Check out this week’s Danger Zone interview with Chuck Jaffe of Money Life and Marketwatch.com – featuring Tutor Perini

Since the presidential election, the S&P 500 is up 5%, the Dow is up 7%, and the Nasdaq is up 4%. This week’s Danger Zone is up 43% on the shoulders of the “Trump Rally,” but the economics of this business cannot justify this stock’s valuation. With a weak competitive position, a history of shareholder value destruction, and a significantly overvalued stock price, Tutor Perini (TPC: $28/share) is in the Danger Zone this week.

Revenue Growth Does Not Equal Profit Growth

Tutor Perini’s economic earnings, the true cash flows of the business, have declined from -$66 million in 2010 to -$170 million over the last twelve months (TTM). This deterioration in the economics of the business comes despite revenue growing 9% compounded annually during the same period, per Figure 1. Investors must look past top line growth to find the true economic reality of the business. See a reconciliation of Tutor Perini’s GAAP net income to economic earnings here.

Figure 1: Tutor Perini’s Negative Economic Earnings

Tutor Perini newconstructs_tpc_profitlessrevenuegrowth_2016-12-12Sources: New Constructs, LLC and company filings

The issues do not end with declining economic earnings. Tutor Perini’s NOPAT margin has halved, from 4% in 2010 to 2% TTM while the company has burned through cumulative $1.1 billion in free cash flow (FCF) over the past five years. Across multiple key metrics, Tutor Perini’s business is showing significant signs of deterioration.

Questionable Acquisitions Cannot Be Ignored

Acquisitions are continually touted by management as “earnings accretive” or “shareholder friendly.” On the surface, most acquisitions would appear to be accretive, due to the high low fallacy. All too often, more rigorous research reveals acquisitions to be poor allocations of capital and harmful to the economics of the acquiring firm which is the case with Tutor Perini.

In 2008, Perini Corp (CEO Ron Tutor) merged with Tutor Saliba (96% owned by Ron Tutor) in an all stock deal. This deal, clearly a major conflict of interest and questionable corporate governance for Mr. Tutor, resulted in a big payday for execs (Mr. Tutor received Perini stock worth over $500 million), but destroyed value for existing shareholders. Per Figure 2, TPC’s return on invested capital (ROIC) was an impressive 24% in 2007 but after the merger, fell to 8% in 2009.

Two years later, Tutor Perini acquired seven separate companies in 2010/2011 with a cost of over $644 million. Unfortunately, these acquisitions did little to earn a quality return on invested capital, as the company’s ROIC continued its downward trend, and currently sits at a bottom-quintile 3%. Management must be held accountable for its capital allocation decisions. Per Figure 2, it’s clear Tutor Perini’s acquisitions have not been as accretive as the company reported at time of purchase.

Figure 2: Tutor Perini’s Capital Destruction

newconstructs_tpc_roicdeterioration_2016-12-12

Sources: New Constructs, LLC and company filings

Compensation Plan Fuels Shareholder Value Destruction

Misaligned executive compensation plans can line the pockets of executives while costing shareholders big time. Tutor Perini’s executive compensation plan is heavily weighted towards incentive pay, which includes long-term equity awards and annual incentive bonuses. When combined, incentive pay makes up 83% of the CEO’s pay and 67% of other executives’ pay. However, in each case, the metrics used to award incentive pay do not align executive interests with those of shareholders – despite what Tutor Perini’s compensation committee claims in its proxy statement.

Annual incentive bonuses and long-term equity awards are paid out upon the achievement of pre-tax income, which, according to Tutor Perini’s compensation committee “best aligns with the goal of shareholder value creation.” As we’ve demonstrated through multiple case studies, ROIC, not pre-tax income, is the primary driver of shareholder value creation. As shown above, Tutor Perini’s pre-tax income goal has not led to shareholder value creation, but rather destroyed value for nearly a decade. Without changes to this plan, preferably to emphasize ROIC, investors should expect further value while management continues to get big payouts.

Non-GAAP Metrics Distort Economic Reality

Non-GAAP metrics are a red flag for investors because of the discretion management gets when calculating them. Tutor Perini uses non-GAAP metrics when it suits them, ignoring them in some years and using them in others. This use of non-GAAP not only masks the deterioration of the economics of the business, but also their inconsistent use makes year-over-year comparisons more difficult. The metrics TPC has used include, adjusted operating income, adjusted net income, and adjusted EPS, each of which management claims “enhances an overall understanding of our historical financial performance and future prospects.” Below are some of the expenses TPC removes to calculate these non-GAAP metrics:

  1. Impairment charge
  2. Litigation-related charge
  3. Litigation provision
  4. Loss on sale of investments

These adjustments have a significant impact on the disparity between GAAP net income, non-GAAP net income, and economic earnings. In 2015, TPC removed nearly $14 million in litigation-related charges (30% of 2015 GAAP net income) to calculate adjusted net income. This adjustment allowed Tutor Perini to report adjusted net income of $59 million, compared to only $45 million GAAP net income, and -$170 million economic earnings, per Figure 3.

Figure 3: Disconnect Between Non-GAAP & Economic Earnings

newconstructs_tpc_nongaapvseconearnings_2016-12-12

Sources: New Constructs, LLC and company filings

Diminished Profitability In An Already Low Margin Industry

Tutor Perini specializes in large construction projects that include highways, wastewater facilities, casinos, office buildings, and airports. While such large projects require significant resources and building knowledge, TPC still faces competition from numerous private and public firms. Competitors include Flatiron Construction Corp, Fluor Corp (FLR) Granite Construction (GVA), Traylor Bros, AECOM Technology (ACM), Suffolk Construction, and Sterling Construction (STRL). While this list is non-exhaustive, per Figure 4 below, it’s clear that Tutor Perini has profitability issues within its own industry.

Note that the firm with the highest NOPAT margin still manages just a 6% margin, which means Tutor Perini’s 2% margin is at a competitive disadvantage in an already low margin industry. Similarly, its 3% ROIC ranks equal to or below all competitors listed in Figure 4. With lagging margins and ROIC, more profitable firms can bid for jobs at prices where TPC cannot operate profitability. This competitive disadvantage leaves TPC bidding on less attractive deals or accepting losses upfront with hopes of increasing efficiency before the project is completed.

Figure 4: Tutor Perini’s Low Profitability

newconstructs_tpc_roicpeercomparison_2016-12-12

Sources: New Constructs, LLC and company filings

Bull Hopes Rest On Backlog Dreams

For many companies involved in construction or manufacturing, management teams point to backlog as a measure of the health of the business. The idea being that the higher the backlog, the greater profit potential of the firm, since backlog represents the value of work yet to be performed. However, as with many metrics, backlog does little to measure the profits generated, yet it remains a strong “reason” for investment in TPC.

As we show below, TPC has effectively grown its backlog, all while cash flows have declined. Per Figure 5, TPC’s backlog has grown from $4.1 billion in 2012 to

1, 23  - View Full Page