Coronavirus-induced disruptions, challenges in the energy market, a tight labor market, slowing global growth and uncertainty around global trade are pressing concerns for the Zacks Engineering – R&D Services industry.
Nonetheless, a major boost in infrastructural spending (mainly government projects), advanced construction and engineering services along with prudent cost-management practices should lend support to some prominent players in this industry like Howmet Aerospace Inc. (HWM), AECOM (ACM), Gates Industrial Corporation PLC (GTES), Quanta Services, Inc. (PWR) and KBR, Inc. (KBR).
The Zacks Engineering – R&D Services industry primarily consists of engineering and infrastructure service providers. The companies basically provide construction, technical, engineering and professional services to a number of industries worldwide, including oil and gas, chemical and petrochemicals, transportation, mining and metals, power, agriculture, consumer applications and manufacturing.
4 Trends Shaping the Future of Engineering – R&D Services Industry
Need of State-Of-The-Art Services: Increasing construction activities in U.S. government projects, which require state-of-the-art construction and engineering services, are expected to benefit the construction and engineering services industry. Also, rapid usage of advanced technologies to deliver smart buildings and mega projects, while identifying and checking margin contraction and costs are expected to be a major tailwind for the industry participants.
Focus on Defense, Healthcare & Communication: The Trump administration’s investment in defense and cyber security is conducive to the industry’s growth. The players are also gaining from rising global demand for alternative nuclear energy as they provide engineering, procurement, construction and maintenance services to nuclear power plants. Meanwhile, increasing public investments in transportation, water infrastructure, utility plant and healthcare market are anticipated to be conducive for the industry’s growth. Additionally, infrastructure services business of the industry players continues to thrive, supported by robust demand from the communications industry.
Challenges in Energy Markets, Project Delays & Absence of Larger Projects: Overall, energy markets have been facing major challenges due to COVID-19. Customers have been restricting onsite activity for services. Also, they have been deferring maintenance and certain turnaround projects owing to the pandemic. Also, volatility in commodity prices and the cyclical nature of the industry’s commodity-based business lines pose significant challenges. Some of the companies have also been witnessing a dearth of larger pipeline projects owing to volatility in capital spending by customers.
Trade War & Uncertain Economic Conditions: Apart from COVID-19-led disruptions, a tight labor market and trade war-induced rise in raw material costs are pressing concerns for the industry players. Also, as the coronavirus outbreak continues, uncertain global economic conditions will create pressure on demand for services provided by the industry players.
Again, significant cost overruns (as prices of several companies’ contracts are fixed) have been hurting the bottom line of some of the companies. The companies also face intense competition in the global engineering, procurement and construction industry, which hurts their contract prices and profit margins.
Zacks Industry Rank Indicates Dull Prospects
The Zacks Engineering – R&D Services industry is a 30-stock group within the broader Zacks Construction sector. The industry currently carries a Zacks Industry Rank #195, which places it at the bottom 22% of more than 250 Zacks industries.
The group’s Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates dismal near-term prospects. Our research shows that the top 50% of the Zacks-ranked industries outperforms the bottom 50% by a factor of more than 2 to 1.
The industry’s position in the bottom 50% of the Zacks-ranked industries is a result of negative earnings outlook for the constituent companies in aggregate. Looking at the aggregate earnings estimate revisions, it appears that analysts are gradually losing confidence in this group’s earnings growth potential. Since May 2020, the industry’s earnings estimates for 2020 and 2021 have been revised 17.5% and 38.7%, respectively, downward.
Despite the industry’s gloomy near-term view, we will present a few stocks that one may consider for the portfolio. Before that, it’s worth taking a look at the industry’s shareholder returns and current valuation.
Industry Underperforms S&P 500 & Sector
The Zacks Engineering – R&D Services industry has lagged the Zacks S&P 500 composite and the broader Zacks Construction sector over the past year.
Over this period, the industry has lost 7.2% versus the broader sector’s rally of 17.6%. Meanwhile, the S&P 500 has risen 14.1%.
One-Year Price Performance
Industry’s Current Valuation
On the basis of forward 12-month price-to-earnings ratio, which is a commonly used multiple for valuing Engineering – R&D Services stocks, the industry is currently trading at 22.9X versus the S&P 500’s 21.9X and the sector’s 17.9X.
