TPC - Tutor Perini Is Being Downgraded To Hold Because Of New York Financial Troubles

2023-12-26 11:07:43 ET

Summary

• CEO Ronald Tutor is finally transitioning out of the company.
• The $3 billion Brooklyn jail project could be impacted by the terrible financial position New York City is in partially because of the immigrant crisis.
• GAAP accounting reports for the last two years have been terrible, but actual cash flow has improved.
• The market to refinance their $500 million notes has recently improved significantly.

Mega-project construction company Tutor Perini ( TPC ) had a series of negatives earlier this year including a cancellation of a major road project, a loss of an appeal in federal court, and an S&P downgrade of their debt to "B-" from "B+". But with continued strong cash flow and a $2.95 billion Brooklyn jail project the stock price recovered. TPC stock price has increased about 18% since my December 2022 "buy" recommendation article . I am, however, downgrading TPC to "hold" because I continue to have concerns about their accounting reports, and I have serious doubts about the Brooklyn jail project. This is an update to my prior article.

Accounting Issues

Tutor Perini's business model timeline for projects is divided into three time periods. The first is the original design and bidding/negotiations for the project. The second is the actual construction. The third, which is often the most challenging, is litigation over final payments. The problem for most TPC investors is the GAAP reporting on both the income and balance sheet during the timeline for these projects. Typical metrics, such as revenue and EPS, can be misleading regarding the actual operating results because of GAAP project accounting standards, in my opinion. Some investors prefer to use annual cash from operations per share instead of EPS because "cash" is less impacted by GAAP accounting interpretations/assumptions.

For the first nine months of 2023 cash from operating activities was $181.8 million or approximately $3.38 per share, which was down from $251.3 million or $4.89 per share for the first nine months of 2022. The GAAP accounting results for the last two years have been terrible, but because I am not a big fan of major project accounting practices, I am not that worried. I focus more on cash instead of GAAP EPS. (See further below for 3Q financial reports.)

I already covered the accounts receivable issue, which has improved, in my prior article, but there are related issues that are troubling. TPC took an $83.6 million charge in 1Q 2023 after losing a 2nd Circuit Court appeal ( text of the decision ) of a bankruptcy judge's ruling that TPC did not have a section 365(b)(1)(A) priority lease agreement cure claim.

The problem I have is that if the bankruptcy court already ruled against their priority claim, Tutor Perini should not have kept that claim on their financial statements. In the event that their appeal was successful, which it was not, then and only then should they record/keep that claim amount on their financial statements. The charge should have been taken when the bankruptcy judge ruled against them in August 2020, in my opinion. In a related case, they currently are in litigation against the developer and "management has made an estimate of the total anticipated recovery of TPBC’s claims against the individual owners of the Developer and the Port Authority on this project, and such estimate is included in revenue recorded to date" according to their 10-Q. The "estimate" is not even mentioned. Investors should be told the estimated amount, in my opinion. I understand that stating the amount may weaken their bargaining hand, but if they are unsuccessful and there is an additional charge, TPC stock could take a modest hit depending on the amount of the estimate/charge.

I assume that their approach to accounting reports will continue because CEO Ronald Tutor (82) is being replaced by the current CFO Gary Smalley in January. I am actually glad Ron Tutor is finally starting to move out of the picture. While he still owns a significant amount of stock (15.7% based on the last proxy statement) he has been a seller of TPC stock for years, including the last few months. His reputation has, in my opinion, had a negative impact on the company and the stock price. There have been many negative articles about him in the media, especially his disastrous investments in Hollywood , but those issues are beyond the scope of this article. His reputation also includes making aggressively low bids on projects and then relying on change orders to make a profit.

New $3 Billion Brooklyn Jail

Over the next few years, TPC's stock price may be significantly impacted by the $2.95 billion Brooklyn jail design-build contract they were awarded last May. This new jail is part of the replacement for Rikers Island and is expected to have 886 to 1020 beds. That is an absolutely staggering amount of around $3 million per bed, depending on the final number of beds and expected large cost overruns. Additional new jails are also planned for Queens, Manhattan, and The Bronx. TPC is expected to bid on those projects.

Graphic Rendering of Proposed Brooklyn Jail

The actual completion of this proposed jail is far from certain. New York City is currently in a financial crisis because of the massive number of immigrants, both illegal and legal, arriving in the city when at the same time many financial firms continue to move out. The city is cutting expenses across almost all categories. There is also intense political pressure to close Rikers Island ASAP. Part of the problem, in my opinion, is the new building looks more like a 5-star hotel (see drawings of the proposed building) and not just some much cheaper banal looking concrete building to secure criminals. The powerful local community board wants something aesthetically pleasing and not just some ugly looking building next to the existing courthouse. Considering that almost nothing in New York is ever built within the budget, the cost per bed could be significantly greater than $3 million.

Since this $3 billion project is a major portion of their current $10.6 billion backlog, investors need to follow the local politics in New York because it could impact this project. It could be many years and many design changes before it is actually completed.

$10.6 Billion Backlog

Besides the Brooklyn jail project there are some other new projects:$62 million I-494 bridge repair project, $222 million Tinian International Airport project, $47 million visitor center in Everglades Park, and a $40 million Miami-Dade water treatment plant

Backlog By Segment

Backlog By Customer

$500 Million Note 2025 Maturity

Tutor Perini has a large refinancing wall in 2025 that overhangs the stock price when their $500 million notes mature May 1, 2025. Fortunately, there have been two positive developments recently. First, interest rates have plunged since the end of October when the effective yield on B high yield debt dropped from over 9.5% to 7.5%. (Tutor Perini currently has a "B-" S&P rating.) That 200 basis point improvement could indicate that TPC might save $10 million per year on interest expense on their $500 million in notes. While a potential 7.5%-8% coupon is still higher than the current coupon of 6.875% is a lot better than a potential 9.5-10.0% coupon.

The second development is that their credit agreement was amended last week regarding the "spring-forward maturity provision". Holders of 89.8% of the $368.2 million Term Loan B Facility have consented to a date change from January 30, 2025 to April 25, 2025. This means that if any of 6.875% notes are still outstanding on April 25, 2025, the Term Loan becomes due. The 10.2% non-consenting holders could still demand payment if the 6.875% notes are still outstanding on January 30, 2025. This amendment gives them a little more time and flexibility to roll-over their notes.

Recent Results

3Q and Nine Months Income Statement 2023 and 2022

Balance Sheet 3Q'23 and Year-End 2022

Conclusion

Some investors are holding TPC stock because the $1.2 trillion Infrastructure Investment and Jobs Act of 2021 ( text of the Act) could still result in a significant number of new contracts. As Ron Tutor transitions out of the company, it could also be a positive development because he was too often a target of negative publicity.

I have serious reservations about the Brooklyn jail project. I expect many delays and potential redesigns to save money. The reality is that the city can't afford the project. Because I am not bullish on the Brooklyn jail project and because I continue to also have reservations about their accounting practices, I rate Tutor Perini a "hold", which is a downgrade from my prior "buy" rating.

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