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URS (URS)Stock (Services Industry, Technical Services Industry)
San Francisco, California-based URS Corporation (URS) provides planning, design, environmental, heavy construction, program and construction management, system integration, and operations and maintenance, management and a wide range of specialized technical services for transportation, hazardous waste, industrial infrastructure and process, petrochemical, general building, water/wastewater, military facilities and equipment platforms, and defense and security programs. The company operates in 34 countries with approximately 55,000 employees. The company's planning services include concept design, technical and economic feasibility studies, community involvement programs, and development and archeological surveys. It ranks among the top designers for the transportation industry and provides a range of engineering and architectural services. URS Corporation s end-markets include federal agencies (its largest segment, accounting for 45% of 2006 revenues), local and state agencies (22% of revenues), and private industry clients both U.S.-based (23%) and international clients (10%) in the chemical, pharmaceutical, oil and gas, power, manufacturing, mining, forest products, and food and beverage industries. Earlier, the company operated two divisions, URS and EG&G (comprising the company s 2002 acquisitions of Carlyle-EG&G Holdings Corp. and Lear Siegler Services). The URS division caters to state and local governments, the private sector, and international business. The URS segment also includes the company's federal business that existed prior to the acquisition of EG&G. URS Corporation s areas of expertise include air and surface transportation (mainly for state/local governments), environmental work, emission control for the power sector, and engineering work for the pharmaceutical and chemical industries. The EG&G division primarily serves the federal government market, providing operations and maintenance and technical support services to the U.S. Departments of Defense (DoD), Homeland Security, Justice, Energy and Treasury, among others. The EG&G division relies heavily on federal government spending toward defense activities and U.S. military projects overseas. With the completion of the acquisition of Washington Group on November 15, 2007, URS added a third division the Washington division. Federal Business hitting on all cylinders: We believe the EG&G and URS divisions' federal businesses have excellent fundamental prospects. The DoD is spending more on operations and maintenance (O&M) spurred on by increased military operational activity in the Middle East. Federal sector revenues grew 7% year-over-year (y-o-y) to $2 billion in 2006 and 9% y-o-y in Q307. The company continues to win several contracts from the DoD. The Congress approved DoD appropriations bill with approximately a 4% increase for the federal government's 2007 fiscal year. The bill includes $120 billion for operations and maintenance, and an additional $44 billion for O&M work related to the Middle East. The bill also earmarks $76 billion for Research, Development, Test, and Evaluation (RDT&E) that funds a portion of the company s EG&G business. Long-term DoD budget trends appear encouraging. In February 2007, the Administration submitted a $481.4 billion baseline DoD budget for 2008, an 11% increase from the baseline budget of 2007. An additional request for $189.3 billion to fund the global War on Terror was also submitted. The baseline budget is expected to grow 4% (at a compound rate) between fiscal 2007 and 2011. There are several other trends expected to positively impact the federal business including the military's focus on maintaining and updating existing equipment, increased outsourcing, increased demand for systems and engineering technical services, and increased demand for homeland security and flight training services. URS is capitalizing on an improving Homeland Security market by securing the receipt of several new contracts. In October 2007, URS received a ten-year $50 million contract from the U.S. Coast Guard/Department of Homeland Security for providing architectural and engineering services for homeland security projects at government facilities across the country. Congress approved a 7% increase in the 2007 budget for Homeland security. In our view, a large portion of the DHS funding will likely be directed towards airports, where URS has excellent relationships to capitalize on. There is $4.3 billion dedicated towards port security programs, with the passage of the Port Security Improvement Act adding new growth opportunities to capitalize on. The company has extensive experience in security issues, which should help it garner an increasing portion of the budget pie. In the last three years alone, URS conducted over 1,000 security prepared events. For FY08, the company stated the House Appropriations Committee is recommending a 7% increase in the DHS budget. The proposals calls for $4.5 billion to fund first responder and port security grant