Stantec Inc. (NYSE:STN) Q1 2024 Earnings Call Transcript

Stantec Inc. (NYSE:STN) Q1 2024 Earnings Call Transcript May 11, 2024

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Operator: Good day, ladies and gentlemen, and welcome to Stantec’s First Quarter 2024 Results Webcast and Conference Call. Leading the call today are Gord Johnston, President and Chief Executive Officer; and Theresa Jang, Executive Vice President and Chief Financial Officer. Stantec invites those dialing in to view the slide presentation, which is available in the Investors section at stantec.com. Today’s call is also webcast. Please be advised that if you have dialed in while also viewing the webcast, you should mute your computer, as there is a delay between the call and the webcast. All information provided during this conference call is subject to the forward-looking statements qualification set out on Slide 2 detailed in Stantec’s Management’s Discussion and Analysis and incorporated in full for the purpose of today’s call.

Unless otherwise noted, dollar amounts discussed in today’s call are expressed in Canadian dollars and are generally rounded. With that, I’m pleased to turn the call over to Mr. Gord Johnston.

Gord Johnston: Good morning. Thank you for joining us today. Stantec is off to a great start for the year. Momentum continues to build on the favorable market trends that have emerged over the past 2 years. We continue to see strong demand in major projects in water security and water treatment. With the recently announced EPA regulations on PFAS, we expect this area to grow significantly. Stantec has been on the leading edge of PFAS work for several years with multiple contracts underway in data analysis, treatment piloting, site remediation and full scale system design, and we have several PFAS treatment systems that are fully operational. We also continue to see great demand for energy transition and climate solutions, including strengthening of electrical grids and for environmental services.

Aging infrastructure continues to drive significant needs, either for the repair or replacement of roads, bridges, railways and transit. With approximately $400 billion of IIJA funding now distributed, investment towards addressing these needs is spurring growth. And the ongoing push to restore productive capacity continues to drive significant work in advanced manufacturing, data centers and other mission-critical facilities in all of our key markets. Our solid first quarter results reflect our ability to capitalize on this robust market demand and to deliver strong operational performance. We are also successfully executing on our plans to grow through strategic and disciplined M&A. In the first quarter, we closed our acquisitions of ZETCON and Morrison Hershfield.

And it’s been very gratifying to see that since joining Stantec, both companies have continued to attract new employees as both firms have grown their head count by over 5% organically. And on May 1, we announced that we acquired Hydrock, a 950-person firm headquartered in Bristol, England. With 22 locations across the U.K., Hydrock provides integrated engineering design and energy and sustainability consultancy services. They offer solutions to major infrastructure projects and landmark buildings across a number of attractive sectors, including health care, energy, education, logistics and distribution, and the public sector. Hydrock is a great strategic fit for Stantec. It grows our presence in the U.K. by more than 30% and provides us with a highly complementary line of services and expertise that bolsters our U.K. service offerings.

Combined with ZETCON and Morrison Hershfield, we’ve added over 2,700 people to the Stantec’s team in the first 4 months of 2024. This, in conjunction with our Q1 performance, sets us up very well in progressing towards our 3-year targets. This brings me to our Q1 results. We achieved record net revenue for the quarter, up 12% year-over-year with 7% organic and 6% acquisition growth. We continue to see high demand for Water in all of our regions, delivering 16% organic growth. Buildings also delivered double-digit organic growth this quarter. Adjusted EBITDA increased to $212 million with a margin of 15.5%. And as a result, we delivered a 23% increase in adjusted EPS of $0.90. Our U.S. business continues to perform extremely well, delivering a 14% increase in net revenue for the quarter, including 10% organic growth and 4% acquisition growth.

We achieved organic growth in every one of our business units. Our Water business delivered over 20% organic growth. The key drivers included industrial and major water security projects like the city of Joliet alternative water source program. Our health care expertise in hospital structures, medical technology and service delivery models drove double-digit organic growth in our Buildings business, along with strong demand for industrial projects, particularly in data centers and other mission-critical facilities. Infrastructure also had a solid quarter with heavy activity in major transit, rail and roadway projects, reflecting the beginning of the ramp up of projects funded by the IIJA. In Canada, we increased net revenue by 7% with 6% acquisition growth from Morrison Hershfield and 1% organic growth.

