October 2017 Vol. 72 No. 10
Features
Utility & Communications Construction Business Update
In the wake of devastating storms in Texas and the Southeast, utility and communication contractors across the country are hard at work picking up the pieces, restoring power and will begin the process of improving the systems for the next weather challenge. While we pray storms never hit, the work in the aftermath is typically beneficial for this segment.
The quarterly updates for the utility and communication contractors were strong as we headed into the final quarter of 2017, and improved share pricing reflected the strength. The segment has lagged the S&P 500 as major infrastructure programs discussed in the most-recent election have not born out. However, the infrastructure repair and replacement work driven by regulatory requirements is keeping most contractors busy.
As contractors begin to start filling their backlog for 2018, some significant themes will influence work availability. In power, reliability standards for the electric distribution networks are an increasing theme among electric investor-owned utilities. We anticipate that capital expenditures from major electric utilities will continue to flow towards their distribution networks. In addition, existing and renewable generation will need interconnection to the grid and existing infrastructure will need to be upgraded to facilitate the two-way flow of power. As more states and municipalities expand their renewable generation, the burden to the distribution network will only increase. The power transmission market remains consistent with upgrades completed for reliability concerns.
The gas distribution market will continue to see increased spending as U.S. pipeline infrastructure continues to age, with replacement programs barely keeping pace. LDCs have gradually increased spending, but are constrained by the number of people who are operationally qualified to perform work on their systems. The regulation from PHMSA and safety concerns of state PUCs in this sector will only increase the spending required to address volatile gas infrastructure. Oil and gas transmission pipelines are currently driven by the need for takeaway from the wellhead and are not being constrained by commodity pricing.
Lastly, significant drivers in the communications industry will influence fiber placement for the next 10 years. Traditional municipal power companies have begun to implement local fiber networks providing gigabit fiber to the home. Verizon and AT&T have both announced their 5G fiber deployment programs, starting in major U.S. cities and gradually expanding to other parts of the United States. Connect American Funds are moving from the engineering phase into actual construction, and contractors are beginning to benefit on a larger scale. The major cable providers continue to expand their offerings to compete with other Fiber To
The Home (FTTH) services. Industry participants are committing to multi-year capital commitments to improve their network offerings, which
enhances visibility and growth expectations for this segment.
The Utility & Communications Construction Index (UCC Index) presented below shows the performance of the sector’s publicly traded stocks over the past six months (Figure 1). The segment outperformed the broader market through April and began a very sharp decline compared to 2016 levels. Based on the most-recent reports from public companies, the pricing has improved and we would expect the trend to continue through year-end.
As we look at performance across the UCC Index, most of the companies are seeing improvement in both return on assets and returns on equity (Figure 2). EBITDA from the index is nearing an all-time high and year-end expectations are increasing, based on solidifying backlog and good execution.
Trading multiples year-to-date are down, but in line with historical pricing (Figure 3). Analyst expectations are high for many index companies and the trend is very favorable for the segment. Tailwinds that include reliability-driven work, communication demand and increased capital spend from investor-owned utilities will likely improve pricing.
Interest in the utility and communications infrastructure markets remains very strong (Figure 4). In addition to the M&A activity below, Forbes Energy Services, a Canadian power transmission and distribution company, has filed a shelf registration that could potentially lead to a public offering in the future. Intren completed a successful private placement of capital to accelerate growth and expand its operations, and MYR Group completed a share buyback. This typically means that the company believes its stock is undervalued relative to market pricing.
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