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Why engineering firms are buys as stimulus sprees end Add to ...

The Canadian government is set to turn off the taps to its emergency stimulus program next year just as U.S. Republicans, reputedly deficit hawks, take control of the House of Representatives following the November mid-terms.

It seems hardly the recipe for prosperous times in the engineering and construction sector, which has had the benefit recently of government infrastructure spending. But fear not, suggests Desjardins Securities analyst Pierre Lacroix, spending from the private sector is poised to take over and the outlook for materials and diversified industries is looking quite strong.

He contends that Canadian engineering companies should benefit from a possible recovery in backlog, earnings and valuations for U.S. peers. Public spending may well ease in 2011, but this should be offset by expectations for stronger private spending in 2012, led by the mining and oil and gas sectors.

"We continue to believe that a recovery in earnings and backlog for U.S. engineering firms will drive multiple expansion in the sector and support better valuations for the Canadian engineering firms in our coverage universe," Mr. Lacroix said in a new study.

He cautions that the transition from government-driven demand to market-driven demand will be uneven, especially in the U.S. "Nonetheless, we believe certain industries are now on the road to recovery and are well positioned for growth, given that the performance of the engineering services sector is strongly correlated with general economic performance," he said.

In Canada, despite federal withdrawal of funding, infrastructure development is likely to continue from other levels of government on the back of strong local demand for improved services. The growing acceptance of public-private partnerships among voters is also a big plus, he says.

Upside: Mr. Lacroix's follows four names in the sector and rates all of them as a "buy-average risk:" SNC-Lavalin Group Inc., Stantec Inc., Genivar Income Fund and IBI Income Fund. He believes Stantec, Genivar and ICI Group will continue to deliver sold earnings in the next year, while SNC-Lavalin, Stantec and Genivar should be bolstered by a pick-up in industrial demand. Meanwhile, IBI Group should benefit from an improving commercial sector in both Canada and the U.S., he says.

His price targets are as follows: SNC-Lavalin: $61.50; Stantec $33.50; Genivar: $31.50; and IBI Income Fund: $16.

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The winter drilling season is off to a much stronger start than expected, and Precision Drilling Corp. is better positioned than all its North American peers, said Canaccord Genuity analyst John Tasdemir.

Precision is currently working 118 rigs in Canada and 121 workover rigs, 24 per cent and 40 per cent higher than year-ago levels, respectively, said Mr. Tasdemir. Expectations were for flattish year-over-year activity.

Precision is set for above-average growth in the short term as roughly half its sales come from Canada, which is expected to see significant dayrate and margin improvement this winter, compared with flattish expectations for the U.S. market. Meanwhile, Precision's new rig fleet should be able to displace more than 1,000 legacy mechanical rigs in North America, he said.

Precision Drilling, he says, deserves to trade at the high end of its peer group, which would be in the 15 to 16.5 times 2011 earnings per share range, against the current 13.2.

Upside: Mr. Tasdemir raised his target price to $11 and reiterated his "buy" recommendation.

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