Jacobs Solutions: Structural Growth From Infrastructure Modernization And Sustainability

Jacobs Solutions (NYSE:J) provides consulting, technical, scientific and project delivery for the government and private sector. Jacobs plans to spin-off their Critical Mission Solutions and Cyber & Intelligence Government Services business, focusing on critical infrastructure and sustainability with higher margin and structural growth tailwinds. I initiate with a ‘Strong Buy’ with a one-year price target of $182 per share.

Benefiting from Infrastructure and Sustainability

Jacobs expects to complete the spin-off and merger of Critical Mission Solutions in Cyber and Intelligence businesses in the second half of FY24, subject to regulatory approvals. Post-separation, Jacobs will become a pure player in infrastructure, sustainability, and industry consulting, poised to benefit from rising demands for infrastructure modernization and sustainability initiatives.

Jacobs is the global leader in the infrastructure & sustainability industry, servicing both private and public sectors across different industries.

Jacobs’s strength lies in the infrastructure modernization, climate change, water treatment and digital transformations. In Q1 FY24, their bookings in water business increased by 30% year-over-year. Jacobs provides services for water reuse, groundwater management and desalination. Direct potable reuse (DPR) is gaining adoptions worldwide including in Europe, Australia, U.S and Singapore. The DPR system could send highly treated sewage water back into drinking water distributions. Several states in the U.S. are working on rules for DPR currently. For instance, California adopted regulations for DPR on December 19^th 2023. As disclosed in the earnings call, Jacobs has been awarded a $191 million project in Florida for a water reclamation facility. I foresee more countries will adopt DPR technology in the near future for the sustainability’s purpose, with these initiatives becoming top priorities for governments around the world. As such, Jacobs will continue to benefit from these infrastructure modernization and sustainability initiatives.

Stale Growth in Engineering Consulting

Jacobs’s consulting business grew by 5.1% in FY22 and 6.1% in FY23 amid a challenging macro environment. Unlike other IT consulting companies, Jacobs focuses on engineering and sustainability consulting for both private and public sectors. For example, Jacobs assisted their customers in developing digital technologies to predict energy utility asset failures. Recently, they secured consulting contracts for program management services and regulatory practices for oil & gas companies in UK.

In my view, their consulting service business is closely tied to the company’s core strengths: infrastructure and sustainability. Another example is their services to the Copenhagen Metro for its operations and maintenance adviser framework, as announced in November 2023. Jacobs has the capability to provide both consulting services and contribute to the build-up/modernization of these infrastructures.

Because of the rising demand for sustainability, Jacobs has experienced accelerated revenue growth over the past few years, as depicted in the chart below.

Recent Result and FY24 Forecast

Jacobs released their Q1 FY24 result on February 6^th with 5.4% of constant revenue growth and 4.7% of backlog growth. They delivered a better-than-expected financial result in Q1.

On the balance sheet, they ended with $1.1 billion in cash and $2.9 billion in debts, with 1.2x net debt leverage. They bought back $100 million of own stocks in Q1 and still have $775 million under authorization.

They are scheduled to report Q2 result on May 7^th, and I consider the following factors for their FY24 growth:

– People and places solutions: The business growth is closely tied to the infrastructure build-up/modernization, and sustainability projects spending from both private and public sectors. According to the infrastructure bill that Biden signed in November 2021, more than $150 billion has been allocated towards projects that address climate change, such as building electric vehicle charging stations and upgrading energy grids etc. These investments in infrastructure modernization have already contributed to Jacobs’s growth in recent years. As discussed, Jacobs possess strong engineering/technology leadership in transportation (electrification), energy, broadband, water treatment/recycle and other environmental programs. Historically, the growth of infrastructure capital spending has hovered around 4%-5%, but I think Jacobs’s business to grow above this historical rate due to their business mix towards energy transition, water and sustainabilities.

– Consulting Business: The business has maintained a steady growth rate of 5%-6%, and I don’t anticipate there is any structural change in the business growth in the near future. Compared to IT consulting, Jacobs’s business appears to be less sensitive to macroeconomics fluctuations in my opinion. The growth of the consulting segment is also tied to the increasing demand for infrastructure modernization and electrifications.

After Jacobs completes their separation of Critical Mission Solutions and Cyber & Intelligence Government Services business, People and places solutions would account for almost 90% of total revenue. Assuming People and places solutions and consulting will grow by 7% and 6% year-over-year, respectively, the combined organic revenue growth would be 6.9%.

Valuation

As discussed, I assume 6.9% organic revenue growth. In addition, I assume they will allocate 2% of total revenue towards acquisitions, contributing an additional 1% revenue growth to the topline. As the spin-off is targeted to complete in the second half of FY24, I adjust their FY25’s revenue forecast to reflect the business separation.

Over the past 2 years, Jacobs repurchased $139 million of own shares, and I estimate the total number of shares outstanding will decline by 1.2% year-over-year considering their remaining balance of repurchase authorization.

Post-separation, Jacobs’s operating margin would get a significant improvement, as Critical Mission Solutions has a segment operating margin of 8.1% and Divergent Solutions has 8.6%, both below the corporate level of 10.1%. In addition, Jacobs has been implementing their cost optimization plan as illustrated in the slide below.

I calculate that Jacobs will benefit 300bps margin expansion due to the spin-off (one-time), and their total operating expenses will grow by 7% year-over-year, driven by 10bps improvement in direct costs of contracts and 10bps leverage from SG&A.

Jacobs operates on an asset-light business model, spending only 0.8% of total revenue on capex. I assume the same spending ratio in the next few years. With these parameters, the DCF summary can be found below:

The detailed calculation of free cash flow from equity can be found in the table below:

The cost of equity is calculated to be 10.3% assuming: risk-free rate 4.32% (US 10Y treasury yield); beta 0.86 (SA’s DATA); equity risk premium 7%.

After discounting all the future FCFE, the one-year price target is calculated to be $182 per share. Currently, the stock price is only trading at 18x of fwd. free cash flow, a quite cheap multiple for a high-single-digit revenue growth and double-digit earnings growth company, in my view.

Risks

U.S. federal government: As the biggest customer, U.S. federal government represents almost 1/3 of Jacobs’s total revenue. The government spending is contingent on tax income and approved budget every year. Although I don’t foresee the U.S. federal government will cut the budget allocation for addressing climate change, future budget decisions could affect Jacobs’s business growth.

Type of Contracts: The majority of Jacobs’s contracts are cost-reimbursable or fixed-price with limited risks, while 5% of contracts carry fixed price with associated risks. In an inflationary economy, Jacobs may encounter strong margin headwinds due to increased material costs and labor expenses.

Conclusion

I favor Jacobs for their leadership positions in infrastructure modernization, engineering, sustainability, and consulting services. Their growth appears to be structural given the rising global demands for sustainability initiatives. The stock price is undervalued, as per my calculation. As such, I initiate with a ‘Strong Buy’ with a one-year price target of $182 per share.