As I checked various sources, they all remain in favor of investing in Matrix Service Co. (MTRX, Financial). I looked further into MTRX as it declined by more than 20% today to see whether there might be any bargains. I found that MTRX provides favorable risk/reward profile given all the bad news have already been reflected in today's share price. According to my target valuation, there is 66% upside potential in MTRX. Although not all stocks' decline deserves to bound back, MTRX happens to be the one among the few misunderstood companies awaiting for patient value investors to accumulate.
Business overview
MTRX was founded in 1984 with only 14 employees. Today, it employs nearly 5000 people across the United States and Canada. MTRX provides engineering, fabrication, infrastructure, construction and maintenance services primarily to the oil, gas, power, petrochemical, industrial and mining and minerals markets. In addition, MTRX was named one of the Forbes 100 Most Trustworthy Public Companies and Fortune's Top 100 Fastest Growing Companies. Further detail can be found at the company website with video for prospective investors to learn more about MTRX.
Financial strengths
The Company's cash balance increased to $77.1 million at June 30, 2014 as compared to $63.8 million a year earlier. The cash balance along with availability under the senior credit facility gives the Company liquidity of $242.5 million.
Upon the latest Q4 2014 earnings release, MTRX shows that it has $242.5 million liquidity. Furthermore, there is no long-term debt other than $11 million borrowings under senior credit facility. Overall, the financial profile of MTRX is strong, and it has $77 million in cash, which makes its enterprise value even below the current market cap of about $600 million.
Why did MTRX decline to today's depressed level?
According to the earning guidance for fiscal year 2015 below:
The Company expects that fiscal 2015 revenues will be between $1.425 billion and $1.525 billion and earnings to be between $1.40 and $1.60 per fully diluted share. The Company is anticipating normal quarterly variability with the first quarter being the lowest as activity in the Electrical Infrastructure and Oil Gas and Chemical segments are typically slower in the summer months.
Together with an expected 37% tax rate, I can derive that MTRX guided for about 4.1% operating margins, which is the second-lowest margin MTRX has attained since 2008. It is no wonder that the Street was disappointed and punished MTRX for in excess of 20% decline today. However, if we step back and research further into what MTRX has accomplished, we might find other positive signs.
First, backlog is increasing as stated in the Q4 2014 earning release below:
Backlog at June 30, 2014 totaled $915.8 million, an increase of $289.1 million, or 46.1%, compared to the backlog at June 30, 2013 of $626.7 million and increased by $10.7 million, compared to the March 31, 2014 backlog of $905.1 million.
Indeed, rising backlog is a good indicator for more revenues in the future. Second, liquidity hits a record high of $242.5 million with cash generated from operating activities totaling $77.0 million. This helps to ensure that MTRX has enough cash flow to prevent any liquidity crisis. Third, operating incomes increased for almost all segments, except Oil Gas & Chemical. But fortunately Oil Gas & Chemical is the smallest out of the four divisions.
Source: Earning Release Q4 2014
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Source: Company Presentation
Although the 2015 EPS guidance of $1.5 is below the street consensus, looking at the above EPS chart can illustrate that MTRX has been capable of increasing its EPS since 2010. Due to the uncertainty in any business, it is hard to imagine that the EPS of MTRX will look like a straight upward line. However, the positive EPS uptrend momentum seems to be intact. I believe that the current $1.5 EPS in 2015 is among the lowest in regards to operating margins, and today's depressed share price should help to provide a floor for the valuation of MTRX.
Valuation
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Source: Gurufocus.com
From an EV/EBITDA perspective, MTRX is currently trading around 6x EV/EBITDA for the assumptions that MTRX generates about 6.5% EBITDA margins and attains around $100 million EBITDA. Based on the chart above, I decided to assign a 10x EV/EBITDA for my target valuation. This will result in an enterprise valuation about $1 billion for MTRX and imply 66% upside potential.
(click to enlarge)
Source: Gurufocus.com
From another perspective to value MTRX, if MTRX earns up to 5.5% operating margins, together with $1.475 billion sales, the net income will be approximately $50 million. As shown from the P/E chart above, MTRX can earn 20x P/E, which will coincidently result in $1 billion valuation as calculated from the EV/EBITDA valuation above.
The Bright Outlook
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Source: Company Presentation
In the oil and gas market, North America is in an early stages of building out the infrastructure to keep up with the ever-increasing demand from Eagle Ford, Permian basin, Marcellus, Bakken, and the Canadian oil sands. This will create additional opportunities for MTRX. Not to mention that as there is more demand for natural gas exported from the North America, MTRX's capabilities in liquefied natural gas (NYSEMKT:LNG) and liquefied petroleum gas (NYSE:LPG) storage tanks should be in demand and drive the profit margins and sales higher.
Management team
John Hewitt has been the CEO of MTRX since May 2011. He has spent his entire career in the engineering, procurement, and construction "EPC" industry. He earned a Bachelor of Business Administration degree in Finance from Stetson University in 1980 and a Bachelor of Science degree in Civil Engineering from Florida Institute of Technology in 1983.
Kevin Cavanah has been the CFO of MTRX since December 2010. He has served various important roles within MTRX, including Chief Accounting Officer and Controller. He also served as Audit Manager of Ernst & Young LLP. He holds Bachelor of Science in Business Administration and Accounting from the University of Arkansas. He is a Certified Public Accountant and is a Member of Financial Executives International.
Despite the experience brought to MTRX by both the CEO and the CFO, the executive officers and directors together own just about 1.3% outstanding shares of MTRX according to the latest proxy statement. This indeed is a negative sign for prospective investors. However, as MTRX trading close to the trough of various valuation matrics and having 66% upside potential, I believe that the risk/reward profile is still favorable for prospect investors.
Risks
First, E&C projects are normally awarded in fixed-price business model, and this leaves execution risk for MTRX to deliver the projects on budgets. Second, energy prices are volatile and able to determine the economical feasibility of most LGL and LPG projects. As energy prices decline, some projects might be delayed or canceled as they are no longer economical for additional investment. Third, forward estimates show steady-to-growth in profit margins and rising sales, which could end up being aggressive as revenues and margins could decline. Fourth, please refer to the risks section of the 10K to further understand the business risk investing in MTRX.
The bottom line
The outlook for MTRX is still bright given that the infrastructure investment in the United States is expected to rise. The latest earning disappointment has already been fully reflected in today's share price. What leaves in MTRX is the strong fundamentals and attractive valuations awaiting for patient value-oriented investors. I believe that MTRX will not be misunderstood and mispriced for long, and I recommend MTRX for high risk tolerant investors. As seen in today's sharp decline in share price, MTRX is not for any investors with faint of heart.
Disclosure: I am not a securities broker/dealer or an investment adviser. I am currently long MTRX. You are responsible for your own investment decisions. All information contained should be independently verified with the companies mentioned, and readers should always conduct their own research and due diligence and consider obtaining professional advice before making any investment decision.
