SNC-Lavalin (SNC.TO) Analysis

A copy of this article originally appeared on Seeking Alpha.

Thesis

With respectable profitability over the past 10 years, and an incredibly strong dividend history, SNC-Lavalin (SNC.TO) would be a worthwhile addition to any dividend growth portfolio. However, its current valuation measured against its price-to-book, and price-to-earnings ratios, as well as when compared to its peers, demonstrates that even with strong dividend performance it is still overvalued. Investors would be better off putting this stock on their watch list, and adding when the price drops below C$40.00.

Background

SNC-Lavalin is a Canadian based engineering firm, which derives its income from six key streams, outlined below.

Collectively, the Mining & Metallurgy, Oil & Gas, Power, Infrastructure & Construction, and Operations & Maintenance, are referred to as the Engineering & Construction segment. Running parallel to this is the Capital Investments segment, which enters long term agreements which use either fixed cost or equity method accounting to record revenue.

Profitability and Stability

Beginning in F2013, SNC started reporting its revenue broken down between engineering revenue and capital investment Revenue. Except for F2009 and F2013, year over year (YoY) revenue growth has been positive, with the most recent year’s revenue coming in at +16% at over $9billion.

The share price has generally trended upwards over the past 10 years, with minor dips in F2008, F2012, and F2014:

The F2008 dip may be attributed to the Kerala Hyderoelectirc Dam Scandal, and the F2012 and F2014 dips may be attributed to the Libya business probe. Of course, this is speculation, but given the negative press it is a plausible explanation, especially since the underlying fundamentals relating to revenue remained consistently strong during that period.

One other financial stability figure to review is the current ratio. Typically, one would hope to see a current ratio of at least 1.50 (i.e. current assets more than covers current liabilities). As of the most recent fiscal year, the current ratio is 1.02 when comparing net current assets to net current liabilities. However, this number quickly climbs to 1.54 once you consider the ratio of short term assets to short term debt (i.e. vs. aggregate short-term liabilities). This is illustrated in the below chart, which breaks down short-term liabilities into its components of debt vs. de-facto liabilities.

Condensed Balance Sheet

Condensed Balance Sheet

Dividend

Dividends are an interesting metric when compared to share price. Provided the dividend payout ratio (i.e. the portion earnings paid to dividends) remains low, and the dividend remains consistent or increasing, a drop in a company’s share price often represents a buying opportunity. It is for this reason that I feel dividends can be observed separately from share price: whereas share price represents capital appreciation, dividends represent (immediate) realized gains to shareholders. That said, over the past 10 years, SNC’s dividend has risen from $0.23 in F2005 to $1.01 in F2015, representing a 14.40% compounded annual growth rate of dividends.

Overall, the dividend payout ratio has been consistently below 50% since F2010, and prior to that, it was consistently below 40%. Overall this indicates that there is still plenty of room for SNC to continue to raise dividends, even in the face of revenue headwinds.

Valuation

SNC’s current valuation is where it falls short in my view, based on the following:

  • Trailing-twelve-months (“TTM”) EPS of 2.03/share
  • Book value of $25.03 based on the most recent fiscal quarter results
  • Current share price of $56.52 (as of February 3, 2017)

Given these numbers, the stock has a price-to-earnings of 27.8, and a price-to-book of 2.2, yielding a Graham number (i.e. P/E × P/BV) of 60.8. SNC’s meaningful peers (Aecon (ARE.TO), Bird Construction (BDT.TO)) have an average P/E × P/BV of 25.0 for the most recent fiscal year, illustrating that SNC’s Graham number is more than twice that of its peers.

What this translates to, is that SNC is trading at much more than it should be at this time, when compared to EPS and/or book value. At the current TTM trailing EPS and book value, I would expect to see a price of no more than $33.81, if we have an upper limit of 22.5 for our Graham number. This puts SNC’s current price at roughly 1.7× what it should be, based on TTM EPS and book value based on the most recent quarterly results. This isn’t quite as bad as the Graham number multiple compared to peers (SNC’s 60.8 is 2.4× that of the peer average at 25.0), but it is still considerable.

Closing Remarks

Fundamentally, I like SNC. Its historical performance, even amidst two scandals, is stellar, and its dividend growth is spectacular. However, the valuation concerns me; as much as I don’t mind paying an “okay price for a good company”, at the current valuation it is no longer “okay”, just “bad”. I would consider buying on dips, and will re-review after the F2016 results are out to see where the valuation sits vis-a-vis its updated fundamentals.

Notes

All figures are reported in Canadian dollars.



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