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Ecology and Environment Inc: Near Historical Low P/B and Historial High Dividend Yield

December 20, 2012 | About:
Mark Lin

Mark Lin

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Incorporated in 1970 and based in Lancaster, New York, Ecology and Environment Inc. (EEI) is a global broad-based environmental consulting firm providing professional services worldwide to minimize the negative impact of economic and human development on the environment. EEI has completed more than 50,000 projects for a wide variety of clients in 122 countries and its staff is comprised of individuals representing 85 scientific, engineering, health and social disciplines.

This stock idea was generated using GuruFocus' All-In-One Guru Screener, screening for microcaps with a minimum of 10 years of dividend payments.

Valuation

EEI is currently trading at a P/NTA of 0.99, a 21% discount to its five-year average P/NTA of 1.26. In terms of earnings-based valuations, it is valued at a trailing 12 months EV/EBITDA of 7.65 and a trailing 12 months P/E of 60.54. EEI achieved a 1.6% ROE for the past 12 months and a five-year average ROE of 8.7%. EEI attributed the decrease in earnings to project delays. Also, EEI has grown its book value per share by a modest 5-year CAGR of 3.2% and a 10-year CAGR of 1.6%, respectively.

From the chart below, it can be seen that EEI has rarely traded at or below book value in the past seven years since 2006.

EEI NAV, NTA Comparison

1356001184240.png

EEI has been profitable in 9 of the last 10 years, except for fiscal 2005. From fiscal 2010 to 2012, there has been a growing divergence between net income and free cash flow, with free cash flow turning negative in fiscal 2011 after six consecutive years of positive free cash flow. Capital expenditures as a percentage of sales increased above 2% for the first time in a decade.

EEI Earnings-Cash Flow Comparison 1356001692922.png

EEI Profit Margins Analysis1356001956241.png

Financial and Business Risks

EEI has a strong balance sheet with a low gross debt-to-equity ratio of 26%, a net gearing of 2% and minimal long-term debt.

EEI Cash-Debt-Market Capitalization Comparison1356002228143.png

EEI has been late in submitting its 10-Q five times and its 10-K twice in its history. In 2012, it was late in submitting its 2011 10K and two 10-Q reports.

EEI's profitability is heavily dependent on municipal, state and federal government work, with 27% and 24% of 2012 and 2011 sales derived from all government contracts. The procurement process is highly competitive, with increasing number of contracts awarded to multiple contractors and pricing pressure. In addition, government agencies such as the Federal Acquisition Regulation and the Cost Accounting Standards audit government contractors such as EEI to determine if its cost structure is compliant with applicable laws and regulations and potentially disallow certain costs on its contracts. EEI claims that it has been able to successfully defend against the disallowance of any significant costs historically.

A change in control transaction is unlikely with the current senior officers of EEI and Gerhard J. Neumaier, president and director of EEI, own in excess of 70% of the Class B Common Stock which has one vote per share while the Class A Common Stock has one-tenth of a vote per share.

Business Quality and Capital Allocation

EEI still has sufficient earnings buffer in the coming year with a backlog of $81.2 million as at July 31, 2012 and of that backlog, $61.8 million is expected to be completed with the next 12 months. It still has approximately $57.6 million of unrecognized revenue from two contracts awarded by the United States Environmental Protection Agency.

According to EEI, its contracts with the Environmental Protection Agency are structured as a combination of time and materials and cost plus contracts. EEI is reimbursed for allowable costs under this structure and this will offer some protection in terms of margins.

EEI has paid a dividend in every single year since listing in 1987 and currently sports a dividend yield of 4.3%. Management has grown dividends in almost every year with a 5-year dividend CAGR of 6.9% and a 10-year dividend CAGR of 4.5%.

EEI DPS-Dividend Yield Comparison1356004596238.png

Conclusion

The decision of federal, state and municipal governments to accelerate, defer or even halt public environmental programs is the single most important driver of EEI's revenues and earnings. EEI is attractively priced, trading in the lower range of its historical P/NTA and dividend yield valuations.

DisclosureThe author does not have a position in any of the stocks mentioned.

About the author:

Mark Lin
Working hard to be a better investor

Rating: 3.4/5 (7 votes)

Comments

SapientInvestor
SapientInvestor - 1 year ago
This one has been on my watchlist. My main problem as you point out is the control issue. Directors pay themselves too much for a company this size and there is locked up value in the balance sheet from long term real estate holdings. Its difficult for me to see how this would ever get unlocked. The directors are in their late 70s so a cynical view would be that value could be unlocked when they retire.

They do not communicate with sharelholders through calls which also turns me off.

The only value I see therefore is the dividend which they have been consistent with but there is not much accountability and it hasnt actually risen enough to justify the other risks.

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