Monday, March 28, 2011

Equity Research Piece: Sterling Construction Co. (STRL)

I came across Sterling Construction Co. (STRL) after running a screen on Capital IQ for companies with: low debt levels, market caps between $100M and $500M and trailing EV/EBITDA multiples below 7x. I happen to believe that there is a lot more inefficiency in the small cap space and thus I often dig in that arena. What I quickly saw was that companies reliant on government infrastructure spending were trading at very low EV/EBITDA multiples. In fact, during my research I also came across Orion Marine Group (ORN), a company that operates in similar markets to STRL. At first I was intrigued by the valuation of ORN, but after more digging, STRL became the more compelling research candidate.

Unfortunately, I discovered the company a few weeks too late. On March 14th, 2011, the stock closed at $12.48, a price that implied a trailing free cash flow yield over 18%. Since then the stock has jumped to a price above $16 and no longer offers a sufficient margin of safety for my taste. However, I do think the stock bears watching because of the uncertainty surrounding state infrastructure spending. It is possible that the pessimism regarding states' ability to fund capital expenditures will drive the stock price down to a level that more than compensates for the inherent risks. Plus, I believe that STRL is a takeout candidate because the larger players such as Fluor and KBR may only be able to achieve growth through acquisitions over the next few years.

I should mention that this is my own personal research and the analysis and opinions presented should not be attributed to West Coast Asset Management. I hope you enjoy the piece as a I think it is representative of the type of research I like to do. For those of you who do not have time time read all 12 pages, I have included an executive summary in the first two pages of the write up. Please feel free to make comments or suggestions. I am always looking for feedback on my research, both positive and constructive.

As usual, I have put the write up in Scribd format to preserve the formatting of the charts. However, if you have trouble downloading the piece, feel free to email me and I will happily send you a copy.

Sterling Construction Co. Write Up