KSW Analysis...

[krishan]

KSW earned 49c in the trailing 12 months giving them a PE of 13.6. I believe they will conservatively earn 68c in FY07 giving them a forward PE of 9.8. The two main competitors are eme with a PE of 28 and fix with a pro forma PE of 20. I think within12 months the stock will trade at 14 with a PE of 20. The PE expansion will be more in line with peers and will highlight the growth rates of the business. Q1-07 should also act as a catalyst as they should see a moderate sequential increase in EPS.

KSW is a specialty mechanical contracting company. They work on HVAC systems for large scale $500K+ contracts. They operate only in NYC.

Normal process for acquiring work is to submit bids for contracts. Generally the lowest priced bid is accepted by the developer. KSW doesn’t work this way. They have no sales force and do not submit bids on contracts. Developers come to them after getting an estimate for the work they are unhappy with. KSW works with them to reengineer the plans in such a way that the goals are met with a reduced cost. This is value engineering.

KSW has a backlog of unfinished work. KSW publishes this number with every press release and every quarter. There is a 2 month LAG between winning a contract and substantial revenues being recognized. Here is a graph of the relationship between backlog and revenue with the 2 month LAG.



As you can see it’s a pretty good match. It makes sense for them to be linearly related. One of the key points is Q1 07 should see a nice bump in EPS. You can see how the backlog spikes up. A regression analysis gives the following trend line.



Revenue = .1851 * backlog + 3677

I know this doesn’t pass a smell test because it doesn’t make sense for a 0 backlog to produce revenue of 3677. However the R-squared of .83 shows the formula to be a good match to the data. If anything the real relationship is more favorable with a larger % of revenue dependent on the backlog.

The current backlog is 110M. This image shows what the expected revenues will be based on the backlog number.



Note my model only predicts through Q207. Beyond that I’m assuming no growth of backlog which is VERY conservative given past growth rates over the past two years. The bottom part of the image shows 2006 numbers (Q4 is estimated) and what I expect 2007 numbers to look like. Management has said SGA costs should not increase to process the larger backlog. Net margins should improve as revenues increase. These numbers show an EPS of 68c in 07 (32% growth).

KSW also has a large amount of cash. As of Q3, they had 11M net current assets (12M in cash). They are looking to buy either into a new market or a complementary company. They have mentioned electrical engineering as a potential good match. I don’t think this is imminent and have not included it in my estimates.

I’ve talked with management so feel free to ask any questions.

Thanks,

Krishan

[SlowHabit]

Why does Warkol Floyd keep exercising his stock options and selling them for the past 14 months?

[krishan]

[ QUOTE ]
Why does Warkol Floyd keep exercising his stock options and selling them for the past 14 months?

[/ QUOTE ]

Diversifying his holdings.

<font color="green"> Floyd's answer, "Well, firstly you have to realize that I hadn't sold a share of stock in over ten years and I actually bought stock early on and the net result was that our options that were initially issued that expired after the end of ten years, the Board voted to extend those options and I just came to the conclusion that I didn't want to be in the same position five years out where I had never excised those options and they lapsed again.

So I decided that there would be a reasonableness of over a period of time exercising those options and selling them. I realized that, although it didn't look good, I would still retain a large share of stock at the end; approximately 700 or 800 thousand shares, so I'd still be the largest shareholder in the company and it just seemed the reasonable thing to diversify my holdings."</font>

It is true he sells all the time. [img]/images/graemlins/smile.gif[/img]

Krishan

[jumbojacks]

[ QUOTE ]
KSW has a backlog of unfinished work. KSW publishes this number with every press release and every quarter. There is a 2 month LAG between winning a contract and substantial revenues being recognized.

[/ QUOTE ]

I'm just curious, but how did you discover this relationship?

[Scorpion Man]

Krishan

Why do you think KSW should achieve a full multiple compared to the peers you cite? Why might it not?

[krishan]

[ QUOTE ]
[ QUOTE ]
KSW has a backlog of unfinished work. KSW publishes this number with every press release and every quarter. There is a 2 month LAG between winning a contract and substantial revenues being recognized.

[/ QUOTE ]

I'm just curious, but how did you discover this relationship?

[/ QUOTE ]

I graphed the two lines and took a look at different graphs with different LAGs. The true best fit is probably somewhere between 2 quarters and 3 quarters but I'm satisfied with the r-squared of the best fit line with a 2 quarter lag.

Krishan

[krishan]

[ QUOTE ]
Krishan

Why do you think KSW should achieve a full multiple compared to the peers you cite? Why might it not?

[/ QUOTE ]

In favor of a high multiple
It's growing much faster than it's peers.

Against a high multiple
Mainly because KSW only operates in a single location. The risk from a localized real estate meltdown would be large. Any direct terrorist disruption of NYC would also hurt KSW as it did after 9/11.

Krishan

[AvivaSimplex]

1. The persistence of a huge backlog suggests the company can't or won't expand to meet the demand for its services. Thus it probably expects the large demand it's experiencing now will slow with the real estate market.

2. The consensus is that the real estate market will decline over the next 1-5 years, especially in regions such as NYC that have been run up during the boom. How will a decline of 20% in real estate prices affect their growth?

[krishan]

[ QUOTE ]

1. The persistence of a huge backlog suggests the company can't or won't expand to meet the demand for its services. Thus it probably expects the large demand it's experiencing now will slow with the real estate market.

[/ QUOTE ]

Revenue has been growing substantially over the past 8 quarter. Look at the revenue graph from the bottom in Q4-04. The backlog is all being worked on at the same time. It's not like they have 20 projects and are only working on 15 because they don't have capacity. They work on all 20 and the backlog represents the portion of the contracts unfinished.

I don't think they are very dependent on price of homes. They are dependent on the amount of 500K+ new construction going on. Here is a quote from Floyd, <font color="green">
I have not seen a market like this in the 40 years I've been in this business. It is not something that is going to stop because the buildings that are already being built, residential, are being occupied. The net result is that there is shortage now of office buildings. They converted downtown Manhattan into residential. Now they need to start just building office buildings. We're just starting to see that coming into the fold.

There is going to be a requirement for schools. As of this date, New York City has just been catching up with dilapidated schools that needed to be fixed up and built new. But unfortunately, with all the influx of new people into the residential market, there is going to be a requirement for more and more schools.

The infrastructure, the MTA has, I believe, $2 billion of construction work coming, which is infrastructure work to support all the new growth of New York. We are gonna, once again, run out of power and need to build new utility plants. So it is a chain effect that the residential market is driving, which is not going to dissipate for anytime in the near future.</font>

I'm not sure how much I believe it though. Could certainly just be CEO spouting sunshine. I do believe the way they win work puts them in a lowest cost provider role. If the market does contract and developers are under more margin pressure KSW may get more work for their value engineering.

Thanks for the questions.

Krishan

[dazraf69]

Just curious to the reasons for this analysis? Krishan are you just getting a double check on your fundamentals or is there some history behind this. I am new to this forum and this seems to be a very intresting company...

Just for the record I am not questiong the integrity of Krishan here