By Brian McCormick - Disclosure: I am long ICA.
For those that follow emerging markets, it's no secret that Mexico is beginning to move into premier position as one of the world's greatest potential investments. With new political leadership, developing regulatory policy & guidance and an increasingly competitive manufacturing base as a result of China's labor issues, Mexico is poised for expansive growth and prosperity. These factors, along with the country's naturally occurring competitive advantages such as its geographical proximity to the United States and its abundant metals and fossil fuel reserves have convinced many experts that Mexico will eventually rise to operate as the 5th largest economy in the world, from its current spot at number 14. Of course given its potential, the next logical question becomes how do you invest in and profit from Mexico's continued development and increasing success?
Mexican construction leader (ICA) is a $1 billion small-cap company that operates in the areas of engineering, procurement, and construction and is the largest provider of construction services in the country. The holding company provides services to public and private-sector clients through its main lines of business: construction of infrastructure facilities, industrial and civil construction, and housing development. ICA hasexpertise in the construction, maintenance and operation of highways, rail, ports, airports, bridges, tunnels, refineries and hospitals, as well as the management and operation of water supply and solid waste disposal systems. The firm, which began operations in 1947, currently has operations in Mexico and selected Latin American countries.
Mexico's Infrastructure Investment
President Peña Nieto will unveil Mexico's New Infrastructure Program in mid-2013 which will be the country's greatest investment in 25 years in the national infrastructure. Under the program, Mexico is taking on close to 500 projects that potentially represent $415 billion over the next six years. The largest investment will be in oil and gas production, as estimates there are over $76 billion. The plan will contain projects that will detail the building of new and improving current roads, rails, bridges, ports, airports, water infrastructure, sanitation and urban transport - all businesses of ICA. More specific targets include the construction and improvement of close to 12,000 miles of roads, the extension of the rail system by nearly 1,000 miles, the construction of at least 3 new airports and the expansion of ports on both coasts. Thus far, highways have been the most successful aspect of recent infrastructure development in terms of volume although there has been significant focus on ports, airports, public transportation and water. Rail is also expected to move into the spotlight as it has been somewhat overlooked historically. Mexico and its President expect that the infrastructure investment program will highlight the country's potential as a global business hub, tourist destination and a major center for economic development. Mexico's goal for 2030 is to be ranked at the top 20 percent of the World Economic Forum's Infrastructure Competitiveness Index.
In late June, ICA CEO Alonso Quintana will speak on behalf of the firm regarding "Strategic Planning for Innovative Transactions and Structures" at Latin Markets' 2013 Mexico Capital Projects and Infrastructure Summit.Quintana recently stated that Mexico has undertaken over 300 projects over the last five years and that annual infrastructure spending could increase by 56% to $70 billion soon. Mexico has also become just the second country worldwide to begin legislating against climate change, which will lead the way for increased investment in smart grids and more sustainable transportation.
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ICA's Rise and Recent Fall
From June 2012 to April 2013, ICA's stock price steadily climbed from $6 to just over $13, with $3 of that appreciation coming in the first three months of 2013. However beginning in late April, the company's first quarter earnings release kicked off a stretch of unfavorable news for ICA that has sent the stock plummeting to below $7 per share again in less than two months.
ICA saw its quarter-over-quarter revenue decrease by 21% in Q1 2013 compared to the same time frame in 2012, mostly as a result of construction revenues falling by 47%. In late May, news that the expected merger between IGA and Javer's (one of Mexico's largest privately owned housing developers) home-building businesses had fallen through sunk the stock another 10%.
Lastly in recent weeks, OMA (Grupo Aeroportuario del Centro Norte, S.A.B. de C.V.) has announced a secondary public offering of 82.6mm series B shares. The shares are currently held by Aeroinvest, ICA's indirect wholly owned subsidiary, which will receive all of the proceeds of the sale. All of the Series B shares and ADS's are being sold by Aeroinvest, which will receive all the proceeds of the offering. OMA will not receive any proceeds from the offering, and its total number of outstanding Series B shares will not change as a result of the offering. ICA expects to retain a significant participation and the controlling interest in OMA through its ownership of OMA's Series BB shares. This recent news may have also put some slight downward pressure on the stock price.
These news events, as well as other emerging markets macro headlines have pushed a stock that rose from $6 to $13 in less than a year, to back below $7 in less than two months. However, the fact remains that Mexico is poised for considerable growth in the coming years, and the country's massive investment in infrastructure (5.5% of GDP) will return the stock to where it traded previously, as the price moves back to reflect the company's fundamentals.
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Courtesy of Yahoo! Finance
A Brief Financial Summary of ICA's Most Recent Results
ICA's first quarter results largely reflect the transition between the completion of current large scale projects and the startup of new ones, which ultimately reduced revenue and margins. Although revenue was reduced by 41% in ICA's Construction business, this was largely offset by significant growth in Concession revenue (81%) and Airports (12%). In Q1 2013 Construction generated 67% of total revenue but only 5% of adjusted EBITDA, while Concessions contributed 21% of revenue and 64% of EBITDA. Airports added 11% of revenue or 31% of adjusted EBITDA.
ICA expects that full-year 2013 revenue will rebound and increase an estimated 9% to 12%, relative to 2012. Construction revenue is expected to pick up in the second half of the year, while Concessions and Airports are expected to continue their recent growth given the solid Construction backlog and the start of new projects and concession operations.
One item to note is that in Q1 2013; ICA invested approximately Ps. 3.9 billion in projects, which is roughly Ps. 3 billion more than their investing activities in the same time frame in 2012. This is a good sign if you consider that the investment in Concessions and other projects result in ongoing revenue generation from the operation of such assets once construction is complete versus the one time and limited revenue recognition from Construction only projects.
