Morningstar | We Lower Our SNC-Lavalin FVE to CAD 34, Moat Trend to Negative, and Stewardship to Poor
After a fresh look at no-moat engineering and construction firm SNC-Lavalin, we lower our fair value estimate to CAD 34 from CAD 35, largely due to a higher estimated weighted average cost of capital (10.3% versus 9.3% previously). We project 2019 adjusted EPS of CAD 2.90, below management’s guidance of CAD 3.00-CAD 3.20, after a challenging first quarter that included a negative CAD 61.4 million resources segment EBIT. Management reaffirmed its full-year guidance, expecting cost-reduction initiatives and recoveries from the Codelco mining project to drive the segment’s EBIT margin to 4%-6%. However, management expects continued weakness in the second quarter, so we are somewhat skeptical that it can hit that target, as it would require a stellar second half of the year.Furthermore, we lower our moat trend to negative and stewardship rating to Poor, as we believe the firm’s competitive position has weakened because of a host of issues, including legal risk due to bribery charges, headwinds in the oil and gas unit due to a political feud between Canada and Saudi Arabia, and recent execution issues. Management recently cut the quarterly dividend by 65% and announced that the firm will sell 10% of its interest in the lucrative Highway 407 in order to reduce leverage and preserve its investment-grade credit rating.
Sentiment around the stock has been very negative, and we think that most of the bad news is already priced in. Shares are currently trading below the CAD 27 value of the firm’s stake in Highway 407 alone, based on the recent transaction with OMERS. This implies that investors would essentially be getting the E&C business and other capital investments for free. Nevertheless, while the current stock price implies around 20% upside, we urge caution given the legal risk, high leverage, and weakening fundamentals in the E&C business, which could drive a wide range of outcomes, as reflected in our negative moat trend and very high uncertainty rating.
SNC-Lavalin Group is an engineering and construction group, and is engaged in the ownership of infrastructure and in the provision of operations and maintenance services. Co.'s segments are: mining and metallurgy, which provide tailored solutions for projects in the aluminum, gold, copper product sectors, among others; oil and gas, which includes projects for oil and gas and resources companies; power, which includes projects and services in hydro, and nuclear and thermal power generation, among others; infrastructure, which include infrastructure & construction, and operations and maintenance; capital, which invest in equity or subordinated debt into projects for public services.
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