Our Water business delivered double-digit organic growth as activity on major wastewater projects remained high. Infrastructure also delivered double-digit organic growth on the strength of several roadway projects across the country. And education and civic projects drove organic growth in Buildings. Energy & Resources retracted this quarter as several significant projects wound down late in 2023, and we experienced delays in the ramp up of new projects. We are beginning to see these new projects moving towards commencement, and we have successfully added new contracts to our backlog. And so we are confident that E&R will shift towards organic growth later this year. Our global operations generated 11% net revenue growth with an 8% increase from ZETCON and 5% organic growth.

Our Water, Building and Environmental Services business units all delivered double-digit organic growth. Our industry-leading Water business delivered strong results across the U.K., New Zealand and Australia through long-term framework agreements and public sector investment in water infrastructure. Buildings achieved over 20% organic growth with high levels of activity in every major region. Growth was most pronounced in the Middle East, where we are the lead designer of the Hamdan Bin Rashid Cancer Center in Dubai. Buildings also started to work on the ₤4 billion Agratas battery manufacturing facility in the U.K. And the strong performance from Environmental Services was driven by European energy transition projects. Infrastructure net revenue retracted this quarter due in part to the Australian government’s decision to delay or cancel certain transportation projects.

And now I’ll turn the call over to Theresa to review our financial results in more detail.

Theresa Jang: Thank you, Gord. Good morning, everyone. We delivered a very solid quarter of performance in Q1 with record net revenue, enhanced project margin and disciplined cost management. In Q1, we generated gross revenue of $1.7 billion and net revenue of $1.4 billion, both of which were up 12% compared to Q1 ’23. Project margin increased 50 basis points due to our continued discipline in project execution, our ability to raise rates on certain projects to mitigate the impacts of wage inflation and increased selectivity in project pursuits. This, along with our continued focus on operational efficiency, drove a 90 basis point increase in adjusted EBITDA margin to 15.5%. Diluted EPS for the quarter increased 19% to $0.70, and adjusted diluted EPS was up 23% to $0.90.

Again, this quarter, we saw a meaningful increase in our share price, which requires a revaluation of our long-term incentive plan. Excluding the effect of the LTIP revaluation, our adjusted EBITDA margin would have been 15.9% and Q1 adjusted EPS would have been $0.94. Turning to our liquidity and capital resources. We delivered a strong quarter of cash flow generation in Q1. Operating cash flow increased to $57 million compared to $37 million in Q1 ’23. And DSO was 79 days, below our target of 80 days. Capital return to our shareholders increased as a result of the Board raising the dividend rate and the higher number of common shares outstanding compared to Q1 ’23. And our net debt to adjusted EBITDA ratio was 1.5x, reflecting the funding for ZETCON and Morrison Hershfield, still within our internal leverage range of 1 to 2x.

And now I’ll turn the call back to Gord.

Gord Johnston: Thanks, Theresa. At the end of the first quarter, our backlog stood at a record $7 billion. Our recent acquisitions contributed 7% to our backlog since December 2023 primarily in Infrastructure and Buildings. Backlog increased organically by 3% with growth in Canada and the U.S. predominantly in our Environmental Services and Infrastructure business units. Project wins in Environmental Services translated into solid low double-digit organic growth in our global and U.S. operations. U.S. Infrastructure also had a number of strong wins translating into mid single-digit organic growth. We are seeing strong demand for transit, bridge and highway projects underpinned with funding from the IIJA. The [indiscernible] organic retraction in Global’s backlog reflects in part the drawdown of our U.K. backlog associated with the AMP7 cycle.

And although we have already won over 60% of the AMP8 programs we are pursuing, these contracts are not yet in backlog. In aggregate, our backlog represents 13 months of work, which is 1 month higher than it was at year-end. We continue to hire at near-record pace, and our voluntary turnover remains well below industry average, meaning that we are attracting and retaining the workforce needed to deliver on our growing backlog. Turning now to major projects awarded in Q1. Through our Climate Solutions Strategic Growth initiative, we continue to advance our services and technologies for efficient water use and reuse projects, including a design build project for Arlington County. This $175 million upgrade will enhance the solids handling facilities and incorporate cutting-edge technology to sustainably transform wastewater into a renewable energy source and a nutrient rich soil amendment.

