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Near-Term Outlook Bleak for Engineering R&D Services Stocks

Shrabana Mukherjee

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.

Some of the prominent players in this industry are Quanta Services, Inc. (PWR), Jacobs Engineering Group Inc. (JEC), KBR, Inc. (KBR), Fluor Corporation (FLR) and AECOM (ACM).

Let’s take a look at the industry’s three major themes:

  • The industry is poised to benefit from rising construction activities in the United States that require state-of-the-art construction and engineering services. The Trump administration’s push to boost infrastructure spending is another vital growth catalyst for the industry. Also, the space is poised to gain from the rapid usage of advanced technologies to deliver smart buildings and mega projects, while identifying and checking diminishing margins as well as reducing costs.
     
  • 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 drive the industry’s growth. Chemical derivative and refining opportunities, both domestic and international, along with upstream and LNG opportunities should also spur growth.
     
  • However, a tight labor market, trade-war induced rise in raw material costs, volatility in commodity prices and the cyclical nature of the industry’s commodity-based business lines pose significant challenges. Again, significant cost overruns (as prices of several companies’ contracts are fixed) have been hurting the bottom line of some of the companies. Increasing competition is another dampener. The industry faces intense competition in the global engineering, procurement and construction industry, which is detrimental to the companies’ contract prices and profit margins.


Zacks Industry Rank Indicates Dull Prospects

The Zacks Engineering – R&D Services industry is a 17-stock group within the broader Zacks Construction sector. The industry currently carries a Zacks Industry Rank #229, which places it at the bottom 10% 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 March 2019, the industry’s earnings estimate for the current year has gone down by approximately 17.8%. Earnings estimates for 2020 have also moved 16.2% south during the period.

Despite the industry’s gloomy near-term view, we will present a few stocks that one can hold on to. 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 theZacks S&P 500 composite and the broader Zacks Construction sector over the past year.

Over this period, the industry has declined 13.2% versus the broader sector’s decline of 0.1%. Meanwhile, the S&P 500 has gained 2.5%.

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 13.8X versus the S&P 500’s 17.2X and the sector’s 14.9X.

Over the past five years, the industry has traded as high as 16.9X, as low as 9.9X and at the median of 13X, as the chart below shows.

Industry’s P/E Ratio (Forward 12-Month) Versus S&P 500

 


Bottom Line

A major boost in infrastructural and construction spending (mainly non-residential) should continue to favor the industry’s performance. Advanced construction and engineering services along with prudent cost management practices should lend support. However, rising raw material costs, a tight labor market and uncertainty around global trade are pressing concerns.

Below we present only one stock from the Zacks Engineering – R&D Services space with a Zacks Rank #2 (Buy). Investors might prefer holding another stock that has impressive growth prospects. You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

KBR, Inc.: The Houston-TX based leading global engineering, construction and services company carries a Zacks Rank #2. The consensus EPS estimate for this company has increased 1.2% to $1.68 for the current year and 2.1% to $1.96 for the next, over the last 60 days. It has a three-five expected EPS growth rate of 10.1%.

Price & Consensus: KBR


Investors might prefer holding on to the following stocks with impressive prospects.

Mayville Engineering Company, Inc. (MEC): This Mayville, WI based company provides prototyping and tooling, production fabrication, coating, assembly and aftermarket services. It has a solid three-five expected EPS growth rate of 17.5% and carries a Zacks Rank #3 (Hold). Notably, the consensus EPS estimate for this company has increased 116.1% to $1.21 for the current year, over the last 60 days. Earnings for the current year are expected to grow 58.7%.

Price & Consensus: MEC



Jacobs Engineering Group Inc.: This Dallas, TX-based technical and construction service provider currently carries a Zacks Rank #3. The consensus EPS estimate for this company has increased 3% to $4.85 for the current year over the last 60 days.It has a three-five expected EPS growth rate of 11%.

Price & Consensus: JEC


AECOM: This Los Angeles, CA based company engages in designing, building, financing and operating infrastructure assets worldwide. The stock carries a Zacks Rank #3 and its EPS estimates for the current year have witnessed upward revision of 0.4% in the past 30 days.

Price & Consensus: ACM


Below are two stocks with a bearish Zacks Rank that we would recommend investors to stay away from for the time being.

Quanta Services, Inc.: This Houston, TX-based company provides specialty contracting services to the electric power, communication, and oil and gas industries in the United States, Canada, Australia, Latin America and internationally. It has an expected earnings growth rate of 25.3% for the current year. The consensus EPS estimate for this Zacks Rank #4 (Sell) company has declined 14% for the current year, over the last 60 days.

Price & Consensus: PWR


Fluor Corporation: Headquartered in Irving, TX, this Zacks Rank #5 (Strong Sell) company delivers engineering, procurement, construction, maintenance and project management to governments and clients in diverse industries around the world. The consensus EPS estimate for the company has decreased 52.3% for the current year, over the last 60 days.

Price & Consensus: FLR


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Quanta Services, Inc. (PWR) : Free Stock Analysis Report
 
Mayville Engineering Company, Inc. (MEC) : Free Stock Analysis Report
 
KBR, Inc. (KBR) : Free Stock Analysis Report
 
Jacobs Engineering Group Inc. (JEC) : Free Stock Analysis Report
 
Fluor Corporation (FLR) : Free Stock Analysis Report
 
AECOM (ACM) : Free Stock Analysis Report
 
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