Sector Watch: Infrastructure repair
While the topic of infrastructure repair rarely makes the headlines, one of the major challenges facing the United States today is an outdated, decaying highway and bridge system. Federal and state agencies acknowledged this issue last year by increasing public works transportation spending 13%, with an additional 10% increase projected for 2007.
The U.S. bridge infrastructure, in particular, is woefully antiquated and in need of repair. According to the Federal Highway Administration, nearly 30% of U.S. bridges are more than 50 years old and warrant frequent inspections for cracks and fatigue. Of the 600,000 bridges in the U.S. National Bridge Inventory (NBI) database, nearly 100,000 bridges are considered structurally deficient and in urgent need of attention. Maintenance and repair costs typically range around $2 .6 million across the life of a bridge, so the amount of spending required to repair 100,000 outdated bridges could easily approach $300 billion. The passage of time only exacerbates infrastructure repair challenges since costs climb as repairs become more frequent and as emergency situations arise.
The federal government oversees the maintenance of the U.S. bridge system. In 2005, Congress passed SAFETEA-LU (Safe, Accountable, Flexible, Efficient Transportation Equity Act: a Legacy for Users), a bill that authorizes spending of $286 billion for, among other things, bridge maintenance and repair between 2004 and 2009. The bill also requires more frequent inspection and maintenance of railroad bridges.
Among U.S. states, Texas is taking a lead in infrastructure repair and development. It ranks as one of the top two states nationwide for construction spending on highways and bridges, and recently allocated a 37% increase in construction spending to $14.5 billion over five years. Texas Department of Transportation engineers have identified nearly $19 billion of transportation infrastructure projects required to keep pace with this region’s population growth.
Among the companies poised to benefit from increased infrastructure spending, Material Technologies Inc. (OTCBB: MTTG) and Sterling Construction Company Inc. (NASDAQ: STRL) stand out as especially interesting small-cap investment opportunities.
Material Technologies
Material Technologies has developed a proprietary technology – electrochemical fatigue sensor (EFS) – for detecting and monitoring microscopic cracks in metal structures, and is aggressively pursuing bridge inspection and monitoring contracts with government agencies.
EFS technology offers an efficient, affordable alternative to the traditional process of visually inspecting bridges. In addition to being time-consuming and labor-intensive, visual inspection is highly inaccurate. The Federal Highway Commission found 56% of visual inspections fail to detect cracks or other structural flaws. EFS technology detects fatigue-sensitive areas in a bridge with maximum accuracy, identifying microscopic cracks as small as 0.0004 inches and indicating where the crack originates. Because the EFS system is portable, it can be used to inspect visually inaccessible parts of the structure.
The company has already secured contracts and/or demonstrated its technology to DOT officials in Pennsylvania, Massachusetts, New Jersey, New York, Utah, Alabama, and Network Rail in London. Revenues increased 55% year-over-year in the 2006 fourth quarter because of initial EFS bookings. Revenues rose 12% in 2006 to $158,153 and net losses narrowed to $11.6 million from $25 million in the prior year. Based on strong interest from government agencies, Material Technologies projects annual revenues relating to its EFS technology could reach $50 million by 2009. Material Technologies shares currently trade at a P/S multiple of 2X projected 2009 revenues. My $3.00 price target for Material Technologies is approximately twice the current $1.42 share price.
Sterling Construction
Sterling Construction Company specializes in the building and reconstruction of transportation and water infrastructure.
The company’s primary market, Texas, is attractive because of the new infrastructure required to serve that state’s growing population. Texas’ population is forecast to grow 64% by 2030 to nearly 40 million residents. Sterling significantly expanded its service capabilities in 2006 by investing $27 million in new equipment, on top of $11.5 million of equipment purchases in the prior year. As a result of these investments, Sterling is positioned to bid on larger projects, improve project margins and work through its backlog more efficiently. The company was awarded $329 million of new construction contracts in 2006 by Texas municipal agencies and began 2007 with a contract backlog of $395 million, up 29% compared with the prior year. Sterling is also establishing strategic alliances with major Texas contractors and operators that will enable it to bid on toll road and light rail projects.
Sterling’s revenues rose 14% in 2006 to $249.3 million and net income climbed 20% to $12.6 million. The company targets 2007 revenues at between $285 and $310 million, and expects 2007 net income to fall in a range of $13.4 million to $15 million. These shares trade at a 20X P/E multiple. My $27 price target for Sterling shares is approximately 25% above the current price.
