Beating Buffett

Jacobs Engineering Group Inc. provides professional, technical, and construction services. Its principal services comprise various aspects of engineering and construction, operations, and maintenance, as well as scientific and specialty consulting services. They serve companies and organizations including industrial, commercial, and government clients across multiple markets and geographies. Primary service markets include aerospace and defense, automotive and industrial, buildings, chemicals and polymers, consumer and forest products, energy, environmental programs, infrastructure, oil and gas, refining, technology, and pharmaceuticals and biotechnology. Jacobs Engineering has about 160 offices in 20 countries, with operations in North America, the United Kingdom, Europe, India, Australia, and Asia. JEC was founded in 1947 and is headquartered in Pasadena, California.

Due to its oil and gas industry exposure Jacobs earnings and share price peaked in 2007-2008. Shares hit highs of $99.60 and $103.30 in those years before toughing at $26 when the market melted down last November. The share price recovered to $54.70 early in 2009 before settling back to this morning’s price of $37.80.

Why did the price drop back again? Management lowered FY 2010 expectations. While there is no clear consensus Zacks now sees FY 2010 and FY 2011 at $2.38 and $2.75 while Value Line is looking for $2.60 and $2.69 respectively. Standard & Poors now carries estimates of $2.50 and $3.15.

Here are Jacob’s per share [split-adjusted] numbers from continuing operations as reported by Value Line:

Jacobs has steadily raised its sales per share and book value without the need for borrowing. As of Oct. 2, 2009 their total debt was $18.2 million against corporate cash of $1.033 billion. Management expects to use their strong balance sheet to finance some acquisitions which should add to future growth.

Even using the lowest estimates, JEC now trades for 16x this FY’s and 14x FY 2011’s earnings. Those are very low multiples for a high-quality issue while EPS are near a cyclical low point. Once earnings begin to pick up again it seems likely we’ll see a P/E expansion coupled with EPS of at least $3. A bounce back to even 18x normalized earnings would bring JEC back to the mid-$50’s.

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JEC:NYSE — Oct. 14, 2009 - $44.60 

52-week range: $26.00 (Nov. 20, 2008) - $54.71 (Jan. 6, 2009)  
 

Jacobs Engineering Group provides engineering, procurement, construction, and maintenance services to a wide range of customers, including oil and gas, chemical, pharmaceutical companies as well as for U.S. federal government agencies. Most work takes place in the USA, U.K. and Ireland. 

Jacobs has had an enviable long-term record of increasing sales, earnings and book value. They have done this all with internally generated funds. As of June 30^th they held $1.059 billion in cash against less than $48 million in total debt. 

Here are their per share (split adjusted) numbers as reported by Value Line: 

FY (end Sep.)	Sales	C/F	EPS	B/V	Avg. P/E
2002	41.59	1.32	0.99	6.30	17.5x
2003	41.33	1.46	1.14	7.54	17.1x
2004	40.51	1.44	1.13	8.86	19.3x
2005	48.47	1.71	1.29	9.81	20.2x
2006	62.90	2.08	1.64	12.03	23.4x
2007	70.49	2.85	2.35	15.34	21.6x
2008	91.70	3.98	3.34	18.30	24.1x

Zacks sees FY 2009 and FY 2010 EPS at $3.26 and $2.98 respectively. That takes into account both the slow economy as well as the less than robust market conditions in the oil and gas industry. 

That puts the trailing multiple at about 13.7x and the forward year’s P/E at< 15x. Compare those with the historical P/E valuations in the prior 7 years from the chart above. A return to about 17 times what should be cyclically low FY 2010 earnings would bring these shares back to over $50 again. 

Value Line projects EPS of $4.60 over the next 3 - 5 years. Morningstar assigns a current ‘fair value’ of $53 /share. Standard and Poors assigns JEC their highest (5-Star) rating and carries a 12-month price target of $57 /share. Value Line also notes that Jacobs Engineering has 90^th percentile rankings in both ‘price growth persistence’ and ‘earnings predictability’ (with 100^th being best). 

How can you best play a high-quality stock like Jacobs when you feel the year-ahead earnings will be lower? Consider buying the shares and selling LEAP options for 2012. 

Why so long? By then earnings should be picking up with the broader economy. If you leave both the shares and the options alone through their early 2012 expiration (and things go as expected) you will get tax deferment on the gains until you file your tax-year 2012 Schedule D in April 2013. 

Jacobs has a fairly high (1.45) Beta making options premiums quite attractive for sellers. 

Here’s a play that looks quite good to me right now… 

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Jacobs Engineering [NYSE:JEC] March 31, 2009 $38.36 (11 AM EST)
52-week range: $26.00 (Nov. 20, 2008) - $98.31 (May 19, 2008)

Jacobs is one of the biggest US professional service firms with 2008 revenues of $11.252 billion. They also operate in the U.K. and Ireland. They have posted outstanding results over the past decade with last year’s results showing all-time highs in sales, cash flow, earnings and book value.

Despite the poor economic conditions consensus estimates for 2009 are centered on $3.60 per share up 7.8% from last year’s EPS. The company had $787.9 million in cash as of year end 2008 against only $40 million in total debt (debt = 2% of total capital).

JEC shares have dropped from an all-time high of $103.30 in early 2008 to just $38.36 right now as investor worry about possible project cancellations that would reduce their backlog. That fear may be already more than reflected in the present very low valuation as these shares now trade at just 11.5x last fiscal year’s and < 10.7x this FY’s expected EPS versus a 10-year median P/E of 19x. Fiscal years end Sep. 30th).

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