2 construction industry stocks to buy

Much construction industry activity, notably public projects, was deemed an “essential service” and continued to operate through the COVID-19 shutdown.

With public-project construction largely deemed an essential service across most of Canada, Vancouver-based analyst Frederic Bastien adjusted his estimates for two construction contracting companies under Raymond James Financial’s coverage umbrella to reflect current disruptions due to the COVID-19 pandemic.

Mr. Bastien assessed the status of Toronto-based Aecon Group Inc.’s (TSX—ARE) 12 largest projects to measure projected activity levels across the company and to get a better sense of the construction industry as a whole. The assessment assumes all projects began experiencing delays or site restrictions in March, and continues all the way to September of this year, when the analyst expects most disruptions caused by the pandemic to have subsided.

For April, Mr. Bastien assigned zero per cent activity to the three projects currently suspended. Those are REM Montreal, the Bermuda Airport and the Darlington Refurbishment. He assigned values ranging from 40 per cent for scaled-down remote construction sites to 80 per cent for largely uninterrupted utilities and telecom work in Ontario.

“This analysis yielded a weighted average score of 45 per cent for the month, suggesting that revenue is likely to fall 55 per cent short of its potential over the period. We anticipate more of the same for May, after which activity should gradually ramp back up,” says the analyst.

Margins under pressure this spring, early summer

Based on the analysis, Mr. Bastien estimates that Aecon’s construction business ran at 93 per cent capacity for the seasonally weak first quarter, and that it will operate at 50 per cent and 86 per cent of its potential in second-quarter 2020 and third-quarter 2020, respectively.

For the purposes of his calculations, the analyst assumes that the second construction industry stock under Raymond James’ coverage, Mississauga-based Bird Construction Inc. (TSX—BDT), will behave in a similar fashion to Aecon, due to the inability to track the status of the company’s smaller projects. Mr. Bastien says that considering the operating leverage inherent in the sector, he sees both contractors facing margin pressure through the spring and early summer months.

Although it is uncertain what the overall economy will look like in six months’ time, most of Aecon’s projects are still moving forward, though at a slower pace. Mr. Bastien says he fully expects Aecon’s backlog of critical projects to keep the contractor in good standing as more than half of the planned $6.8-billion order book will be carried out in 2021 and beyond.

The analyst notes that while disruptions are never good, he takes some comfort in knowing that they are occurring during a low point of the construction season.

“We expect activity levels to bounce back in early summer and perhaps accelerate into the fall as governments inject cash into the sector, as they often do in recessionary times and tackle new projects that fall squarely within Aecon’s strike zone,” he says.

Mr. Bastien names Aecon Group and Bird Construction as “strong buys”, the equivalent of “best buys” and the highest rating at Raymond James.

“Aecon is arguably in the best position it’s ever been from a financial standpoint,” says the analyst. The contractor has $74 million of cash on hand, $495 million available on its revolving line and a $700 million Export Development Canada (EDC) performance guarantee to support letters of credit. To further protect its balance sheet, Aecon eliminated all non-essential spending, reduced discretionary capital expenditures, and paused its share buyback program.

With the COVID-19 situation now in play, Aecon’s continuity plans extend from stringent site pre-screening and physical distancing to additional personal protective gear and staggered shifts.

Bird is no one-trick pony

Bird Construction is continuing to advance the majority of its projects, although also at a slower pace or in scaled down versions. The firm is racing to complete the Cedar Valley Lodge’s first 1,500 beds by this spring in Kitimat, British Columbia. Mr. Bastien says some may point to Bird’s high dividend as a cause for concerns, but he says he see’s no issue whatsoever.

“With $2.2 billion in backlog and high-probability sales opportunities at the end of fourth-quarter 2019, and no big design, build, finance and maintain (DBFM) project to drag on results any longer, we are confident Bird can manage the current COVID-19 disruptions and still deliver earnings growth this year,” comments the analyst.

Further supporting Mr. Bastien’s expectations is the firm’s diversification into sectors with lower risk contract types and its embrace of modular construction. Bird is no longer a one-trick pony operating in Western Canada’s energy sector, and it has the credentials to prove it.

This is an edited version of an article that was originally published for subscribers in the May 8, 2020, issue of Investor’s Digest of Canada. You can profit from the award-winning advice subscribers receive regularly in Investor’s Digest of Canada.

Investor’s Digest of Canada, MPL Communications Inc.
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