Stantec Inc.
Note that Stantec has restated its revenue and adjusted earnings for 2018, 2017 and 2016 to exclude its Construction Services Division which it divested in late 2018. It had been purchased as part of a larger acquisition in 2016 and was outside of Stantec’s core business – and proved to be very problematic. I generally don’t like to see restatements. But in this case, I think the restated results graphed here are more useful in thinking about how Stantec’s earnings will grow in future.
The lower GAAP earnings in 2016 to 2018 years were due to some management stumbles regarding the construction services division and should not be entirely forgotten about.
The graph of Stantec’s revenue per share (red line) shows strong and steady growth although somewhat slower in 2017 and 2018 then stronger growth in 2019 — and then a drop with the pandemic. But growth now in the past four quarters was very strong.
Adjusted earnings per share (purple line) shows very strong and steady growth until 2014 after which earnings flattened in 2015 then declined in 2016 mostly due to the energy price recession and then strong growth since then. It is impressive that adjusted earnings rose in 2020 and 2021 despite lower revenue with the pandemic.
The lower GAAP earnings in 2016 through 2018 were caused mostly by problems and write-offs in its 2016-acquired Construction Services division. Those losses and write-offs were quite real and the division has now been sold at a loss. But the adjusted earnings figure is more representative of the continuing operations.
| Stantec Inc. (STN, Toronto and New York) | |
| RESEARCH SUMMARY | |
| Report Author(s): | InvestorsFriend Inc. Analyst(s) |
| Author(s)’ disclosure of share ownership: | Author(s) hold no shares |
| Based on financials from: | Dec ’22 Y.E. |
| Last updated: | March 14, 2023 |
| Share Price At Date of Last Update: | $ 78.44 |
| Currency: | $ Canadian |
| Generic Rating (This rating does not consider the circumstances of any individual investor and is therefore not specific advice for any individual): | (lower) Buy at $78.44 |
| Qualifies as a stock that could be bought with confidence to hold for 20 years? | Yes |
| Has Wonderful Economics? | Yes |
| Has Excellent and Trustworthy Management? | Yes |
| Likely to grow earnings per share at an attractive rate over the next decade? | Yes |
| Positive near-term earnings outlook? | Yes |
| Valuation? | Somewhat Expensive |
| SUMMARY AND RATING: This cell of the report summarizes information from the cells below. Looking at the graph, (and focusing on adjusted earnings) Stantec has a good history of earnings per share growth. The Value ratios at this time would support a Weak Buy to (lower) Buy rating due to the high P/E ratio. Stantec has reasonably good industry characteristics and economics and does well on Buffett’s tenets. Management of Stantec has historically been excellent with very few stumbles. The macro environment is strong with government infrastructure spending. The near-term outlook is for strong earnings growth in 2023 although a possible recession could lower expectations. The insider trading signal is neutral. The balance sheet is reasonably strong with reasonable debt which leaves Stantec well positioned to pursue acquisitions. Overall, we rate Stantec a (lower) Buy. It is a good company to accumulate on dips. | |
| MACRO ENVIRONMENT: Stantec’s management indicates that the macro environment is quite strong as they are benefiting from the U.S. Infrastructure and Jobs Act, the Inflation Reduction Act and the CHIPS and Science Act as well as high levels of activity in its UK water business. Stantec has a heavy exposure to government infrastructure work. | |
| LONG TERM VALUE CREATION: (Updated March 2023) The share price has risen to about $78 from under $1 at its IPO in 1994. Therefore, Stantec has a very strong history of value creation. | |
| DESCRIPTION OF BUSINESS: (Updated Q1 2022) A now global professional consulting services consulting firm in engineering, architecture and related. Operates on a fee for consulting service basis. Notably it does take cost over-run risks on a significant number of its contracts. Has about 25,000 employees operating out of about 400 locations in North America and globally (primarily the U.K, Australia and New Zealand but also South and central America, Europe and the Middle East). Head office, in Edmonton integrates the far-flung offices through centralized computer and finance systems. We are not clear as the extent that the individual offices operate independently versus controlled more centrally. In 2021 50% of revenues were from the U.S., 29% from Canada, and 21% from U.K. Australia and other international. For many years, Stantec has very successfully pursued a business model of growth by acquisition (plus organic growth). It provides consulting services over the full life cycle of projects, planning, design, construction, maintenance and decommissioning. Stantec believes that its work advances the quality of life in communities across the globe. The company notes its diversification: It works on tens of thousands of projects for thousands of clients in hundreds of locations. | |