programs, including $400 million to protect critical port facilities and infrastructure. In addition, URS continues to benefit from the Base Realignment and Closure (BRAC) program for at least the next couple of years. The near-term focus of the program is reducing the global military infrastructure by some 25% and supporting the DoD's military transformation initiative. The company estimates the U.S. government to spend more than $20 billion implementing BRAC, reaching peak levels in 2010. In February 2007, Congress approved $2.5 billion to fund BRAC projects in fiscal 2007, a 43% increase over 2006, and a supplemental funding bill that was approved in May included an additional $3.1 billion for funding BRAC. The President's 2008 budget request includes $8.2 billion in BRAC funding. The company will work on supporting the DoD's military transformation. Given its solid relationship with the Army Corps of Engineers and the recovery efforts in the Gulf region, we expect strong demand for its planning, design, and engineering services. During third quarter 2007, the task orders under the indefinite delivery contract with the Army Corps of Engineers, Baltimore District, increased to $50 million over the next five years. The company will provide design and construction management for a variety of military transformation and BRAC projects in the Mid-Atlantic States. Given the above trends, management expects federal revenue to increase up to 5% y-o-y in FY07. Recovery in Local & State business: State and local government revenue is also gaining momentum from the flat growth witnessed in 2004. During 2006, revenue increased 7% year-over-year. In the first nine months of 2007, revenue from this sector grew 20% y-o-y with an increase of 14% in the third quarter. Increased tax receipts are driving the recovery in local and state budgets. This, in turn, allows local governments to spend more on transportation and water/wastewater projects. State budgets are expected to increase by nearly 7% in FY07. We expect continued State spending on transportation. During the third quarter, the company announced a ten-year contract to provide program management services for Phoenix Sky Harbor Airport, $10 million in new contracts to provide engineering design for the Denver Regional Transit District, and $9.5 million to assist the San Francisco Public Utilities commission with upgrades to the Crystal Springs Dam. In November, the company was awarded a one-year $17.5 million contract as a sub consultant to J.D. Abrams, LP from the Texas Department of Transportation to be the lead designer for the new Spur 601 freeway in El Paso, Texas. Earlier, URS also received a five-year $50 million indefinite delivery/quantity contract from the U.S. Bureau of Reclamation for providing engineering services for water resource projects in the California Bay-Delta and flood control projects in California's Central Valley. The company sees particular strength in California, Florida, Arizona, and New York, where infrastructure spending is large. In addition, the passage of the Highway funding bill, SAFETEAU-LU became law in August 2005. This bill is a catalyst for the re-start of several construction projects that were held up for federal funding. The bill represents a 31% increase in total funding relative to the last bill. Essentially, the bill provides up to $287 billion in matching funds for State projects through 2009. This includes $226 billion for highway projects and $53 billion for transit programs. In July, Congress approved $49.9 billion for new highway and transit projects under SAFETEA-LU for fiscal 2008, which commenced on October 1, a 4 % increase from the $48 billion approved in fiscal 2007. The Highway Bill is the catalyst for the sorely needed investment in infrastructure spending. The deterioration in the national infrastructure is well documented by the American Society of Civil Engineers. According to their report, more than 3,500 dams are in unsafe condition and more than 33% of bridges found in urban areas are structurally deficient or functionally obsolete. The report states that more than $1.6 trillion is needed over the next five years to prevent further deterioration and only 60% of that amount is committed. As a result, we expect infrastructure spending to rise by 10%-12% out to 2010. Further, bond offerings are likely to finance a large portion of future infrastructure development and tax receipts the rest. URS estimates that of the $65 billion slated for infrastructure, it can account for approval of $50 billion in funds nationwide. During the first nine months of 2007, states and municipalities sold $323 billion in new bonds, up 21% y-o-y. During the period, states issued $83 billion in bonds for education projects, about $37 billion for healthcare, and $32 billion for transportation projects. Given the improved budget outlook and the increased need for infrastructure rebuilding, management expects state and local government revenue will increase by 15% to 20% y-o-y in 2007. While we are bullish on the FY07 state budget, the risk of a general economic slowdown causes us to revise