J - Jacobs Solutions: The Market's Muted Response To A Seismic Development

2023-05-10 11:36:16 ET

Summary

• In addition to announcing strong financial results for the second quarter of the company's 2023 fiscal year, Jacobs Solutions made a major announcement on May 9th.
• Management elected to split the company into two in an attempt to deliver more value to its shareholders.
• Add on top of this how shares are priced, and investors are right to be bullish about the company.

May 9th of 2023 proved to be a rather fascinating day for shareholders of Jacobs Solutions ( J ). And to many, it was also likely something of a confusing day. You see, the management team at the company announced financial results covering the second quarter of the company's 2023 fiscal year. In addition to beating expectations on both the top and bottom lines, the company announced that it was splitting up its business into two separate, publicly traded enterprises. Normally, a move like this would be lauded by the investment community, with shares of the company in question skyrocketing. But for the day, units were up only about 1.3%. This would make sense if the stock were expensive. But on an absolute basis, and even relative to some competitors, the stock looks quite affordable right now. Though the lack of upside resulting from these developments may be discouraging, investors who are bullish about the company should see this as a potential buying opportunity.

A look at the headline news

Before the market opened on May 9th, the management team at Jacobs Solutions announced financial results covering the second quarter of the company's 2023 fiscal year. On the top line, management reported revenue of $4.08 billion. This was roughly $100 million more than analysts anticipated . In addition, it translated to a nice increase over the $3.83 billion that the company reported only one year earlier. The most significant contributor to the increase in sales for the company was its People & Places Solutions segment, with revenue spiking from $2.16 billion to $2.35 billion. This increase, management said, was driven largely by growth in both its advanced facilities and US operations caused by attractive demand for its offerings. Sales growth would have been higher here had it not been for foreign currency fluctuations that impacted it negatively to the tune of $51.2 million.

On the bottom line, the company also performed quite well. Earnings per share totaled $1.70. That's nearly triple the $0.68 per share generated one year earlier and it exceeded analysts' forecasts by approximately $0.20 per share. On an adjusted basis, profits of $1.81 per share beat expectations by $0.03 per share. The earnings per share generated by the company translated to net profits of $216.5 million. That's well above the $88.8 million reported one year earlier. Other profitability metrics followed suit. Operating cash flow, for instance, inched up from $124.6 million to $132 million. If we adjust for changes in working capital, the increase would have been from $238.9 million to $338.5 million. And finally, EBITDA for the company expanded from $340.4 million to $358.2 million.

Another important data point to discuss is backlog. For those not familiar, backlog refers to the amount of work that the company has been awarded by customers. Often, but not always, backlog is work that is guaranteed to the business. Overall backlog at the end of the most recent quarter was $28.97 billion. This is up from the $27.79 billion reported one year earlier. It also represents a nice improvement over the $28.26 billion that the company had as of the end of the 2022 fiscal year.

A major development

In addition to exceeding analysts' expectations, the management team at Jacobs Solutions announced that it had decided at last just split up its business into two separate, publicly traded enterprises. The larger of these two enterprises will keep the Jacobs name and will include substantially all of the company's core operations. Of the $10.5 billion in revenue that it will generate, using results from 2022, 81% will come from the aforementioned People & Places Solutions segment. Another 11% who involve its PA Consulting operations, while the final 8% will include what it calls Divergent Solutions.

The objective of this enterprise is to focus on certain high growth sectors such as water and the environment, energy transition activities, transportation, and advanced manufacturing. About $20.84 billion of the $28.97 billion of backlog on the company's books as of the end of the most recent quarter are attributable to this enterprise. And according to management, the adjusted operating margin of it should be around 12%.

On the other hand, you have the separate publicly traded company that really is comprised of Jacobs Solutions' Critical Mission Solutions business. I have written about this to some extent before. But in short, if focus is on establishing long term contracts with customers in the space, national security, and other related spaces. Its solutions also touch on nuclear remediation and even the very attractive 5G technology expansion phase that we are going through. This would be a much smaller company, with revenue of only about $4.4 billion and an operating margin of around 8%. However, it is very US centric. About 78% of its revenue comes from the US, with the rest coming from abroad. Management has described this enterprise as a pure-play government services provider.

We don't yet know all the details of this planned transaction. But management has said that the deal will be a tax-free distribution to shareholders of the company. Unfortunately, these types of initiatives do take time. It likely won't be until the second-half of the 2024 fiscal year before the split is completed. Between now and then, investors should keep an eye out for additional details. Examples will include planned synergies, leadership structure, capital structure, and more.

Shares are attractive right now

When it comes to the 2023 fiscal year, management has provided some guidance. They currently think that adjusted earnings per share will be between $7.25 and $7.45. At the midpoint, that would translate to net profits of $940.8 million. Meanwhile, EBITDA is forecasted to come in at between $1.42 billion and $1.47 billion. If we assume that adjusted operating cash flow will rise at the same rate that EBITDA is expected to at the midpoint, we would anticipate a reading for the year of $1.34 billion.

Based on these figures, the company is trading at a forward price to earnings multiple of 16.1. The forward price to adjusted operating cash flow multiple is 11.3, and the forward EV to EBITDA multiple is 12. As you can see in the chart above, these numbers are all a bit lower than if we were to use data from 2022. As part of my analysis, I also created the table below, which stacks the company's 2022 valuation results up against the results of five similar firms. On a price to earnings basis, two of the five companies were cheaper than Jacobs Solutions. When it comes to the price to operating cash flow approach, our prospect was the cheapest of the group. And finally, using the EV to EBITDA approach, only one of the companies was cheaper, while another was tied with it.

Takeaway

Truth be told, I am quite amazed at what has transpired over the past several hours. I would have thought that shares of Jacobs Solutions would have roared higher after the company reported better-than-expected sales and profits. Cash flows and backlog were both stronger year over year and shares of the company look affordable, particularly on a forward basis. Add on top of this the typical excitement associated with significant corporate restructuring activities, and I would have thought that the stock would have reacted meaningfully to these developments. Although disappointing, this could also prove to be a good window of opportunity for investors who still believe in the enterprise.

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