11/11/11: Bird Construction and IBI Group Are Building Profits

By Roger Conrad • November 11, 2011

Third-quarter earnings season is rapidly winding up for Canadian Edge Portfolio picks. Yesterday it was the turn of two infrastructure engineering firms in the Conservative Holdings, Bird Construction Inc (TSX: BDT, OTC: BIRDF) and IBI Group Inc (TSX: IBG, OTC: IBIBF).

The pair have a slightly different focus. Bird not only designs a range structures but builds them. IBI, meanwhile, is solely concerned with design and architectural solutions. In addition, Bird’s operations are entirely in North America, while IBI’s now span the globe.

Fundamentally, however, both companies live and die on their ability to successfully bid for major infrastructure projects, and to execute on those contracts in a cost-effective way. For the past several years, their primary market has been lower margin government-sponsored projects. That’s held down growth and forced them to manage finances and labor carefully to maintain profitability.

The good news about third quarter results is two-fold. First, both companies have once again proven their ability to manage the environment, building order backlog, maintaining financial strength and covering dividends comfortably with cash flow. Second, signs are emerging that private sector contracts are again picking up, which augurs well for long-term profit margins and hence earnings.

Bird’s third-quarter results reflect just a month’s worth of contributions from its merger with HJ O’Connell. But that was enough to help spur a 20.5 percent jump in revenue and a 17.3 percent boost in net income.

The unit also won a CAD100 million contract from ArcelorMittal Mines Canada, to remove waste rock from a major mine. That, in turn, helped drive Bird’s order backlog to a record CAD1.2997 billion. Other contracts inked in recent weeks include a design-build deal with Canada Post to build a new processing facility at the Vancouver International Airport, and a design/build contract for the Restigouche Hospital Centre in Campbellton, New Brunswick.

CEO Tim Talbott notes “we are now beginning to see the impact of what we believe are improving market conditions.” That’s quite encouraging, and having O’Connell in the fold gives Bird the ability to leverage that growing strength as never before.

Nine-month adjusted net income (ANI)–the primary measure from which dividends are paid–is still less than half the year earlier tally. That’s the result of a lower margin contract mix prior to the O’Connell deal that reflected the weak environment for infrastructure contracts. Third-quarter ANI per share, however, is up 20 percent from year-earlier levels.

That’s a payout ratio of just 68.8 percent for the quarter, which should set to rest any concerns about the current dividend. The nine-month payout ratio is still 117.9 percent, which may delay future dividend increases. But profitability is now clearly back on track. And with backlog at a record, rising and focusing more on private sector deals, growth should continue going forward. That should ensure another dividend increase in 2012. Bird also has no debt, ensuring it against any possible credit events.

Bird shares set off alarm bells with some Canadian Edge readers in early October, when the stock hit a low of barely USD8. Since then the shares have recovered a bit over USD10.50 but are still below my buy up to target of USD12.

IBI stock has been if anything even more volatile than Bird. And its yield of 9 percent indicates at least some investors are skeptical about its future profitability. The good news is there’s nothing in third-quarter numbers to indicate business weakness, as virtually every measure of growth and profitability moved higher and the payout ratio sank to just 69.7 percent.

Revenue rose 9.8 percent to a new record of CAD84.3 million. Cash flow rose by an even faster 11.2 percent, also to a new record. Cash flow as a percentage of revenue rose 0.1 percentage points from year earlier levels to 15.3 percent, as the company maintained profitability even as it grew. Distributable cash earned per share was best of all, soaring 43.5 percent to CAD0.4635.

Looking ahead, order backlog rose to 9.5 months of equivalent work, as the company continues to add new business both by acquisitions and “organically” at existing businesses. Management also continued to execute on its strategy of reducing the time working capital is tied up in various projects.

That reached a peak of 195 days at the end of the second quarter of 2010 and was a major inhibitor to profitability. The company was able to take that down to 167 days at the end of the first quarter. It was back up to 186 days in the third quarter. That, however, was mainly due to the start of numerous new projects, some of which are quite large and have been affected by project delays and holidays. And it’s since improved substantially, declining to just 178 days in October.

