Stock Mart: Granite Construction

Bad infrastructure means good business following a $175 billion highway spending increase.
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The nation's highways are in a sorry state. And over the next few years, that will keep

Granite Construction

(GVA) - Get Report

very busy.

The Watsonville, Calif.-based company is one of the largest civil construction contractors in the U.S. So it stands to benefit from a transportation bill, passed last year, that has greatly increased federal funding to fix the nation's sagging infrastructure.

Between 1998 and 2003, federal spending on highway construction is expected to increase 44% over the prior six-year period to $175 billion. Spending on transit is expected to jump 30% to $42 billion, according to

Merrill Lynch

.

"When you throw

the transportation bill into the picture and the amount of potential business into the mix, it's phenomenal," says Rob Mathai, chief operating officer of

Capital Technology

, a Charlotte, N.C.-based money management firm and Granite shareholder.

Granite generated almost 70% of its $1.2 billion in revenue last year from public sector infrastructure projects such as highway construction, bridges and tunnels. Last year it earned $46 million, or $1.72 per share, compared with $28 million, or $1.03 per share, in 1997.

Thanks to the transportation bill, Granite is expected to bid on about $8 billion in new work this year, more than three times last year's amount, says analyst Fritz von Carp at Merrill Lynch. Earlier this month, he raised his rating on the stock to accumulate from neutral to reflect the improving outlook. Merrill hasn't performed underwriting for Granite.

"I think our prospects have never looked better

based on the amount of money being brought to the table by state and local governments," as well as normal demand, says William Barton, a Granite vice president and chief financial officer.

Historically, the company has won between 20% and 30% of the projects it has bid on, Barton says. But profits take some time to roll in after a job has been won, so projects this year most likely won't translate into earnings until next year. In addition, Granite's accounting methodology recognizes profits only after a job is 25% complete.

Yet construction companies tend to trade higher in anticipation of projects being awarded. Investors got excited about the legislation, known as the

Transportation Equity Act for the 21st Century

, when it was passed last June. Between June and January, Granite's shares ran from near 20 to a 52-week high of 37.

Then, when it became evident that much of the spending would only begin late this year and in 2000, the stock tumbled. When Granite reported fourth-quarter earnings of 36 cents, 4 cents short of the Street estimate, the stock was pummeled, falling to near 20.

Granite Construction
Shares plunged on news of delayed federal transportation spending and a fourth-quarter earnings shortfall. But investors think there's room to run.

HGK Asset Management

beefed up its position when shares of Granite were in the low 20s, and Managing Director Arthur Coia says the stock is still a compelling value. "I wouldn't shy away from buying it here," he says. His firm holds about 20,000 Granite shares.

At a trailing price-to-earnings ratio of 14.5, Granite is well below the sector's 20.28 ratio, according to

Market Guide

, and less than half the ratio of the

S&P 500's

at 37.33. Its price-to-sales ratio is 0.55, well below the 1.0 ratio that value investors traditionally seek. The stock closed at 28 5/8, up 1/2 Friday.

Coia thinks Granite could earn as much as $2.50 a share in 2000, but for now he is using $2.20, still well above the

First Call

consensus of $2.03.

"The fundamentals of Granite's markets are better than they've been in 30 years," says Merrill's von Carp, "and that is not reflected in the stock price."

Von Carp expects Granite to win several large jobs in this year's second half as states ramp spending in conjunction with the federal funds. Typical are two recent projects Granite won, a $28 million highway project near Palm Springs, Calif., and a $33 million highway contract near Orlando, Fla. But other major projects in the works include a $92 million highway interchange project in Texas and a $500 million light-rail project in Utah that Granite is working on with

Morrison Knudsen

(MK)

and construction giant

Kiewit

.

Of course, Granite's projects could be delayed. After all, governments are bureaucracies. And the weather is a big, unpredictable factor. A third hurdle the company could face is the potential flattening of its prep work for residential development in California.

Making a successful move into new markets is another challenge for Granite, says Marc Sulam, who covers the firm at

Donaldson Lufkin & Jenrette

. He has a market-perform rating on the stock; DLJ hasn't performed underwriting for Granite.

For now, however, the transportation bill promises plenty of work in the company's current markets.