ACA - Arcosa: Some Warning Signs

2023-08-10 01:55:37 ET

Summary

• Arcosa offers infrastructure-related products in North America, with segments in transportation, engineered structures, and construction.
• Q2 FY23 revenues declined by 3%, mainly due to weakness in the engineered structures segment.
• Despite some positives like backlog growth and improved balance sheet, the stock is showing signs of correction and is currently overvalued. Hold rating assigned.

Arcosa ( ACA ) offers infrastructure-related products for transportation, engineered structures, and construction markets in North America. They work in three segments: Transportation Products, Engineered Structures, and Construction Products. In the transportation products segment, they provide inland barges, winches, circular forgings, and rail transportation equipment. In the engineered structures segment, they offer utility structures, traffic structures, wind power generation, and telecommunication structures. In the construction products segment, they provide natural and recycled aggregates and shoring products. ACA recently announced its Q2 FY23 results . In this report, I will analyze its financials and technicals. We might see a correction in the stock; hence I assign a hold rating on ACA stock.

Financial Analysis

ACA recently posted its Q2 FY23 results . The revenues for Q2 FY23 were $584.8 million, a slight decline of 3% compared to Q2 FY22. I believe the major reason behind the decline was weakness in its engineered structures segment. The revenues from the engineered structures segment were down by 23% in Q2 FY23 compared to Q2 FY22. I believe there were two major reasons behind the underperformance in the engineered structures segment: the divestiture of its storage tanks business and lower volumes in its wind tower operations. Its operating margin for Q2 FY23 was 8.7%, which was 9.4% in Q2 FY22. I believe the margin decline was mainly due to operating inefficiencies in its specialty materials business and unfavorable product mix in utility structures.

But despite the decrease in the revenues and operating profit, its net income slightly increased in Q2 FY23 compared to Q2 FY22, mainly due to low interest and tax expenses. I believe ACA’s performance in Q2 FY23 was underwhelming, and they failed to impress in the quarter as the cyclical nature of their business may have impacted their revenue growth. But there were some positives in this quarter, except for its engineered structures segment; both of its segments performed quite well. The revenues from the construction markets and transportation products segment grew by 8% and 28% in Q2 FY23 compared to Q2 FY22. In addition, the backlog in its engineered structures by the end of Q2 FY23 was $1.5 billion, a rise of 267.5% compared to Q2 FY22, which is huge, and the backlog in its transportation segment has grown by 117.8% in Q2 FY23 compared to Q2 FY22. The significant rise in its backlog is an optimistic sign, and if we look at its balance sheet, we can see that its cash and cash equivalents have increased by 23.3% compared to December 2022, and the debt has also decreased, which shows that its balance sheet is improving. These might be the reasons that despite a decline in revenues and margins in Q2 FY23, their stock is trading at its all-time high.

Technical Analysis

ACA is trading at the $78 level. The stock is trading at its all-time high and has been looking super bullish since July 2023; the stock has risen 10% without any consolidation, showing strength in the stock. But despite the stock being super bullish, I would not recommend buying it at the current level, and I am saying this because of some reasons. In my opinion, the stock is showing some early signs of correction; if we look at the RSI indicator, it has gone above 70, which is an overbought zone. Whenever the RSI indicator goes above 70, it shows that the stock is in the overbought zone, and in the case of ACA, it has happened only three times in the past since its listing. The first time when RSI went above 70 was in December 2019, and the stock corrected more than 35% that time; the second time it happened was in January 2021, and the stock corrected 30% that time, and the third time it happened in August 2022 and the stock corrected 20% that time. So this is the fourth instance, and I believe we might see a correction in the stock in the near future. Hence I would advise to avoid it for now.

Should One Invest In ACA?

First, talking about ACA’s valuation. ACA has a P/E [FWD] ratio of 27.36x which is higher than its five-year average of 22.94x and sector ratio of 17.71x. ACA has an EV / EBIT [FWD] ratio of 19.57x compared to the sector ratio of 15.61x. It shows that ACA is currently overvalued, and in my opinion, its recent financial performance hasn’t been that good. Hence I believe it doesn’t deserve to trade at higher premiums. In addition, as I mentioned before, it is trading at its all-time high, and the stock is giving some early signs of correction. So I believe investing at such high levels is not worth it. Hence considering all the factors, I assign a hold rating on ACA.

Risk

A few of the markets that Arcosa supplies have a small clientele. Customers don't all make purchases every year, and the volumes they buy in each of Arcosa's business sectors vary from year to year. Furthermore, delays in orders from Arcosa's clients may be caused by inflationary pressures on the costs of key raw materials like steel, including but not limited to clients delaying or canceling orders for new barges as a result of changes in the price of steel. As a result, Arcosa's product order levels have fluctuated dramatically from quarter to quarter in the past and may continue to do so in the future. As a result, Arcosa's operational performance for any given quarter may also change.

Bottom Line

I believe we might see a correction in the stock soon. In addition, its valuation seems high, which is not backed up by strong financials. There are some positives, like improving balance and increasing backlog, but I believe investing at such a high level is not worth it. Hence I assign a hold rating on ACA.

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