| ECONOMICS OF THE BUSINESS: The economics of the business have historically been very good. It is employee intensive and not capital intensive. The necessity to finance substantial working capital is directionally a negative aspect of its economics. The net profit on sales was recently about 6.1%. The adjusted ROE is calculated as 16.2% which is very good. While it does face competition it appears to have significant customer loyalty. This is likely due to the fact that selecting the cheapest consulting engineering firm for a major project would be a false economy for its clients. Its economics include high operating leverage in that a small change in the percentage of professional hours which are billable or a small percentage decline in admin and marketing costs can lead to a large change in profits. | |
| RISKS: Higher interest rates are an emerging risk to profits but they have locked in a material portion of their debt at lower rates. Tends to be cyclic with sales related to industrial activity including oil and gas related and to commercial and residential building and to government infrastructure spending. Engineering design involves risks that are difficult or impossible to quantify in advance and therefore may not be entirely covered by insurance. Accounts Receivable are relatively high, (which they indicate is normal in this industry) and represent a risk of loss. There is a risk that if operating costs such as wages increased only moderately, there could be a much larger impact on profits compared to most companies. But the company may have an ability to control this through adjusting bonus pay which is a significant percentage of the pay-roll and also by reducing headcount if needed. A few years ago the company seemed to mention competitive pricing pressures much more prominently than in the past but this was not much mentioned in the 2022 annual report. See also annual report for more risks. | |
| INSIDER TRADING / INSIDER HOLDING: (Based on March 1, 2022 to March 15, 2023). The insider trading signal is neutral. Insiders receive shares regularly as compensation and there has not been too much selling although a former CEO has been selling regularly. About 15 insiders did exercise shoe share rights for cash all on the same day June 24, 2022. Stantec itself has been buying back shares regularly. | |
| WARREN BUFFETT’s CRITERIA: Buffett indicates that all investments must pass four key tests: the business is simple to understand and therefore its earnings are predictable (pass, it has far-flung operations but the business seems relatively simple) Has favorable long-term economics due to cost advantages or superior brand power (marginal pass due to scale and reputation offset by the presence of many competitors), apparently able and trustworthy management (pass based on track record), a sensible price – below its intrinsic value (pass or marginal pass), Other criteria that Buffett appears to use include: a low debt ratio (pass with debt at 57% of book equity), proven profit history (pass) little chance of permanent loss of the investors capital (marginal pass due to large goodwill) a low level of maintenance type capital spending required to maintain existing operations excluding growth (pass). | |
| MOST RECENT EARNINGS TREND: The adjusted earnings per share growth in the past four quarters beginning with Q4 2022 and going back was 44%, 19%, 33%, and 22%. In the same four quarters starting with Q4 2022 and going back, revenue per share increased 29%, 27%, 22% and 21%. Overall the recent revenue and earnings trend is very positive. In 2022 overall, adjusted earnings per share were up 29% while revenues per share were up 25%. In 2021 adjusted earnings were up 25% despite that revenues per share were down 3%. In 2020 adjusted earnings were up 10% despite the pandemic with revenues down 2%. In 2019, adjusted earnings per share were up 11%. In 2018 overall the adjusted earnings per share were up 5.5% (excluding Construction Services) and revenue per share was up 7%. | |
| INDUSTRY SPECIFIC STATISTICS: | |
| Earnings Growth Scenario and Justifiable P/E: This stock with a 1.0 yield (25% earnings payout ratio) can justify a P/E of about 25 if earnings are assumed to grow at 10% for ten years followed by 4% growth with a 50% pay-out for the longer term. This is based on the investor earning 7.0%. | |
| VALUE AND GROWTH RATIOS: Analysed at a price of CAN $78.44 and US $57.50. The price to book value ratio is ostensibly high at 3.8. But this may not have much meaning given that this is not an asset intensive business and given that there is very substantial purchased goodwill on the books and so investors are paying for intangibles here and earnings power, not hard assets. The adjusted P/E, in isolation, appears unattractively high at 25. Adjusted Return on Equity is very good at 16%. The dividend yield is modest at 1.0% (the payout ratio amounts to just 25% of trailing adjusted earnings). Five calendar year compounded growth in adjusted earnings per share is strong at 13%. 5 year compounded growth in revenues per share is reasonably strong at 5%. Calculated intrinsic value per share, based on earnings growth is calculated as $55 to $76 using a five year assumed annual average growth rate of 8% to 10% and assuming the P/E declines to 16 in the first scenario or 20 in the higher scenario. The assumption so such a large decline in the P/E ratio may be quite conservative. These ratios demonstrate a very high quality company which however seems somewhat expensive and would support a rating of Weak Buy to (lower) Buy. | |
