Take a pass on Aecon, says iA Capital 

Mixed quarterly results and a dimmer near-term view have clouded the picture on Canadian construction infrastructure company Aecon Group (Aecon Group Stock Quote, Charts, News, Analysts, Financials TSX:ARE), according to iA Capital Markets analyst Naji Baydoun, who reviewed the company and stock in an update to clients on Friday. 

Toronto-headquartered Aecon released its second quarter 2022 results last Thursday, reporting a 16 per cent year-over-year increase in revenue to $1.123 billion. 

“Demand for Aecon’s services across Canada continues to be strong, particularly in smaller and medium sized projects,” said Jean-Louis Servranckx, President and CEO, in a press release. 

“As we navigate through broader economic challenges in the short-term, we are focused on ensuring solid execution on our projects and selectively adding to backlog through a disciplined bidding approach that supports long-term margin improvement, supported by a diversified and strong level of backlog, growing recurring revenue programs and ongoing recovery in traffic at the Bermuda airport,” Servanckx said.

Aecon generated Q2 adjusted EBITDA of $38.5 million with a margin of 3.4 per cent compared to $61.3 million and a margin of 6.3 per cent a year earlier. The company’s net loss was $6.4 million or $0.10 per share.

Aecon said some of the highlights for the quarter included the finalization of a $219 million contract with ADM Aéroports de Montréal for Connect Cité, a 50/50 general partnership between Aecon and EBC, to build the Montréal-Trudeau International Airport Réseau express métropolitain (REM) Station project and a $273 million design-build contract for its 50/50 JV with Graham for the Buffalo Pound Water Treatment Plant Renewal Project in Saskatchewan. All told, Aecon said its backlog stood at $6.605 billion at the quarter’s end compared to $6.524 billion a year ago.

But Baydoun declared the Q2 results to be mixed, with the $1.123 billion topline coming in ahead of his estimate at $1.004 billion and the consensus call for $1.017 million while the $39 million in adjusted EBITDA was under his estimate at $60 million and the Street’s $61 million. 

“Construction revenues benefitted from higher activity levels across Aecon’s operations, while the Concessions business performed in line with expectations (with recovering Bermuda operations). However, (1) an unfavourable margin adjustment on an LRT project, (2) higher project costs, and (3) higher labour and project pursuit/bidding costs impacted margins, which lead to EBITDA missing expectations,” Baydoun wrote.

Baydoun said Aecon’s contract wins were higher than expected over the quarter but that macro economic uncertainties are likely to weigh on the construction industry going forward, leading to a slowdown in new project awards, which will in turn impact margins and earnings growth. The analyst also noted that several of Aecon’s large-scale, previously secured contracts are being negatively impacted by forces including cost inflation, supply chain disruptions, project delays as well as labour and materials issues.

“Overall, we see risks from legacy fixed-price projects and therefore margins over the near-term (Exhibit 4); in our view, until cost increases are compensated for/recovered, we see further near-term margin pressures limiting the potential upside in the shares (for now). As such, until these issues are resolved (or at least behind Aecon), we are electing to take a more neutral stance on the shares at this time,” Baydoun said.

With the update, Baydoun has dropped his rating on ARE from “Buy” to “Hold” and lowered his target price from $20.00 to $17.00 per share, which at the time of publication represented a projected one-year return including dividend of 38.3 per cent.

In the stock’s favour, Baydoun noted Aecon offers investors a company with a stable balance sheet and cash flow fundamentals along with its solid backlog in an industry which has upside potential from additional infrastructure investments. As well, the analyst pointed to ARE’s current dividend yield of six per cent and said there’s even potential for growth in that respect with a roughly 30 to 40 per cent free cash flow payout through 2026. On valuation, too, Baydoun said ARE is currently trading at a discount to its wider peer group.

Aecon’s share price slid by about 13.5 per cent in trading on Friday and the stock is now down about 34 per cent year-to-date. For the past 12 months, ARE is down about 45 per cent.

Looking ahead, Baydoun is expecting Aecon to deliver full 2022 revenue of $4.379 billion compared to $3.977 billion in 2021 and rising to $4.381 billion in 2023. On adjusted EBITDA, Baydoun is estimating $240 million for 2022 compared to $239 million last year and rising to $275 million for 2023. The analyst has ARE’s EV/EBITDA moving from 5.7x in 2021 to 5.3x in 2022 to 4.9x in 2023.