MTZ - MasTec: Engineering Struggles

2023-11-01 13:41:01 ET

Summary

• MasTec, Inc. has struggled with supply chain issues and project delays, impacting sales and margins.
• The company's guidance for the fourth quarter indicates continued weakness and raises concerns about leverage.
• Despite the challenges, the company's long-term potential and current valuation make it an interesting investment opportunity with above-average risks.

In August, I believed that MasTec, Inc. ( MTZ ) was struggling after it embarked on an acquisition spree. (Profitable) growth of the firm was hindered by supply chain issues and project delays, hurting both sales and margins.

I thought that the focus of the business should be on execution and margins, rather than inorganic growth given the headwinds faced, after the integration process had been challenging and debts incurred.

After its struggles were visible for a while, the company has seen another shortfall in this most recent third quarter , guiding for continued weakness in the fourth quarter, to thereby spark a renewed set of (leverage) concerns here. That being said, current levels do start to look interesting for those with an above-average tolerance for risks and volatility.

Critical Infrastructure Contractor Appears Not So Critical

MasTec is a contractor which makes critical infrastructure tied to communications, power delivery, clean energy and energy infrastructure. The company was an $8 billion diversified business in 2021, with diverse operations between communication (5G, spectrum deployment and fiber), oil & gas (pipelines, emission reductions) as well as clean energy & infrastructure business, and a power delivery business.

The company embarked on a dealmaking spree to grow the business towards the $10 billion mark following a $420 million deal for INTREN in 2021, as well as a $600 million purchase of Henkels & McCoy, among others.

For the year 2021, the company grew sales by 26% to $8.0 billion (driven by dealmaking) as EBITDA improved to $931 million. Nonetheless, margins were down 110 basis points to 11.7% of sales, with adjusted earnings down to $5.58 per share.

The company initially believed that sales were seen up to $10 billion for the year 2022, as EBITDA was originally seen up just 2% to $950 million, indicating that further margin pressure could be expected. In fact, additional interest costs incurred made that earnings were seen down to $5.32 per share.

In the end, 2022 sales felt a bit soft at $9.8 billion. The real issue was that EBITDA was only reported at $781 million, with adjusted earnings only coming in at $3.05 per share. These setbacks caused shares to rise from levels above the $100 mark in 2021 to levels in the sixties during 2022.

About 2023

In February of this year, the company guided for 2023 sales to improve to $13 billion (aided by more dealmaking, including the purchase of IEA). Adjusted EBITDA was seen between $1.10 and $1.15 billion, with earnings seen recovering to $4.64-$4.91 per share, up from a dismal 2022, but down from the 2021 performance of course.

This guidance was cut alongside the first and second quarter this year results, with sales seen between $12.7 and $13.0 billion by the second quarter. EBITDA was now only seen between $1.05 and $1.10 billion, while adjusted earnings were seen down to $3.75 and $4.19 per share. All this was rather worrying, with net debt reported up to $3.2 billion, pushing up leverage ratios to around 3 times.

Shares actually recovered to the >$100 mark over the summer, as they fell to the $90 mark in August, pushing up the valuation quite a bit again given the continued pressure on margins. With the business facing real integration issues in choppy conditions, concerns were arising given the debt load, as this remains a long-term grower in a well-positioned industry here.

If the company could return to 10% EBITDA margins over time, potential would certainly be seen, certainly as delays on IRA project could be caught up in 2024. The issue is that great execution would be required to unleash the potential, as I lacked conviction to get involved.

A Terrible Quarter

Since August, shares of MasTec fell to the $60 mark, now trading around $50 per share after the third quarter numbers revealed a bombshell report. MasTec posted third quarter sales of $3.25 billion, and while it was up 30% on the year, it was soft. Lower margins and higher interest expenses meant that adjusted earnings came in at $0.95 per share (vs. a $1.34 per share number this quarter last year).

The issue is really with the guidance, with full-year sales now seen at just $12 billion, EBITDA seen down to $850 million and adjusted earnings seen at $1.75 per share. The guidance implies that fourth quarter sales are seen close to $3.3 billion, as EBITDA is seen around $221 million (down from a $271 million number in the third quarter).

With full year adjusted earnings seen at $1.75 per share, and this earnings metric already coming in at $1.31 per share so far this year, fourth quarter earnings are seen at just $0.44 per share. This earnings power is very modest, certainly as it excludes about $0.40 per share in stock-based compensation expenses.

While net debt ticked down to $3.0 billion, the issue is that leverage ratios jumped to 3.5 times EBITDA here, as lower earnings power and higher interest expenses furthermore reduce the ability to deleverage here.

Delays Are Hurting Margins

The 78 million shares of MasTec have fallen to the $50 mark, granting the company a $3.9 billion equity valuation, as the business is now valued at $6.9 billion including debt. The resulting 8 times EBITDA multiple might look reasonable given the long term positioning of the business, yet the issue is that of leverage and very poor execution.

The company continues to be hurt by delays in the clean energy and infrastructure segment as the company had to maintain resources to complete these projects in the coming quarters. This hits margins in a big way. It furthermore is clear that the fourth quarter will not provide a quick solution, based on the downwards revised guidance.

The company has been facing headwinds across all segments due a combination of general economic uncertainty, higher financing costs, supply chain issues, legal battles, permitting delays, hiring delays, and others.

While the company claims that these headwinds hurt the near term results, there are some headwinds of a longer term nature as well (despite its sound positioning). The overall backlog of $12.5 billion (estimated to be realized in the coming 18 months) is down nearly a billion versus the second quarter, and up just modestly from an $11.2 billion number this time last year.

And Now?

Arguably, the situation is a bit worse than I feared in August. Shares have been cut in half from August, shedding about $4 billion in value in the process.

Quite frankly, I think that current MasTec, Inc. stock price levels are starting to look quite interesting for potential outsized and long term returns, albeit that some volatility is to be expected. Note that there are some above-average risks, given that any investment here carries a highly speculative element.

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