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Another Play on Trump Infrastructure Spending

- By Rupert Hargreaves

A few weeks ago I wrote about Gencor Industries (GENC), concluding that the firm was an interesting value play on President Donald Trump's planned infrastructure boom. Recently my research has turned up another company that may be an excellent way to play this theme: Sterling Construction (STRL).

A Trump spending play


Sterling is a Texas-based heavy civil construction company with a focus on roadways and bridges. Over the past few years, the company has been through an aggressive restructuring. Between fiscal 2011 and fiscal 2015 the company reported substantial losses, which peaked at -$74 million in fiscal 2013.

Sterling has now reversed most of these losses. The firm reported earnings per share of 9 cents for its second fiscal quarter.

Still, much remains to be done, and the company is not yet where it wants to be. Margins have risen from 6.3% in June 2015 to 7.8% in June 2016 while recent contract wins are closer to 9.4%. Further margin expansion is expected as old contracts expire, some of which are generating zero profit margins. Approximately 10% of revenue or $70 million is tied to such legacy contracts, and $40 million worth of these deals expected to close out in 2016.

The group will receive a further boost from refinancing existing debt facilities. Sterling is currently paying 12% per annum on its lending. The company raised money via an equity issue during the middle of 2016 to help increase its financial flexibility.

Active management

Sterling's recovery is being steered by Paul Varello, who took over as CEO three years ago. So far, his attempts to turn the business around have succeeded; to align his interests with those of shareholders, Varello's pay packet has been reduced to $1 per annum with the rest of the salary coming via 600,000 restricted shares. With such an agreement in place, you cannot argue that Sterling's management does not have shareholders' best interests in mind.

Along with improving profit margins and the winding down of the low margin legacy portfolio, Sterling is projecting revenue above $1 billion in the next few years. The firm's order backlog is already above $1 billion, and orders continue to arrive, the most recent of which is a joint venture on a $139 million Utah highway project announced at the beginning of this month.

Alongside the $1 billion revenue target management is also aiming for earnings per share of $1 in the coming years; $150 million of net operating losses should help the company reach this objective.

A growth play

Shares in Sterling are not as cheap as they once were. Today the stock trades at a price-book (P/B) value of two compared to 0.5 at the beginning of 2015. What's more, because the group has yet to report sustainable profitability it's difficult to value the firm based on earnings.

Nonetheless, after stabilizing the ship, Sterling is well placed to capitalize on any increased infrastructure spending that may come from the Trump administration. The company's goals to increase revenue to $1 billion and earn $1 per share in the near term do not include any additional infrastructure spending. To put it another way, Sterling could be viewed as an option on Trump's infrastructure promises. If the promised spending does not emerge, the business will still generate returns for investors over the next few years. Targeted earnings of $1 put the company on track for a forward price-earnings (P/E) of 10 at current prices. Also, management incentives indicate that Sterling's CEO might try to boost growth via bolt-on acquisitions if they appear.

If Trump's infrastructure program does become a reality, the potential boost to Stirling's revenue and earnings will dramatically improve the company's outlook, and a re-rating of the shares should follow. All in all, Sterling's downside is limited, but upside potential could be massive.

Disclosure: The author owns no share mentioned.

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This article first appeared on GuruFocus.