our FY08 outlook. Our 2008 forecast calls for a general fund budget increase of only 1%-2%. Fortunately, for the company as a whole, we expect the federal business to offset any deceleration in state and local revenues in 2008. URS to benefit from EPA regulations: The private sector business was the slowest growing among its segments. However, a few opportunities appear quite attractive as a result of high oil prices and the EPA's tough stance on air emissions. High oil and gas prices are driving investment in refinery upgrades. We see investment spending on refineries, pipelines, and environmental work rising at a double-digit pace for the next couple of years. The company has won several agreements with large multinational oil companies to work on downstream facilities, such as refineries and terminals. Moreover, URS is experiencing more project work in the power sector (i.e. utilities), thanks to the EPA's tough stance on air emissions. During the third quarter, URS won a three-year $107 million assignment to install FDG scrubbers at Southern Company's Miller Power Plant in Alabama. The EPA regulations require companies to cut sulfur dioxide and mercury emissions. The power sector unit, through a partnership with Advatech, has a North American license to FGD technologies that reduce sulfur dioxide emission. URS is benefiting as the new FDG units are retrofitted on the existing power plants. The partnership with Advatech has paid off handsomely. The team is working on a number of FGD scrubber projects for utilities such as Southern Company, Reliant Energy, and Tennessee Valley Authority. Over the next decade, management believes the market to retrofit new FDG units on existing power plants could reach $15 billion. As a result of the above trends and the company's focus on Master Service Agreements (accounting for about 75% of the company's global private sector business), domestic private sector revenue rebounded nicely by increasing 13% y-o-y in FY06 as compared to flat growth witnessed in 2005. The momentum continued in FY07 with domestic private industry revenue growing 38% y-o-y in the first nine months of the year (30% in the third quarter) and for full year 2007, management now expects domestic private sector revenue to increase 30% to 35% y-o-y, compared to its prior expectations of a y-o-y growth of 25%-30%. Meanwhile, revenue growth of the international business also remained healthy (up 27% y-o-y in the first nine months or 19% excluding currency impact, and 30% or 21% excluding currency, in Q307) amid continued favorable economic trends in Europe and Asia-Pacific as well as growth in the work that URS performs for multinational clients outside the U.S. under MSAs. As URS gains further traction in the faster growing international accounts, we foresee potential for accelerated growth rates of international business in 2007 and beyond. Management expects international revenue to grow approximately 25% y-o-y, excluding the currency impact, above its prior expectations of up 20%, in full year 2007. Cash flow used to strengthen the balance sheet: Given the strength across its business segments, URS Corporation continues to generate healthy cash flows and de-leverage its balance sheet. The company paid down $150 million of debt during 2006, above its expectations of $120 to $130 million, thereby lowering its debt-to-capitalization ratio to only 10% from 19% at year-end 2005 and 34% in 2004. During the first nine months of 2007, URS repaid $76.6 million of debt from year-end 2006 level and further lowered its debt-to-capitalization ratio to 5%. This capital structure reduces interest expense and provides financial flexibility to pursue attractive acquisition opportunities caused by a weaker economy in FY07. Further, the company's acquisition of Washington Group combines two leaders in engineering, construction and management services, expand the capabilities of both firms, and capitalize on their positions in important high growth sectors, including power, infrastructure, and environmental management. The combined company would have projects in over 50 countries. Though this acquisition is expected to raise URS' debt-to-total capital ratio to approximately 37%, it will still not be at a very high level. With a growing backlog of $5.80 billion at the end of Q307, up 25% from $4.64 billion at year-end 2006, a 18% increase in bookings from the 2006 level to $14.7 billion at the end of Q307, and our expectations for continued sales momentum in the URS segment, we expect the company to achieve a double-digit (19.6%) earnings growth to $2.62 per share in FY07 from only 3.3% growth recorded in 2006. We believe the URS segment is well on its way to achieving 50 basis points of margin expansion by year-end. Also, the company's outlook is very strong due to strong growth in the private sector, the continued rebound in the state and local budgets, and continued growth in the federal sector. Given a pristine balance sheet and a growing backlog to deliver in FY07, we reiterate our Buy recommendation on shares of URS.
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