In support of the energy transition, our Energy & Resources team will be providing project management and transmission and distribution engineering to the BC Hydro and Power Authority. This is a 7-year master services agreement valued at $186 million. And in Eastern Canada, also under a 7-year MSA with options to be extended, we will be providing services to Hydro-Quebec for environmental assessments. The last project I’d like to highlight is an exciting win in Australia that underscores our global strength in the water industry. As part of this 4-year project, our Water, Environmental Services and Infrastructure teams will collaborate to assist with the $595 million wastewater system upgrade in Sydney, Australia. This is a prime example of how we are able to leverage our leading expertise in water to broaden the scope of services and bring together our expertise from all disciplines and regions across Stantec.

Looking at the remainder of the year, we are reaffirming our 2024 financial targets, which were provided in February. We expect net revenue growth for the year to be in the range of 11% to 15% and expect organic net revenue growth to be in the mid to high single digits. For U.S. and global, we expect mid to high single-digit organic revenue growth. And in Canada, we are guiding to mid single-digit growth. Acquisition net revenue growth, which will now include a partial year for Hydrock, is expected to be in the mid single digits. Our adjusted EBITDA margin target for the year remains in the range of 16.2% to 17.2%. And finally, we expect our adjusted diluted EPS growth to be in the range of 12% to 16%. We are very confident in being able to achieve these targets given the robust activity we are seeing throughout our regions and the three successful acquisitions we’ve completed so far this year.

And with that, I’ll turn the call back to the operator for questions. Operator?

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Q&A Session

Operator: [Operator Instructions] Our first question or comment comes from the line of Benoit Poirier from Desjardins. Sir, your line is open.

Benoit Poirier: Yes, thank you very much, and congratulation for the strong start of the year. In terms of M&A environment, obviously, quite positive. You’ve been able to add almost 2,700 people so far. So congrats. And obviously, in terms of size, it compares pretty well to Cardno, but is there any main difference when it comes to integrating these different acquisitions versus a big one like Cardno? And could you talk about whether there’s any limit in terms of number of people you could integrate, let’s say, over a year? Thank you.

Theresa Jang: Hi, Benoit. So, as we look at integrating these three different firms, they are all a little bit unique and slightly different from Cardno. So Cardno, we had almost two integrations, one in the U.S., one in Australia. The U.S. business, of course, very mature and lots of expertise around to — contribute to getting that information accomplished. Australia was a little bit farther afield, but still had development, a pretty good ability to integrate there. But you’ll recall, there was some disruption. It was challenging just given its overall size. We look at these three acquisitions we just completed. ZETCON does — is a little bit different from other firms we’ve acquired because it is our only presence in Germany.

And so between language differences, they use German GAAP at ZETCON. We, of course, report under IFRS. And so the transition will take a little bit longer. And we are not looking to move as fast to bring them on to Oracle because they are only present in Germany. Morrison Hershfield in Canada, again, great depth here, more presence here. And so I think that is a process that is already underway, and we would look to complete that financial integration in the second half of this year. And then Hydrock, it’s pretty early days for Hydrock as we start mapping out what that integration could look like. So I think these things are always complicated. They always create a little bit of noise, particularly in the acquiring firm. But I think we have a pretty great track record of getting through that quickly and then moving towards sort of that holistic value creation that we can achieve from our acquisitions.

Benoit Poirier: Okay. And is there any reason, Theresa, where — why you did not adjust yet the guidance this year in light of the solid start, but also the fact that you just completed the Hydrock acquisition?

Theresa Jang: Yes. I mean, I think the range for guidance is appropriate. We are off to a strong start to the year. But as we look out to the rest of the year, there’s always puts and takes in various corners of our business that we consider. And I think at the beginning of the year, we want to make sure that we’ve got a latitude to adapt if things unfold either more quickly or more slowly than we’ve seen. Hydrock is 8 months of results we’ll have. And as we just talked about, we are going to be moving into integration of — at varying paces, though, of three firms. So that’s a pretty high degree of difficulty that we’ve set for ourselves. We are confident that we are going to be successful in getting these firms integrated and creating value.

But I think it’s early in the year. We want to make sure that we are focused on integrating and getting these firms aligned within Stantec’s practices and driving towards those revenue synergies and not overly concerned about how that first stub period performance looks for the year.

Benoit Poirier: Okay. And last one for me on the Water side. Obviously, a great achievement so far Q1, organic growth 16%. Great opening remarks also about all the awards that are not yet in the backlog with respect to the AMP8 program. So could you maybe talk a little bit about the kind of that quantify the opportunities that could — will be added to the backlog? And I know that over the next 3 years, you’re targeting high single-digit growth. But given the start and the potential around the AMP8, could we even see a low double-digit given the backdrop in the Water segment overall?

