Monday, October 12, 2009

From The Mailbag: Matrix Service

Matrix Service Co. (MTRX) provides construction and repair services to companies in the oil and gas sector. Considering its highly cyclical industry, it has held up well through the recession, with profits actually increasing in 2009 vs 2008. As a result, its stock trades at a premium to book value (P/B = 1.5) with a P/E of 9.

Its revenues have held up due to the fact that almost half of its sales comes from its repairs segment, which is much more stable than its new construction segment. Furthermore, revenue stability is helped by the fact that the company often operates with long-term contracts. But going forward, revenue is almost sure to continue to decline: construction backlog is down some 30% from last year.

Nevertheless, the company has a pristine balance sheet, with a debt to equity ratio (including operating leases) coming in at less than 10%. As a result, the company is positioned to outlast the downturn, despite the expected drop in revenue.

Considering the above factors, this appears to be a worthy investment for a regular investor. For value investors, however, there are some noteworthy factors to consider. First of all, the company's price does not appear overwhelmingly cheap. While the P/E is 9, we know that earnings should reduce in the future due to the fact that customers are now more hesitant to invest in new construction (as shown by the backlog numbers).

The premium to the price to book is also a concern: if there are outsized profits to be had, competitors will be compelled to provide the same services, driving down margins. Investors paying a premium to book value must be sure to understand the competitive advantage or moat this company has that prevents the competition from eroding profits. Not being an expert in this field, I do not.

Secondly, the company is exposed to the oil and gas sector. We've previously discussed the fact that commodity cycles can be unpredictable, exposing the investor to downside risk if oil prices were to move in an unfavourable direction.

Finally, the company's customers are concentrated, with the top three customers accounting for 30% of the company's revenue. Reliance on just a few customers always presents an added risk.

While Matrix may be a great company with excellent potential, value investors should ensure they understand the risks before investing. Exposure to commodities, reliance on a few customers, current returns which invite competition, and a price which does not appear to offer a terrific margin of safety all have the potential to derail what otherwise looks like a decent investment.

Disclosure: None

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