Canada has plenty of reasons to build things. Electricity demand needs capacity, trade needs transport links, and aging infrastructure has a habit of requiring attention at inconvenient times. Announcing another ambitious project is the easy part. Getting it approved, financed, and built is where the work begins.
Ottawa’s Major Projects Office is intended to improve coordination and advance projects considered important to the national interest. Faster reviews can reduce uncertainty for developers and contractors. They don’t supply every permit, settle every financing issue, or guarantee that a particular builder wins the work.
For investors, that distinction keeps a promising spending theme from turning into an assumption that every construction company is about to enjoy effortless growth. Infrastructure spending can create opportunity while still producing some very unpleasant contracts.
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Backing up a backlog
Backlog records work a company expects to perform under contracts. It helps show future revenue potential, but it isn’t cash in the bank. Costs still have to be paid, schedules still have to be met, and customers still need to accept the work.
A fixed-price contract can be especially unforgiving when labour, materials, or execution costs exceed expectations. A large order book with weak economics can cause more trouble than a smaller book of well-priced projects. Size is important only when the company can deliver profitably.
Aecon Group (TSX: ARE) offers exposure to Canadian construction and infrastructure activity. Its latest reported backlog was $10.5 billion at June 30. That’s substantial, though it was below the comparable year-earlier balance. It isn’t the record $12 billion figure that an investor might assume from a more optimistic headline.
Into earnings
Aecon’s construction segment reported second-quarter adjusted earnings before interest, taxes, depreciation and amortization (EBITDA) of $89.7 million, with a 5.5% margin. That said, EBITDA isn’t the same as free cash available after equipment spending and working-capital needs. Adding projects helps only if the work is priced and managed well. A stronger order book won’t compensate shareholders indefinitely for repeated execution problems.
Aecon also announced additional contracts since the quarter-end reporting date. Those announcements deserve attention, but simply adding every headline contract value to June’s backlog would ignore work completed in the meantime, ownership shares, and the company’s recognition rules. I’ll wait for the next reported total before calling a new record.
High expectations
Shares closed at $50.60 at writing. At that price, investors need more than evidence that Canada intends to build infrastructure. They need earnings and cash flow that justify the valuation after financing costs, ongoing investment, and the risks attached to the remaining projects.
The $0.19 quarterly dividend annualizes to $0.77, a yield of only about 1.5%. That modest income means a buyer is relying heavily on future business improvement. A backlog-to-market-value comparison by itself leaves out too much of the cost of delivering the work.
Investors buying Canadian stocks should also keep the business separate from a government policy bet. Project delays, weaker margins, and working-capital demands can hurt returns even while Ottawa remains enthusiastic. Its role in a dividend portfolio should reflect those risks.
The reported bottom line adds another reason for restraint. Aecon recorded a second-quarter diluted loss of $1.58 a share, compared with adjusted diluted earnings of $0.33. Much of the difference involved a non-cash derivative item, but the gap still needs explanation. I prefer waiting for a cleaner picture of earnings and cash conversion before paying heavily for the next wave of infrastructure work.
Bottom line
Aecon is worth researching for exposure to long-term infrastructure needs. My next checkpoint would be whether new contracts produce consistent margins and cash as construction progresses. Faster approvals would help create opportunities, but shareholders will ultimately be paid from work delivered well, not from the number of ceremonial shovels in a photograph.