Gord Johnston: And — the Water segment, on top of 20% organic growth last year, putting up another 16% in Q1 just shows the strength of that Water franchise we have really around the world. And so we see strength in all of the regions. It could be — in Canada, we are seeing great opportunities from a wastewater perspective, a lot of water work here as well. The U.S., certainly, while it’s already very robust with most municipal and advanced manufacturing facilities, we see considerable growth opportunities in the PFAS space there as well. And then outside of North America, we’ve talked about the — just the strength as we come into the AMP8 program and the framework agreements in Australia and New Zealand. So we feel very, very strong and positive about our Water franchise moving forward.

But that said, it’s one component of the overall diversified profile that we have. And so while we do see opportunities for continued organic growth going forward, I think we — at this point, we are not looking to change that guidance from that 7% organic growth CAGR for the next 3 years. And as things evolve, as we move into budgeting and guidance for next year and the following year, then perhaps we’ll make an adjustment, if required, but we’re not looking to do so at this point.

Benoit Poirier: Perfect. So congrats, and thanks for the time.

Gord Johnston: Thanks, Benoit.

Operator: Thank you. Our next question or comment comes from the line of Devin Dodge from BMO Capital Markets. Mr. Dodge, your line is now open.

Devin Dodge: Yes. Thanks. Good morning.

Gord Johnston: Good morning.

Devin Dodge: So I asked one of your competitors a similar question earlier, but I wanted to give you a chance to address it as well. So, look, the demand environment is clearly strong across a lot of your regions. You talked about this. But how do you think about the balance between pursuing the growth opportunities that are available but requires a lot of effort to expand the workforce with being more selective in your bidding activity to drive margin expansion?

Gord Johnston: Yes. So that’s actually a good question. But I think we are really in a unique environment right now. At Stantec, we are focusing on both. So we are absolutely being more selective in both our project and our client selection. And you can see that in the strong project margins that we’ve been delivering. And actually, last year in December, when we rolled our 3-year strategic plan and targets, we increased the top end of our project margin guidance range previously from 53% to 55% to now 53% to 56%. So we see that client selection that being more discriminating, only taking the higher margin projects, being very, very successful. We’ve also talked to our project managers about if you have a client that is particularly problematic and that they pay slow, they don’t want to give change orders for changes in work, they’re litigious, this is the time in the evolution of our overall company and the industry to not work for those clients and instead expend your energy on positive clients with good projects and good project margins.

So we are absolutely increasing the selectivity of the projects and clients that we’re working on. But in the same way, you’ve heard us say and very accurate that we have one of the lowest voluntary turnover rates in the industry and one of the highest attraction of new staff. So we are growing our head count both by retaining existing staff and attracting new so that we can also take on that higher volume of work and grow organically because of that. So I think there’s — while it’s an excellent question, we are focusing on both the focus on clients and projects and on the growth component.

Devin Dodge: That was excellent. Good color. Thanks for that. Second question, look, the double-digit organic growth in the building sector, I thought, was interesting. You went through some of the major projects in your prepared remarks. But what are some of the subsectors that are driving that strong growth?

Gord Johnston: So a couple in particular. Health care is very, very strong for us. And so we are continuing to ramp up over the past number of years on that. So we talked about the cancer center in Dubai. We’ve also been awarded the design of the first proton therapy treatment center in Canada because we have a particular expertise from that perspective. We are seeing a lot of growth also in data centers. Now we were strong in data centers before. But then when ESD joined us, we’ve got even stronger. And then with the Morrison Hershfield team joining us, we are even stronger again. So we see a lot of growth in that data centers, mission-critical facilities, and health care in particular, as two areas that are very, very strong.

And then, of course, on top of that is our focus on advanced manufacturing. And so we’ve talked about the Agratas battery facility. We’ve talked previously about the solar panel manufacturing facilities. So there’s just an enormous amount of work out there that’s really driving solid growth in our buildings business.

Devin Dodge: Great. Thanks for that. I will turn it over.

Gord Johnston: Thanks, Devin.

Operator: Thank you. Our next question or comment comes from the line of Jacob Bout from CIBC. Mr. Bout, your line is now open.

Rahul Malhotra: Good morning, Gord and Theresa. This is Rahul on for Jacob.

Gord Johnston: Hey, good morning.

