We Expect Aecom to Capitalize on Growing Infrastructure Spending

Equity Analyst

Krzysztof Smalec

In recent years, Aecom has transformed its portfolio and focused on growing its professional services business. The firm exited several business lines including fixed-price combined cycle gas power plant construction, at-risk oil and gas construction, and international at-risk construction projects. Furthermore, in January 2020, Aecom completed the sale of its management services business. We view Aecom’s transformation favorably, as we believe that the strategic shift has resulted in a less volatile and more profitable portfolio.

Furthermore, Aecom has improved its profitability thanks to several recent initiatives, including a $225 million general and administrative cost reduction plan completed in fiscal 2019, real estate consolidation, and focus on the most profitable markets. We are encouraged by Aecom’s margin expansion thus far and see room for further upside, especially in the international business. We note that there is a significant difference in profitability between the Americas and international segments: the adjusted operating margins on a net service revenue basis are in the high-teens in the former but only high-single digits in the latter. Considering a nearly 1,000-basis-point differential, we see room for further margin expansion in the international segment, and we expect the firm will continue to work to narrow the gap by further simplifying the business and focusing on higher-margin markets.

We remain optimistic about the long-term outlook for Aecom as we believe that it's poised to benefit from favorable long-term tailwinds in infrastructure and sustainability solutions. The company has a strong competitive position in the transportation, water, and environment end markets. As such, we think Aecom is well positioned to capitalize on opportunities created by a growing focus on ESG concerns, including areas such as electrification of transit, clean water, and PFAS.

Business Strategy & Outlook

We assign Aecom a no moat rating. We believe that most E&C firms lack moats as intense competition, significant customer power, and the relatively standardized nature of most projects hamper economic moat creation. Furthermore, E&C firms have to contend with high cyclicality and event risk, such as legal disputes and cost overruns (which could be caused by a number of factors including labor shortages, subcontractor performance, and inclement weather). As a result of a fragmented industry structure, high historical volatility, and the potential for large losses on individual projects, it is difficult for E&C firms to maintain consistently attractive returns on invested capital throughout the economic cycle.

Although we think that most E&C firms derive the bulk of their revenue from no-moat activities, we acknowledge that the potential for moat creation exists within certain niche sectors. Aecom has a strong reputation for its design and consulting capabilities and was ranked the number four design firm in the U.S. in 2022 by Engineering News-Record magazine. The firm boasts a number of signature projects, including One World Trade Center, London’s Crossrail, and the Los Angeles Rams stadium (currently under construction). Furthermore, Aecom’s unique expertise in nuclear decommissioning makes it one of the leading competitors in the space alongside private company Bechtel. We think that Aecom’s reputation, portfolio of signature projects, and differentiation within certain niche markets could ultimately help the company forge an economic moat based on intangible assets in the more specialized parts of its business.

Nonetheless, despite some moat creation potential in certain niches, we view most of the design and construction work that E&C firms engage in as relatively routine. Industry cyclicality has historically driven relatively volatile returns on invested capital, and we do not expect that to change. We forecast Aecom to earn average returns on invested capital roughly in line with its cost of capital throughout the business cycle. As a result, we believe that Aecom lacks an economic moat.

None

Economic Moat

AECOM

AECOM engages in the design, manufacture, financing, and operation of infrastructure assets for governments, businesses and organizations. It operates through the following segments: Americas, International, and AECOM Capital. The Americas segment deals with planning, consulting, architectural and engineering design and construction management services to commercial and government clients in the United States, Canada and Latin America in major end markets such as transportation, water, government, facilities, environmental and energy. The International segment focuses on planning, consulting, architectural and engineering design services to commercial and government clients in Europe, the Middle East, Africa and the Asia-Pacific regions in major end markets such as transportation, water, government, facilities, environmental and energy. The AECOM Capital segment includes investing in real estate, public-private partnership and infrastructure projects. The company was founded on January 31, 1980 and is headquartered in Dallas, TX.

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AECOM engages in the design, manufacture, financing, and operation of infrastructure assets for governments, businesses, and organizations. It operates through the following segments: Americas, International, and AECOM Capital. The Americas segment deals with planning, consulting, architectural and engineering design, construction management, and program management services to public and private clients in the United States, Canada, and Latin America in major end markets such as transportation, water, government, facilities, environmental, and energy. The International segment focuses on planning, consulting, architectural and engineering design services and program management to public and private clients in Europe, the Middle East, India, Africa, and the Asia-Australia-Pacific regions in major end markets such as transportation, water, government, facilities, environmental, and energy. The AECOM Capital segment is involved in investing and developing real estate projects. The company was founded on January 31, 1980 and is headquartered in Dallas, TX.

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