Thursday, March 15, 2012

Poor Conditions, Sterling Price

Shares of Sterling Construction (STRL) fell 13% yesterday following the announcement of the company's net loss for Q4 and weak guidance for 2012. As a result, while the rest of the market is doing well, shares of Sterling are now near a 7-year low! Consequently, value investors may be interested in going long this builder of highways and other transportation infrastructure.

Sterling now trades for under $150 million, despite a net cash position of $60 million and operating income that has averaged $30 million/year over the last four years. But Mr. Market's concern, as usual, is with what's going on right now. The company just experienced its first quarterly loss since the mid-1980s (1) and guided low profits for 2012. The question for value investors is whether the causes are temporary or long-term.

The company cited a number of reasons for this shortfall, including unanticipated onsite conditions, contract modifications, subcontractor failures, delayed financing (on the part of a customer for two large projects), worker shortages (especially in the Texas area, where oil&gas is going full tilt) and productivity shortfalls.

Basically, all the problems likely come down to this: the company was too optimistic in setting its assumptions, thus bidding for (and winning) jobs with prices that were too low. This has led to changes at the top for Sterling, as an executive search is underway for a new CEO.

On the most recent conference call, the company's chairman stated that bidding process changes have already taken place since mid-December, which should result in better labour and productivity estimates, price discipline, and feedback information.

Unfortunately, industry conditions are not likely to be a tailwind as Sterling sorts out its internal problems. Overcapacity continues to reign since the US government still hasn't renewed a multi-year highway bill, causing highly competitive pricing among the companies trying to stick it out. But these may be exactly the kind of conditions that produce potential value investments. With a strong cash balance, Sterling should be able to outlast both its own problems and those of its industry, richly rewarding investors who buy when Mr. Market is most pessimistic.

(1) According to its most recent conference call

Disclosure: No position


Anonymous said...

I listened to the call and press release and couldn't have summed it up any better. I would add that the CFO mentioned these new bidding processes (sounds like a checklist type of bid process) really won't have an impact until late this year. Plus they are working through 5 unprofitable projects in 2012. As such, I think there are still a few quarters of pain left for Sterling. It sounds like they became victims of bidding for projects at an unprofitable level, something Buffett never does with insurance premiums.

Anonymous said...

How much of the net cash position is actually "free" in light of the significant bonding requirements typically required of construction companies? (The same issue applies to KSW.)

Saj Karsan said...

Hi Anon2,

No amount was specified on the call, however, the company did say that bonding requirements were based on tangible book value rather than cash. It was also implied that there was enough excess cash to complete the remaining $7 million on the company's current buyback authorization.