As of March 31, 2012, ICA's Concessions segment was participating in 18 projects, including ten highways, five water projects, two social infrastructure projects, and one port. Of these, nine were in full operation, two in partial operation, and seven under construction. As you can see from the below investors relations presentation, ICA plans to be operating 33 concessions including airports through 2015. The average remaining life of the company's current concessions is 23 years.
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Timeline and Catalysts
ICA traded around $7 during the Summer of 2012 and had crossed the $13 mark by April 2013 largely as a result of newly elected president Peña Nieto's plan to invest a record 5.5% of GDP into Mexico's infrastructure which was announced in mid-2012 and priced into the stock over the next nine months.
Over the last couple of months, ICA has since fallen back below $7 per share, largely as a result of:
-Overall Emerging markets indices have fallen with Mexico's IPC dropping around 15% from its peak in 2013
-The falling through of Javer housing deal which cut 10% off of the stock
-Reduced Q1 '13 Construction Revenue relative to Q1 '12 - overall revenue decreased 27% as a result of Construction revenue decreasing 41%.
However, these recent negative events and their effect on ICA's stock appear to be short-term in nature as the company's fundamentals are strong and the businesses in which they operate will experience massive investment starting in late 2013 and lasting through 2018 and beyond:
-ICA attributes the Q1 '13 fall of Construction revenue to the transition between the completion of large scale projects and the start up one of new ones. The company expects Construction revenue to recover in the 2nd half of 2013 and overall revenue to grow by 9% to 12% year-over-year in 2013.
-This recovery will be led by Mexico's 2013-2018 Infrastructure Investment Plan which will be released mid-2013 and is predicted to inject over $400 billion into Mexico's infrastructure (twice as much as the last six year plan), as 2013 investments begin to take effect in the second half of the year this capital infusion will be reflected in ICA's earnings.
**If just the news of the plan last year moved the stock up around 100%, once investment actually begins this year and is reflected in ICA's earnings, the stock should revisit early Spring 2013 levels.
**I equate much of the stock's gains from 2H2012 to the news of the infrastructure plan given that ICA posted modest revenue growth in Q3 and Q4 of 2012. Growth was 8% and 3% respectively, versus the same time frames in 2011. However, there has been significant growth in ICA's other two businesses (Concessions and Airports) amid the stock's decline, which has not been reflected in ICA's valuation. There is more on these businesses below.
-With the newest infrastructure plan, Mexico plans to invest around5.5% of GDP or $400+ billion, which could grow to $600+ billion in coming years, if Mexico was to invest at the rate of some of the fastest growing countries in the world (China ~9%, India ~8%) in order to meet their goal of ranking in the top 20% of the World Economic Forums Infrastructure Competitiveness Index. They are currently ranked 68th out of 144 (top 47 percent).
-In addition to growth in ICA's Construction business as a result of Mexico's pending massive infrastructure investment, the company's other two businesses (Concessions and Airports) have experienced rapid growth in revenue even as Construction slowed last quarter. These are attractive propositions for ICA given their recurring revenue streams:
**The Concession Business represented 8% of total revenue and 28% of adjusted EBITDA in 3Q2012, 14% and 55% in 4Q2012 and 21% and 64% in 1Q2013. Q12013 revenue represented an 81% increase compared to 1Q2012.
** As of the end of 2012, ICA's Concessions segment was participating in 18 projects, including 10 highways, five water projects, two social infrastructure projects, and one port. Of these, nine were in full operation, two in partial operation, and seven under construction. Including ICA's 2013-2015 pipeline, the company will be involved in 33 total concessions including airports, which will nearly double their current total.
**The Airport Business represented 6% of ICA's total revenue and 18% of adjusted EBITDA in 2Q2012. Those figures were 6% and 21% in 3Q2012, 7% and 21% in 4Q2012 and 11% and 31% in 1Q2013. Airport passenger traffic has increased on average 7% each quarter over the last 3 quarters.
Catalysts for ICA's Move back to $13
-Release of actual infrastructure plan in mid-2013 - plan will be over $400 billion and ~500 projects compared to the 2007-2012 plan which was around $200 billion and 300 projects.
-Release of Q2 Earnings will be more in line with traditional revenue figures, specifically in the Construction business given that new large scale projects will be up and running rather than in the transition phase. Concession and Airport earnings will continue to grow as multiple projects are complete (Ly Yesca H.P. construction, N.Necaxa Tihuatlan Hwy, Equeduct El Realito). Recurring revenues will increase and begin to be priced into the stock.
-Release of Q3/Q4 Earnings will begin to reflect Mexico's 2013-2018 $400 billion investment in infrastructure. Construction revenues will rise above 2010-2012 levels as a result as Concession and Airport revenues also grow more rapidly.
-2014 will see the completion of 8 of ICA's current top 12 backlog construction projects and 3 of its Concession projects, which will add to the company's government driven expansion of revenue.
In Closing
ICA's dip to its 52-week low represents a great buying opportunity, as the price has been quickly depressed by no more than mere recent short-term investor psychology and market momentum. As the stock begins to bottom out, and the fundamentals of the company move back into the driver's seat, I believe ICA's price can return to and pass its $13 per share level of earlier this year, after Mexico's infrastructure plan first came to light. The country's investment in infrastructure will allow ICA's construction business to continue to grow, but more importantly, the company's high margin Concession and Airport businesses (~35% operating margins) are expanding even faster, which means these recurring revenue businesses will allow ICA to continuously increase revenue and ultimately profits for years to come. I expect ICA to post 2013 FY EPS of .65, right between 2011 and 2012 figures, and trade at a multiple of 20 which is slightly below its multiple from earlier this year and below the industry average of 27. This equates to a 2013 year end price target of $13 per share.
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