That’s still well above management’s ultimate target of cutting the tie up to just 140 days. But the improvement does portend well for IBI’s already strong results going forward.

Much of IBI’s growth in recent years has been due to acquisitions and expansion of operations globally, particularly to developing Asia. Encouragingly, however, the third quarter saw “organic” growth–sales added at existing operations–accelerate to 4.5 percent. Nine-month organic growth is 5.4 percent, well above the 2.5 to 5 percent management had targeted for 2011.

The contract mix is still heavily public sector weighted, at 69 percent of third-quarter revenue. That tally, however, also includes quasi-government sovereign wealth entities in other countries, which have an entirely different dynamic than increasingly budget-constrained governments in North America. The company has also been able to overcome weakness in certain geographic areas of operation by being able to focus on faster-growing ones, a benefit of its extremely broad reach. That remains a major advantage over rivals and it’s a huge factor keeping revenue predictable and stable.

Management continues to keep the strategic focus of the company’s expansion outside its home market of Canada, where it’s already a market leader. It’s also keeping a focus on the US, where it sees numerous targeted opportunities and continues to build its own expertise and reach. A push to serve health care facilities is likely to spur 2012 sales. Meanwhile, it’s also moving in a big way in Brazil, India and China, three very large and fast growing markets.

As for cost controls, IBI continues to gauge the size of its operations to order backlog. As that grows, so will the labor force and other costs. On the other hand, while management’s perspective is clearly long-term, it also has considerable flexibility to downsize any underperforming operations. Neither is debt an issue, as the company has no outstanding maturities in a convertible note comes due Dec. 31, 2014. That note will not be in the money unless IBI rises to CAD19.17 by that time. But even if the company were to cover it with cash, it would have little trouble with CAD120 million in credit lines not expiring until Jul. 29, 2016.

To be sure, the level of economic growth does affect IBI’s order flow. But conservative finances, diversification and well-run operations enabled the company avoid a dividend cut in 2008-09. And, if anything, this company is even better positioned for any future debacle.

In the company’s third-quarter conference call, CEO Philip Beinhaker stated that both debt ratios and the payout ratio were in target ranges and that the company in general is “heading in the direction that we’ve said previously we want to achieve.” That’s very good news for the long-term security of IBI’s dividend, which at this point is well north of 9 percent.

The timing for a return to dividend growth is a bit cloudier. Mr. Beinhaker did respond to a question regarding dividend level and related loan covenants by stating the company is “striving to reach the low to mid 60s” as a payout ratio and that “we expect to be there in 2012.” Further, he stated “once we’re comfortably settled that level and as the volume of cash earned increases, then we will start to increase dividends as well.”

That would seem to imply at least a year before we see anything happen to the dividends, particularly as management won’t do anything that even in a worst case wouldn’t be sustainable. The conservatism is a major selling point for this stock in my view, and yet another stark contrast to the prevailing perception that IBI’s dividend is at risk.

One question that did come up during the conference call was how much exposure IBI has to the European sovereign debt crisis. The company has no business in Italy but does have contracts in Greece on which it continues to get paid. Even throwing in the UK–where the company does have extensive business–European sales are but a small fraction of total revenue.

The bottom line is there’s no more exposure on the revenue than the company has on the operations side. And to the extent the stock is weak because of macro concerns, it’s that much more of a value. IBI is a buy up to my target of USD15 for anyone who doesn’t already own it.

Third-Quarter Earnings Dates

Here are the confirmed and expected reporting dates Canadian Edge Portfolio members yet to report, including links to articles with my analysis for those that have already submitted numbers.

Atlantic Power Corp (TSX: ATP, NYSE: AT) will report later today, but its conference call isn’t until Monday morning. Consequently, I’ll report on it and Ag Growth International Inc (TSX: AFN, OTC: AGGZF) in a Flash Alert Nov. 14. Capstone Infrastructure Corp (TSE: CSE, OTC: MCQPF) reports after the close on Nov. 14, with a conference call on Nov. 15.

I’ll have a Flash on it at that time, with a full recap of all the numbers including non-Portfolio companies in the December issue.

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