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Engineering R&D Services Industry's Near-Term Prospects Bleak

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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.

Some of the prominent players in this industry are Quanta Services, Inc. (PWR - Free Report) , Jacobs Engineering Group Inc. (J - Free Report) , KBR, Inc. (KBR - Free Report) , Fluor Corporation (FLR - Free Report) and AECOM (ACM - Free Report) .

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

  • Increasing construction activities in U.S. government projects, which require state-of-the-art construction and engineering services, are expected to benefit the construction and engineering services industry. Other tailwinds include the rapid usage of advanced technologies to deliver smart buildings and mega projects, while identifying and checking margin contraction and costs.
  • 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 the industry’s growth. In addition, infrastructure services business of the industry players continues to thrive, supported by robust demand from the communications industry.
  • However, coronavirus pandemic-related disruptions will weigh on the companies’ near-term results. Slowing global growth, a tight labor market, trade-war induced rise in raw material costs, volatility in commodity prices and the cyclical nature of the industry’s commodity-based business lines pose significant challenges. Some of the companies have also been witnessing a dearth of larger pipeline projects owing to volatility in consumer spending. Again, significant cost overruns (as prices of several companies’ contracts are fixed) have been hurting the bottom line of some of the companies. The companies also face intense competition in the global engineering, procurement and construction industry, which hurts their contract prices and profit margins.

Zacks Industry Rank Indicates Dull Prospects

The Zacks Engineering – R&D Services industry is a 19-stock group within the broader Zacks Construction sector. The industry currently carries a Zacks Industry Rank #190, which places it at the bottom 21% 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 50% 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 2020, the industry’s earnings estimates for 2020 and 2021 have been revised 33.2% and 33.9%, respectively, downward.

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 Underperforms S&P 500 & Sector

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

Over this period, the industry has lost 13.2% versus the broader sector’s rally of 9.1%. Meanwhile, the S&P 500 has gained 8.9%.

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 Engineering – R&D Services stocks, the industry is currently trading at 14.5X versus the S&P 500’s 22.1X and the sector’s 19.1X.

Over the past five years, the industry has traded as high as 17.6X, as low as 10.3X and at the median of 13.8X, as the chart below shows.

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

Bottom Line

A major boost in infrastructural spending (mainly government projects) should continue to favor the industry. Advanced construction and engineering services along with prudent cost-management practices should lend support. However, coronavirus-induced disruptions in the near term, a tight labor market, slowing global growth and uncertainty around global trade are pressing concerns.

Below we present only one stock from the Zacks Engineering – R&D Services space with a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Howmet Aerospace Inc. (HWM - Free Report) : This Pittsburgh, PA-based company is a provider of advanced engineered solutions for the aerospace and transportation industries. Its earnings for 2020 are expected to grow 22.1%. Its trailing 12-month return on equity or ROE of 22.1% is higher than the industry’s 8.2%.

Price & Consensus: HWM

Below are four stocks with a Zacks Rank #4 (Sell) that we would recommend investors to stay away from for the time being.

Willdan Group, Inc. (WLDN - Free Report) : Headquartered in Anaheim, CA, this company provides professional, technical and consulting services primarily in the United States. Its earnings for 2020 are expected to decline 80.6%.

Price & Consensus: WLDN

AECOM: This Los Angeles, CA based company engages in designing, building, financing and operating infrastructure assets worldwide. The company’s earnings for 2020 are expected to decline 27.6%.

Price & Consensus: ACM

KBR, Inc.: Headquartered in Houston, TX, this company provides professional services and technologies across the asset and program life-cycle within the government services and hydrocarbons industries worldwide. The company’s 2020 earnings are likely to decline 5.9%.

Price & Consensus: KBR

Jacobs Engineering Group Inc.: Dallas, TX-based Jacobs Engineering Group is one of the leading providers of professional, technical and construction services to industrial, commercial and governmental clients. Its earnings for 2020 are expected to fall 0.8%.

Price & Consensus: J

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