Over the past five years, the industry has traded as high as 22.9X, as low as 10.6X and at the median of 14.4X, as the chart below shows.
Industry’s P/E Ratio (Forward 12-Month) Versus S&P 500
5 Engineering – R&D Services Stocks to Keep a Close Eye on
Howmet Aerospace Inc.: This Pittsburgh, PA-based company is a provider of advanced engineered solutions for the aerospace and transportation industries. The Zacks Rank #2 (Buy) company has been benefiting from growth in the defense and industrial gas turbine market, offsetting the disruptions in the commercial aerospace and commercial transportation markets primarily due to COVID-19 and 737 MAX production declines. The company also expects defense aerospace to grow in the near term on strong demand for the Joint Strike Fighter on both new airplane builds and engine spares. Also, its rapid cost-containment actions and ability to quickly flex variable spending have been aiding margins. You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.
Its earnings for 2020 are expected to decline 66.8% and the stock has lost 26.5% in the past year. Nevertheless, Howmet Aerospace has seen upward estimate revisions for its 2020 bottom line over the past 60 days of 32.1%, depicting analysts’ optimism over the stock’s earnings prospects. Earnings for 2021 are expected to grow 4.3%.
Price & Consensus: HWM
AECOM: This Los Angeles, CA-based company engages in designing, building, financing and operating infrastructure assets worldwide. Despite economic pressure in few domestic and international markets, a solid backlog level and high win rates on key pursuits are resulting in market share gains that position AECOM for outperformance in the near term. Again, the company has been benefiting from successful execution of the G&A reduction plan, restructuring efforts and favorable end-market trends.
That said, the ongoing political instability in Hong Kong and lower profitability in the U.K. have primped analysts to remain slightly edgy, resulting in negative earnings estimate revision of 2% for fiscal 2021 over the past 60 days. Nevertheless, the company’s earnings for fiscal 2021 are expected to grow 16.6%. The stock has also gained 20.5% in the past year against the industry’s 7.2% decline.
Price & Consensus: ACM
Gates Industrial Corporation plc: This Denver, CO-based company manufactures and sells engineered power transmission and fluid power solutions worldwide. This Zacks Rank #2 company is poised to benefit from continuous demand for mission-critical components globally. Also, efficient cost-saving initiatives in order to mitigate the impact of COVID-19 on margins from the volume decline is expected to aid its bottom line. The company also expects demand to recover in the second half of 2020.
Importantly, Gates Industrial has seen 56.7% upward estimate revisions for its 2020 earnings over the past 60 days. The stock has gained 22.1% in the past year. Although COVID-19-led disruptions are likely to impact this year’s bottom line, earnings for 2021 are expected to grow 56.4%.
Price & Consensus: GTES
Quanta Services Inc.: This Houston, TX-based company is a leading national provider of specialty contracting services, and one of the largest contractors serving the transmission and distribution sector of the North American electric utility industry. This Zacks Rank #3 (Hold) company is set to deliver a resilient performance for the balance of 2020 and beyond despite a challenging environment. Backed by solid strategies and operational excellence, it lifted its adjusted earnings, adjusted EBITDA and non-GAAP free cash flow projection for 2020. Notably, 80-90% of its revenues are derived from utility, communications, and few pipeline and industrial infrastructure services, which continue to be strong.
Importantly, Quanta Services has seen 6.3% upward estimate revision for its 2020 earnings over the past 60 days. The stock has gained 52.4% in the past year. Although COVID-19-led disruptions are expected to weigh on its 2020 bottom line to some extent (as earnings for the year are expected to grow a meager 0.9%), earnings for 2021 are expected to advance 20.1%.
Price & Consensus: PWR
KBR, Inc.: Headquartered in Houston, TX, this company provides professional services and technologies across the asset and program life-cycle within the government services and hydrocarbons industries worldwide.
Although COVID-19 impacts and a soft energy market are expected to hurt 2020 bottom line, its mission critical government services and proprietary technology solutions, and significant increase in backlog (particularly in Government Solution) are expected to boost earnings for 2021. The company’s 2021 earnings are likely to grow 13%. This Zacks Rank #3 company’s consensus estimate for earnings has remained unchanged for 2020 but revised 5.7% upward for 2021 over the past 60 days. The stock has declined 3.1% in the past year, faring better than the industry.
Price & Consensus: KBR
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