Emerging from its legal woes, SNC-Lavalin shares poised for long-term gains

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SNC-Lavalin Group Inc. has been stuck in a volatile trading range for the past decade, but the combination of big infrastructure spending and a proven ability to win major contracts should push the stock to new heights.

Just last week, investors got a good look at what the engineering and construction company can achieve: It was tapped to build and equip Montreal's electric-powered light-rail transit (LRT), a fully automated 67-kilometre network supported by a mammoth $6.3-billion budget.

Benoit Poirier, an analyst at Desjardins Securities, is assuming that SNC will get a 25-per-cent share of the contract (other firms are also involved), driving $1.6-billion in revenue over three years. With a profit margin of 5 per cent, the company should be able to add 36 cents a share to its net earnings over this period.

What's more important, though, is that the contract bolsters the argument in favour of buying this stock for the long term: The company is clearly emerging from its recent legal headaches and is establishing itself as a smart bet on global infrastructure spending.

In the United States, the Trump administration is pushing ahead with its plan to improve crumbling roads, bridges and terminals with a plan to encourage US$1.5-trillion in spending over 10 years. In Canada, the federal government has announced nearly $12-billion worth of infrastructure improvements over the past few years, with a second phase of spending worth $33-billion in the works.

SNC is well-positioned to benefit from these ambitious plans, which will take years to unfold. The company operates in 100 countries. Although about 40 per cent of its $8.6-billion revenue in 2016 flowed from projects in Canada, big chunks also came from Australia, the United States and the Middle East.

Its experience is also deep. It designs and builds chemical plants, transmission systems, water treatment plants, bridges and highways – the type of infrastructure that countries, and investors, have been clamouring for.

The company's experience with LRTs is particularly deep. In 2015, a consortium that included SNC won a contract to build Toronto's 19-km Eglinton Crosstown LRT. SNC also won a contract in 2005 to build Vancouver's 19.5-km Canada Line – completed on budget and ahead of schedule.

"We see the potential for SNC to be viewed as an infrastructure asset play, and for that matter, to appeal to more traditional infrastructure-focused investors," said Derek Spronck, an analyst at RBC Dominion Securities, in a note published after the release of SNC's fiscal third-quarter financial results in November.

But SNC's stock price, although well off its lows, is hardly reflecting this enthusiasm, which is why it is a compelling opportunity right now.

Its engineering and construction business is valued at just 7.7-times estimated 2018 profit, according to Frederic Bastien, an analyst at Raymond James.

That's much cheaper than its peers. Among integrated engineering and construction firms, including AECOM and Fluor Corp., the average price-to-earnings ratio is 14.3. And among firms that specialize in either construction or engineering, average P/E ratios are above 16.

There are reasons why SNC stands out as a cheap stock. Its contract to lead construction on the new $4-billion Champlain Bridge into Montreal is facing cost overruns and potential late penalties (although management is upbeat that it can accelerate construction to meet its deadline at the end of this year).

More broadly, its reputation took a battering several years ago when the company became embroiled in an extensive bribery scandal that felled its chief executive in 2012. The scandal fed concerns among investors that the company would lose access to international and Canadian government contracts, and could even lead to the sale or breakup of SNC. The shares fell more than 40 per cent between 2011 and 2012.

Although its reputation has largely recovered, and SNC continues to win government contracts, the stock has been struggling to rise above $60. It closed Monday at $53.51 in Toronto, up 1.3 per cent. Perhaps that's one step along the way toward a long-awaited breakout rally.