for Chile (in light of the ongoing constitutional convention there), and inventory position/ability to meet demand amid ongoing supply chain constraints.