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Bleak Near-Term Outlook for Engineering R&D Services Industry

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The Zacks Engineering – R&D Services industry primarily consists of engineering and infrastructure service providers. The companies basically provide construction, technical, engineering and professional services to a number of industries worldwide, including oil and gas, chemical and petrochemicals, transportation, mining and metals, power, agriculture, consumer applications and manufacturing.

Let’s take a look at the industry’s three major themes:

  • The industry is poised to benefit from the rising construction activities in the United States that require state-of-the-art construction and engineering services. The Trump administration’s push to boost infrastructure spending is another vital growth catalyst for the industry.
     
  • The Trump administration’s investment in defense and cyber security is conducive to the industry’s growth. The players are also gaining from rising global demand for alternative nuclear energy, as they provide engineering, procurement, construction and maintenance services to nuclear power plants. Meanwhile, increasing public investments in transportation, water infrastructure, utility plant and healthcare market are anticipated to drive growth for the industry. Chemical derivative and refining opportunities, both domestic and international, along with upstream and LNG opportunities should also drive growth.
     
  • However, trade-war driven increases in raw material costs, rising freight expenses, volatility in commodity prices and the cyclical nature of the industry’s commodity-based business lines pose significant challenges. Again, significant cost overruns (as prices of several companies’ contracts are fixed) have been hurting bottom lines of some of the companies. Increasing competition is another dampener. The industry faces intense competition in the global engineering, procurement and construction industry, which is detrimental to the companies’ contract prices and profit margins.


Zacks Industry Rank Indicates Dull Prospects

The Zacks Engineering – R&D Services industry is a 15-stock group within the broader Zacks Construction sector. The industry currently carries a Zacks Industry Rank #185, which places it at the bottom 29% of more than 250 Zacks industries.

The group’s Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates dismal near-term prospects. Our research shows that the top 50% of the Zacks-ranked industries outperforms the bottom 50% by a factor of more than 2 to 1.

The industry’s position in the bottom 29% of the Zacks-ranked industries is a result of negative earnings outlook for the constituent companies in aggregate. Looking at the aggregate earnings estimate revisions, it appears that analysts are gradually losing confidence in this group’s earnings growth potential. Since January 2018, the industry’s earnings estimate for the current year has gone down by approximately 8.9%.

Despite the industry’s gloomy near-term view, we will present a few stocks that one can hold on to. Before that, it’s worth taking a look at the industry’s shareholder returns and current valuation.

Industry Lags on Stock Market Performance

The Zacks Engineering – R&D Services industry has lagged the broader Zacks Construction sector as well as the Zacks S&P 500 composite over the past year.

Over this period, the industry has declined 32.2% versus the broader sector’s decline of 29.9% and the S&P 500’s decline of 6.5%.

One-Year Price Performance

 

Industry’s Current Valuation

On the basis of forward 12-month price-to-earnings ratio, which is a commonly used multiple for valuing building products stocks, the industry is currently trading at 10.5X versus the S&P 500’s 15.1X and the sector’s 10.6X.

Over the past five years, the industry has traded as high as 16.9X, as low as 9.9X and at the median of 13.4X, as the chart below shows.

Industry’s P/E Ratio (Forward 12-Month) Versus S&P 500


Bottom Line

A major boost in infrastructural and construction spending should continue to favor the industry’s performance. Advanced construction and engineering services along with prudent cost management practices should provide support. However, rising transportation and raw material costs are pressing concerns.

Only two stocks in the Zacks Engineering – R&D Services space currently carry a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Altair Engineering Inc. (ALTR - Free Report) : This Michigan-based company provides enterprise-class engineering software worldwide and carries a Zacks Rank #2. The consensus EPS estimate for the company has increased 8.6% to 32 cents for the current year, over the last 60 days. Shares of Altair have gained 23.4% year to date. The expected earnings growth rate for the current year is 23.1%.

KBR, Inc. (KBR - Free Report) : The Houston-TX based company carries a Zacks Rank #2. The consensus EPS estimate for this global engineering, construction and services firm has increased 4.8% to $1.52 for the current year, over the last 60 days.

Investors may hold on to the following Zacks Rank #3 (Hold) stocks, as they currently carry a Zacks Rank #3 (Hold) and are experiencing positive estimate revisions.

Willdan Group, Inc. (WLDN - Free Report) : This Anaheim, CA-based professional technical and consulting services provider has an expected earnings growth rate of 67.8% for the current year. The consensus EPS estimate for the company has moved 10.6% north, over the last 60 days.

Gates Industrial Corp. plc (GTES - Free Report) : Denver-based power transmission and fluid power systems manufacturer has an expected earnings growth rate of 44.6% for the current year. The consensus EPS estimate for the company has increased 1.7% to $1.20 for the current year, over the last 60 days.

Quanta Services, Inc. (PWR - Free Report) : This Houston, TX-based company provides specialty contracting services to the electric power, communication, and oil and gas industries in the United States, Canada, Australia, Latin America and internationally. It has an expected earnings growth rate of 40.1% for the current year. The consensus EPS estimate for the company has remained stable, over the last 60 days.

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