AEGXF - Aecon: High-Risk Play With Big Reward Potential
2023-03-27 11:25:43 ET
Summary
- Aecon is a cyclical business with highly cyclical earnings.
- The stock appears to be cheap from a long-term perspective.
- It has maintained or increased its dividend since 2007.
- It currently yields 5.7%, which appears to be sustainable from a reserve of retained earnings. A swift earnings rebound can alleviate investor concerns about the dividend safety.
- High-risk investors could consider a trading position in the stock on a near-term dip.
Aecon Group (AEGXF) (ARE:CA) stock is down about 21% in the last 12 months. As you can tell from the stock price alone, with the stock recovering over 60% from the bottom in late 2022, it is a highly unpredictable stock.
Its long-term 10-year stock price chart shown below provides further illustration on how volatile the stock can be.
Here is its long-term price-to-earnings ("P/E") chart based on diluted earnings. If anything, it shows how unpredictable or cyclical its earnings can be. The chart also suggests that Aecon stock could be a good multi-year turnaround investment.
(The company reports in Canadian dollars, so the figures in this article are in CAD$ unless otherwise noted.)
What Triggered a Big Selloff in the Stock?
Aecon stock lost about 60% of its value from the 2021 peak to the recent bottom of approximately $8.30 per share in late 2022.
The selloff in 2022 was primarily due to high inflation and the fact that the company was stuck with some fixed price contracts. You can imagine that construction projects cost more from high inflation but it was not able to charge higher prices on those contracts. The stock would have held up better if it had some sort of inflation adjustments for those projects.
Specifically, Aecon reported having 4 large fixed price legacy projects that were being performed by joint ventures in which the company was a participant. Fixed price contracts made up just over 50% of Aecon's revenue in 2022.
Recent Results
In 2022, Aecon increased its revenue by 18% to $4.7 billion. Unfortunately, direct costs and expenses rose 20%, leading to gross profit falling 3% to $356 million. Operating profit fell 18% year over year ("YOY") to $97 million. Consequently, the diluted earnings per share ("EPS") fell off a cliff -- declined 40% -- to $0.47.
The continued recovery of the stock since the company reported its Q4 and full-year 2022 results on February 28, 2023, was likely because it showed the sign of a recovery of results in Q4.
Particularly, in Q4, Aecon's revenue rose 16% YOY. Gross profit rose 5%. Importantly, operating profit climbed 33% and diluted EPS jumped 37%.
Since the press release on February 28, the stock has appreciated about 30%.
Is the Dividend Safe?
At $12.97 at writing, Aecon stock offers a relatively high yield of 5.7% versus the one-year risk-free GIC rate of 4.8% in Canada (or CD rate of about 5.2% in the U.S.).
However, as the earlier F.A.S.T. Graph shows, the significant decline in earnings in the past 2 years resulted in a stretched payout ratio last year. Specifically, the 2022 payout ratio was almost 149%.
That said, management seems inclined to maintain its dividend. Aecon has maintained or increased its common stock quarterly dividend since 2007.
Although its payout ratio is extended right now, it has a strong buffer from retained earnings which sat at $435.3 million at the end of 2022 versus its annualized dividend payment of $45.1 million.
Aecon has maintained the same quarterly dividend for 5 quarters. So, management seems inclined to support its dividend. It makes good sense to freeze the dividend now as even with earnings expected to rebound this year, the payout ratio could still be in the high 90%.
No one can guarantee Aecon's dividend safety given its highly cyclical earnings. However, from the earnings rebound expectation, reserve of retained earnings, and its decently long healthy dividend payment history, there's a slim chance that it could cut its dividend over the next year.
Valuation
It seems no analyst cover the stock on the OTC, but analysts have a consensus price target for TSX:ARE. Their consensus 12-month price target for TSX:ARE is $15.81, which suggests a discount of 18% or near-term upside potential of close to 22%.
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There's continual demand for Aecon's construction and infrastructure development services in Canada, as it increased its backlog by 1.6% year over year to $6.3 billion at the end of 2022.
If Aecon is able to shift its future contracts to have inflation adjustments, it would certainly help with its earnings rebound. Three to five years down the road, the stock could be trading at $27 per share. This is like a best-case scenario.
An economic expansion phase that increases construction and infrastructure spending would increase the probability of this materializing. Assuming it took the stock 5 years to get to $27, it would mean annualized returns of about 21.5%, including a 5.7% dividend yield.
Investor Takeaway
On one hand, Aecon stock looks cheap compared to its long-term stock price chart (see the above F.A.S.T. Graph), which indicates a normal stock price of about $20.
On the other hand, the stock has recovered about 60% from its recent low and could be bound for a dip in the short term. Additionally, Aecon is reporting its Q1 2023 results on April 25. So, it could be wise for interested investors to wait about a month longer for the latest company results to be cautious. So, I'm more inclined to rate the stock as a "Hold" currently.
Because of how volatile Aecon's earnings can be, only high-risk investors should consider the stock. Instead of on the OTC, interested investors should invest on the TSX, where the stock is much more liquid.
Other References
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Aecon: High-Risk Play With Big Reward Potential