Rahul Malhotra: Good morning. So looking at organic net revenue growth, strong performance in Water and Buildings, but noticed that growth in the Infrastructure business has been creeping higher as well. So with about 40% of that IIJA funds now released, are you seeing that hit the revenue line more meaningfully now? And how should we be thinking about the ramp-up there for the balance of the year?

Gord Johnston: Yes, yes. So we absolutely are starting to see more IIJA projects being awarded. We are starting to generate some revenue there, but we see that ramping up even more towards as the year progresses, so a little bit coming up now. but backlogs are coming up, and we see that work increasing even more in the second half of the year and then holding pretty steady, even growing a little bit, kind of through ’25 through ’28, ’29. So we see now that the ramp up is happening, of course, it always took longer to get going than we — Industry hoped it would. But we are seeing it now ramping up through the second half of the year and then holding at kind of the elevated level for the next 3 to 5 years.

Rahul Malhotra: Right. Okay. That’s helpful. And then maybe just a question on the pace of M&A. So three deals announced so far this year. Do you expect this pace to continue in 2024? Or do you now anticipate taking a bit of a pause to focus on integration? And maybe if you can comment on your overall M&A pipeline, that would be helpful.

Gord Johnston: Great. So the overall M&A pipeline is really full and just continues to strengthen. And so our balance sheet is good. Our ability to integrate is solid. So we don’t see taking a pause at all. So we are, as we always are, actively in different levels of discussion with companies around the world. And so — but we are maintaining our discipline. And so when the right opportunity comes around, we absolutely would pull the trigger and make that happen.

Rahul Malhotra: Great. Appreciate the responses. Thank you. I will turn it over.

Gord Johnston: Thank you.

Operator: Thank you. Our next question or comment comes from the line of Michael Doumet from Scotiabank. Mr. Doumet, your line is now open.

Michael Doumet: Good morning, guys.

Gord Johnston: Good morning.

Michael Doumet: Good morning, Gord. Hi, Theresa. So maybe first question, can you remind us how much of the E&R is in Canada? And just maybe discuss the moving pieces for Canada. And then just maybe as a follow-on to that, I think you laid out in the prepared remarks a comment about returning to organic growth in E&R in the second half of the year. Just wondering if we should assume that maybe Q2 growth there should be a little squishy.

Gord Johnston: Sure. So I’ll start there. So we had really strong growth in E&R in Canada through last year, working on several significant projects, [indiscernible] Trans Mountain and others. And they — a lot of them wrapped up near the end of last year. So we expected, of course, a little bit of revenue retraction from that. But our backlog has really increased in that group over the last period of time. So we do see that coming back in the second half of last year. We are also coming off a really high comp. And when you look at Q1 2023 in E&R, it was a really high comp. So we are seeing that inflation, rising interest rates, slow regulatory approvals, all slowing a little bit of that in Western Canada in particular. But overall, E&R in Canada is less than 5% of the overall net revenue for Stantec.

Michael Doumet: Okay. Very helpful. Thank you. And then, last year the organic hires accounted for about 5% of the increase in the employee base. So you’re nearing or maybe a couple of months away from peak season. How do you think 2024 will trend versus that? And I’m just wondering, how much of the organic hires is in Water, maybe versus the rest of the company?

Gord Johnston: Yes. We are, of course, actively hiring in Water, but we are actively hiring in a number of our other groups as well. Well, Water ramps up a little bit in the summer months. Some of our other groups even ramp up more when you get into the Northern Hemisphere field season, environmental services gets more busy, more people out in the field, a lot of transportation, land development work out. So it always depends a little bit about the types of people you’re hiring has had some seasonality impact as well. So as we said in the prepared remarks, we are at record hiring. We are just a little bit off of kind of the pace where we were last year. So we see really continued strong organic growth from a hiring perspective this year.

And we’ve also seen that labor pressures have come off a little bit. A little easier to hire people than it was a couple of years ago. Salary increased pressure a little bit less than it was a couple of years ago. So we are actually feeling really good about both our ability to retain, of course, and our ability to attract people and then as you’ve seen through our project margin, pass along any salary increases or any pressure we see that way to our clients. The other interesting point just to note is that our Water group has the lowest voluntary turnover rate of any of our business lines. And so while we are actively hiring there, we also do — while we do an incredibly good job of retaining everywhere, it’s even more solid in the Water franchise.

Michael Doumet: Super helpful. Thank you very much.

Gord Johnston: Thanks, Michael.

Operator: Thank you. Our next question or comment comes from the line of Chris Murray from ATB Capital Markets. Mr. Murray, your line is now open.