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Is More M&A Coming to the E&C Industry?

M&A can boost growth despite lagging engineering and construction earnings.

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Engineering and construction companies are generally considered late-cycle in that their performance lags the broader economy by several quarters. So far, profits have held up very well as they work through the project backlogs accumulated in past years, even as current order win rates remain rather anemic. Going forward, as customers move out of capital conservation mode and begin posturing themselves for sustainable growth, backlog will eventually grow again. However, companies will be reluctant to commit to sizable new projects until the economic recovery gains stronger footing--making growth elusive as the economy totters along. Moreover, new backlog probably won't translate into sizable revenue for some time, as E&Cs don't book revenue until the projects get underway. Lastly, due to increased competition during these lean times, backlogs booked during this period can carry a slimmer margin which will impact E&Cs' earnings for many quarters, or even several years in some cases.

Against this challenging backdrop, E&C companies accumulated sizable cash piles during the last two years in response to the extremely uncertain economic climate. Due to their low capital intensity, and the fact that many projects booked during fatter times were reaching completion, E&C companies had very strong cash-generating capabilities. We expect companies to counter the lack of organic growth with bolt-on acquisitions in order to reach their targeted growth rate, fill in technical competencies that they lack, or expand into geographies they don't serve. Historically, E&C companies have relied on acquisitions for a third to half of their growth, and we expect more intensive M&A activity in the next several years.

Morningstar Analysts does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.