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Dycom Dying for Attention

By Brian Lund (TMF Tardior)
May 22, 2000

Looking for a communications infrastructure play that has outperformed Cisco (Nasdaq: CSCO) over the last five years? Who isn't? Too often, however, the pesky unprofitability and triple-digit P/E ratios for companies in the industry test the mettle of even the boldest investor and vitiate potential returns.

Check out Dycom Industries (NYSE: DY) . Dycom designs, installs, and maintains equipment for telecom, cable, and utility providers throughout the U.S., as well as providing premise wiring within commercial buildings. That's a growth industry, my friend, that has rewarded Dycom shareholders with 87% annualized share price appreciation on only slightly lower net income growth over the past five years.

The Palm Beach Gardens, Fla. company wired in its earnings for the third quarter this morning, providing the most recent snapshot of its progress. Revenues rose to $212 million, 65% above the year-ago quarter, thanks in part to the March 8 acquisition of Neils Fugal, a telecom construction and maintenance services provider. Excluding the acquisition, Dycom realized 32% revenue growth for the quarter.

Thanks to a 120 basis-point drop in general and administrative expenses, Dycom netted $16.9 million excluding merger expenses, 75% better than last year's Q3 and in line with analysts' expectations. Net margins improved 50 basis points to 7.9%, up from 7.8% for fiscal year (FY) 1999 and 5.9% for FY 1998.

One worry about Dycom has been its dependence on big contracts with a small number of customers. Dycom is improving the situation, however. In FY 1999, 60% of its business came from five companies: Bell South (NYSE: BLS) ; AT&T's (NYSE: T) TCI Communications; Comcast (Nasdaq: CMCSA) ; Sprint (NYSE: FON) ; and U S West (NYSE: USW) . That percentage was down from 65% in FY 1998. The positive trend continued this quarter, with just less than 50% of Dycom's revenue coming from the Big Five.

Dycom has over 50 master service agreements (MSAs) and long-term service contracts with telecom and cable providers. These contracts accounted for 53% and 31% of revenue, respectively, in FY 1999. The benefit of the agreements is that they provide stability to the revenue stream. MSAs, which usually last several years, make Dycom the service provider for a given geographic area. At the end of that period, it often can negotiate a new contract without subjecting itself to a bidding war.

In addition, Dycom currently has about $1.2 billion in backlog business, which offers further insurance for future revenues. The Neils Fugal acquisition brings with it a working relationship with energy powerhouse Enron (NYSE: ENE) and access to the Western U.S., where Dycom has plenty of room to grow.

The company has experienced some growing pains in the last few years. Its cash flow has been hampered by large capital expenditures necessary to fund its rapid growth. Cash flow has also suffered from a 62% increase in days sales outstanding (DSO) between FY 1997 and FY 1999. DSO increased another 8% year-over-year this quarter.

Dycom has also watched its two main competitors, MasTec (NYSE: MTZ) and Quanta Services (NYSE: PWR) , surpass it in market capitalization over the last year. Though analysts expect all three companies to grow in the low-twenty-percent region annually, MasTec and Quanta are expected to have a strong FY 2001. Whereas Dycom used to trade at a high multiple compared to its competitors, they now all trade at around 30 times FY 2001 estimates.

For a company in a booming industry with no debt, numerous long-term contracts, and over $1 billion in backlog business, Dycom trades at a very low multiple. The same could be said of its competitors. I think that the entire sector is worth a look.

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