Since Arcadis published its 1H11 results on August 3, the markets have been in steady decline, economists have reduced their worldwide GDP growth forecasts, signs of a hard landing in China have emerged, the US has lost its AAA credit rating and several governments have become the plaything of speculators. Preferring not to ignore these developments, we’ve decided to cut our 2012-2013 revenue growth projections by 3-4%. Our scenario does not take into account an outright recession but merely a slowdown in economic growth spanning several quarters. Although our industry contacts suggest that engineering companies are not yet seeing a change in spending patterns by their clients, all say that they are monitoring the situation closely. We understand Arcadis has a contingency plan ready should markets turn sour again. In fact, the company is even more prepared than during the previous downturn. In Europe, Arcadis still has 11% of its 15% flexible shell left, while the US labour market (> 50% of revenues) is much more flexible. This should enable Arcadis to maintain margins at ~10%. On average we cut our EBITA margins forecasts by 3% and 7% over FY12 and FY13 and trim our EPS numbers by 4% and 8% respectively. Our new EPS forecasts are 7-8% below consensus.
Infrastructure – Weakness across Europe (NL, UK, Poland) is set to remain but will be fully offset by excellent performances in Brazil and Chile (RoW represents 1/3rd of infra). With the upcoming WC 2014 and Olympic Games 2016, Brazil is set to start updating its national infrastructure, while mining companies still represent the lion’s share of orders. We could see risk when commodity prices start to decline however.
Water –The US water market remains tough, with municipalities postponing projects. We do not expect organic growth to return this year and also see a challenging 2012 ahead. Rest of the World will this time not be large enough to compensate. We do expect margins to recover though on the back of the integration of Malcolm Pirnie’s back office, and an easy comparison basis due to accidental losses over 2010.
Environment –An economic downturn could somewhat defer the announcement of new orders but the division should continue to perform strongly with a well-filled order book and a supportive pipeline. Most environment contracts run over an extended period and are difficult to cancel.
Buildings – The mix of buildings is different to the previous crisis, with RTKL (~50% of revenues) deriving the bulk of its orders from new markets (Middle East, Asia). While the UK and NL remain somewhat challenging, France and Belgium are strong in niche markets like healthcare, datacenters etc. These orders are usually backed by the private sector.
Conclusion:
After the downgrading of our forecasts, our DCF now points to a value of € 16.5/sh, which we set as our new TP (from € 18/sh). At the current share price this leaves 25% upside. In the event of another downturn similar to that of 2008-2011, we believe Arcadis is less protected since governments are now at the root of the problem. But with a well-filled Environment order book, higher emerging market exposure and lessons learned from the previous crisis, Arcadis should be well prepared. Accumulate.