2023-06-23 09:34:04 ET
Summary
- Dycom Industries Inc is experiencing strong momentum with a solid backlog and increasing revenues, primarily driven by the telecommunications market.
- The Infrastructure Investment And Jobs Act and the deployment of high-speed gigabit networks in FY2024 are expected to provide further tailwinds for the company.
- However, DY's negative cash flow and lower margins compared to competitors make it a hold rating for now, with potential for a buy rating if cash flow improves.
Investment Rundown
As a contractor of services to the telecommunications industry, as well as the utility industry, Dycom Industries Inc ( DY ), is seeing strong momentum as their backlog remains solid and revenues are increasing. The deployment of a high-speed gigabit network in FY2024 could be a significant tailwind to the company and help carry revenues forward even further.
The announced Infrastructure Investment And Jobs Act [IIJA] will also help be a tailwind for the company as spending to develop telecommunications in rural areas from the act will amount to $40 billion. There are plenty of tailwinds ahead for the company and I do see them growing, but right now the company is cash flow negative and that does worry me slightly about the actual value investors might get here. It's a tough call because the company is trading at what I believe is a fair p/e of around 16 and growing revenues strongly. But it comes down the cash flows being negative and margins not where I would like them to be. For now, I am comfortable rating them a hold until further improvements are made.
Company Overview
Dycom Industries is a prominent company that specializes in offering specialized contracting services to the telecommunications and infrastructure sectors. They provide a wide range of services, including engineering, construction, maintenance, and installation of telecommunications networks, broadband infrastructure, and utility systems.
With a customer base that includes major telecommunications companies, cable television operators, utilities, and government entities, Dycom Industries is recognized for their expertise and dependable service. Their contributions are instrumental in constructing and upkeeping the vital infrastructure that enables communication networks and connects individuals globally.
Strong Demand From Telecommunications
Right now DY is generating a large majority of their revenues from just the telecommunications market, around 89% to be exact. The larger telephone companies are spending vast capital to help establish gigabit and high-speed connections for all parts of the US.
2023 Revenues (Investor Presentation)
The lack of broadband in rural parts of the US presents an opportunity for DY to be a major contracting supplier here as investments are made to connect all parts of the US. The consumer demand for bandwidth capabilities is one of the key drivers for the deployment of fiber networks. In 2023 the expectations are that it will be the fastest year for fiber deployment and buildouts. As of Q1 2023, the number of homes in the US that has access to a direct fiber connection is only 41%, whereas the goal is to reach 55% by the year 2025. This type of ambitious goal will help funnel further contracts in DY's way.
Customer Relationships (Investor Presentation)
Besides the deployment of fiber, the boom of 5G lets DY have yet another market to serve and DY sees strong growth opportunities in the near to immediate term as a result. DY has managed to grow its business very well in the US and now has a nationwide footprint with over 15,375 employees. This broad exposure has helped the company a lot in retaining customers throughout the years. The top 5 customers for the business have accounted for over 60% of the total revenues in the last several years and that highlights the strong relationships that DY has built up and can leverage as they will continue to be a main supplier for them for years to come.
Earnings Highlights
The last earnings report had DY post some very impressive results as a consequence of the demand the industry is placing on DY. Contract revenues growing 19.3% YoY reaching over $1 billion is great to see.
But perhaps the largest gain was had in the bottom line of the company where the EPS grew from $0.65 in Q1 2022 to $1.73 in Q1 2023. During the quarter as well, DY deployed over $20 million in the pursuit of buying back shares. So far that seems to have been great timing by the company as the average price they paid per share was $90.21, and right now the share price is around 10% higher than that.
Q1 2024 Overview (Earnings Report)
During the last quarter, the company also managed to grow its backlog to its highest level ever, reaching above $6 billion. This sort of robust backlog should be a major benefit for DY going forward as the difficulty of raising their margins should be easier if they are able to leverage this current situation effectively.
A negative from the quarter however certainly is the cash flows, they aren't where they used to be and that is one of the reasons for my hold rating right now with DY. In 2022 the cash flows reached above $300 million and helped DY build up its cash position. But it has since taken a dive and for the last quarter, the operating cash flows were a negative $85 million. But it seems better times are ahead as DY sees the shares outstanding continuing to decrease. The diluted shares are estimated to be 29.7 million, down from 29.9 million in the last report.
Risks
With 5 customers making up the majority of the revenues I see the lack of diversification as a potential risk. The telecom market is very competitive , other companies might see what the same an opportunity to also leverage and in turn take market share. A noticeable sign would be the lack of renewal of contracts with some of their major customers or a slowdown in the backlog.
But as mentioned previously, the blow that makes me not rate them a buy is the fact the cash flows remain negative. That means the fundamentals of the business aren't as solid as one would hope. When DY manages to reach a positive cash flow then I could see a case where my hold rating would be revised to a buy, given that nothing major changes with the business and the share prices remain in the same multiple ranges.
Valuation
Looking at the valuation of DY right now they are trading a fair bit under their 5-year average p/e of 27 on a forward basis. That in and of itself would be a plus for me as the company might have the potential for upside to reflect its average multiple. But looking at the p/fcf it's trading just in line with its 5-year average of 22. I think that is a bit high to pay for the company and without significant margin improvements recently I think the valuation might stay in this range for a while. Perhaps a buy rating could be argued once DY is able to achieve both strong FCF and margin expansion. Where I would be comfortable buying is somewhere around the 16 - 18 range instead for the p/fcf multiple.
Industry Comparison
Looking at another similar company to DY which operates in the same industry we have Arcosa Inc (ACA). A company that offers infrastructure-related products across North America. Their current valuation is a fair bit above DY at an FWD p/e of 25 right now. Where ACA does win out slightly is the fact their margins remain better than DY. TTM gross margins of 19% and net margins of 12% beats out DY's 17% and 4% respectively. I think the higher margins are the reason for the higher premium you have to pay for ACA, but that does necessarily make it a better buy either. It seems a little high to pay for the growth they have.
Nonetheless, the upside potential of DY seems to be better given the solid partnerships they have, and the fact they are expanding margins at an impressive rate, even growing the EPS faster than the revenues.
Final Words
Dycom Industries Inc offers investors an opportunity to gain solid exposure to the steady buildout of broadband and fiber connections across the US. With their 5 biggest customers being some of the largest in the telecom industry they have solidified their market position and should be able to leverage their relationships into steady growth. DY has been able to grow the EPS much thanks to the repurchasing of shares, but also as a result of the expansions the company has undertaken. But the cash from operations is decreasing which seems to be because of a negative change in the "change in accounts receivables". I'd argue it's a setback for the short term until DY is able to establish more partnerships and secure more revenue streams.
Where the buy case falls apart is the fact that the cash flows have taken a steep downturn, and in order for me to rate them a buy I'd like to see solid improvement here. That would present a much better possibility of making DY a long-term position in a portfolio. For the moment, I am rating DY a hold.
For further details see:
Dycom Industries: Momentum Builds But Faces Cash Flow Challenges