KSW Inc (KSW)

KSW Inc.

1. Company Summary:

KSW furnishes and installs HVAC and process piping systems for institutional, industrial, commercial, high-rise residential and public works projects in New York City. KSW also performs project management services.

2. Strengths and Weaknesses:

a) Strengths

1. KSW enjoys a $121.5m order backlog, equivalent to approximately two years of operations
2. KSW has a flexible operating structure, whereby it outsources much of the work to subcontractors and carries very little inventory (as evidenced by its reduction in SG&A and COGS roughly in line with revenue over the recession).
3. KSW is well positioned to take advantage of government stimulus aimed at increased construction spending on public works projects (an area in which KSW has operated historically).
4. KSW has an extremely strong balance sheet, without bank debt since 2003. It has a small $1m mortgage.

b) Weaknesses

1. KSW operates in a highly cyclical industry (construction) and would be subject to revenue disruption in the event of a double-dip recession (However, this is mitigated by i and iii above).
2. KSW operates in a highly competitive industry against larger regional/national operators with greater resources. KSW relies on its knowledge of and reputation in the New York City area to compete.
3. KSW guarantees the maximum price of projects to its clients, above which it is responsible for cost overruns. While acting as a barrier to entry against upstarts less able to guarantee their prices, this subjects KSW to potential losses associated with unforeseen overruns (The balance sheet shows accrued overruns as a liability of $6.27m, approximately 10% of one year’s revenue)
4. Possible Management Impropriety (?): KSW purchased a storage yard from its CEO for $2.5m in 2008 at an implied cap rate of 4% which appears substantially below market rates. It is unclear whether the company had been paying market rents historically (quite possibly not, given $7.29 p.s.f. rent), which would explain whether this was impropriety.

3. Valuation:

a) Intrinsic Value as Reproduction of Cost of Assets

I adjusted the firm’s last quarterly balance sheet to estimate the cost of reproducing the firm’s assets. I added a 2x multiple of the 10-year average SG&A expense as a non-current asset to reflect the cost of reproducing the firm’s operational and marketing activities. The result was equity valued at $4.38 per share (fully diluted).

b) Intrinsic Value as Earnings Power

In estimating the value of the firm’s earnings power, I used different revenue scenarios including average revenue for the last three, nine years and trailing twelve months. I used margin ratios from the past 10 years and the statutory tax rate to calculate free cash flows of between $1 – 1.4m per year.  I should note that margins have increased over the last four years due to reduced COGS and SG&A as a percent of Revenue, thus these calculations were extremely conservative. Treated as a no-growth perpetuity using a WACC of 8.1%, I calculated the value per share to be between $4.22 and $4.93.

4. Evaluation:

Estimated intrinsic value is between $4.38 and $4.93. It currently trades around $3.60, representing an 18% – 27% discount. Given the conservatism built into my valuations, this is a sufficient margin of safety.

Author Disclosure: At the time of publication, the author DOES have a position in securities of this company.

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