| TAXATION FOR INVESTORS: Nothing unusual | |
| SUPPORTING RESEARCH AND ANALYSIS | |
| Symbol and Exchange: | STN, Toronto |
| Currency: | $ Canadian |
| Contact: | ir@stantec.com |
| Web-site: | www.stantec.com |
| INCOME AND PRICE / EARNINGS RATIO ANALYSIS | |
| Latest four quarters annual sales $ millions: | $5,677.2 |
| Latest four quarters annual earnings $ millions: | $247.0 |
| P/E ratio based on latest four quarters earnings: | 35.3 |
| Latest four quarters annual earnings, adjusted, $ millions: | $347.1 |
| BASIS OR SOURCE OF ADJUSTED EARNINGS: Uses management’s figure for adjusted net income from continuing operations. Added back an unusual compensation charge caused by the stock price increase in 2021. Added back goodwill write downs in 2008, 2009, 2011, 2017 and 2018. In Q4 2017 and Q2 2018 added back half of some unusual construction services expenses and starting Q1 2018 adjusted to remove unrealized gains / losses on investments. In 2019 restated 2017 and 2018 per management’s figures to use adjusted net income from continuing operations. | |
| Quality of Earnings Measurement and Persistence: Probably reliable, no issues with large estimated items such as depreciation. The company has (through 2022) been profitable for 69 straight years since inception! Earnings have risen persistently through acquisitions and organic growth. However earnings do tend to be cyclical to some degree and, on a GAAP basis, declined in 2016, 2017 and 2018. On an adjusted basis, earnings rose in 2017 and rose moderately in 2018, 2019 and 2020 and rose strongly in 2021 and very strongly in 2022. | |
| P/E ratio based on latest four quarters earnings, adjusted | 25.1 |
| Latest fiscal year annual earnings: | $247.0 |
| P/E ratio based on latest fiscal year earnings: | 35.3 |
| Fiscal earnings adjusted: | $347.1 |
| P/E ratio for fiscal earnings adjusted: | 25.1 |
| Latest four quarters profit as percent of sales | 6.1% |
| Dividend Yield: | 1.0% |
| Price / Sales Ratio | 1.54 |
| BALANCE SHEET ITEMS | |
| Price to (diluted) book value ratio: | 3.80 |
| Balance Sheet: (It’s always good to understand what share owners get for their money in terms of assets and liabilities.) As of Q1, 2022, Assets are comprised as follows: 6% cash, 30% other current assets (largely trade receivables and unbilled revenue), 48% goodwill and equivalent, 5% property and equipment and software, 9% capitalized leases, 4% other assets. The high level of goodwill is notable. But the recent approximately 14% ROE (and historically somewhat higher) suggests that this goodwill although intangible has real value above the amount paid to acquire it. On the other side of the balance sheet these assets are supported as follows: 21% by current working capital liabilities (which leaves Stantec investors to fund a large investment in working capital) , 25% by debt, 10% by long-term capitalized lease liabilities (more than offsetting the lease assets) 1% by deferred tax liabilities, 2% by provisions for external legal claims, 1% pension liability and 38% by common equity. Despite the substantial goodwill this is a strong balance sheet with a reasonable modest debt level. | |
| Quality of Net Assets and Book Value Measurement: The value of the assets is not particularly important because this company is valued for its earnings and if earnings were to evaporate, the assets would provide little protection. The assets are mostly purchased goodwill and working capital. The relatively high ROE suggests that the assets have excellent value. Past write-offs of goodwill appear to have been driven by declines (that proved temporary) in market prices of Stantec shares and similar companies and do not appear to suggest that the future earnings would not have supported the goodwill. An exception to this, was recent write-offs and losses related to Construction Services a few years ago. Those were real losses. In summary, the book value per share is solid under the “going concern” assumption. | |
| Number of Diluted common shares in millions: | 110.8 |
| Controlling Shareholder: It appears that no one owns more than 10% | |
| Market Equity Capitalization (Value) $ millions: | $8,691.2 |
| Percentage of assets supported by common equity: (remainder is debt or other liabilities) | 40.4% |
| Interest-bearing debt as a percentage of common equity | 57% |
| Current assets / current liabilities: | 1.4 |
| Liquidity and capital structure: The debt level was recently about 57% of the book equity amount. Overall its liquidity and capital structure seem strong. | |
| RETURN ON EQUITY AND ON MARKET VALUE | |
| Latest four quarters adjusted (if applicable) net income return on average equity: | 16.2% |
| Latest fiscal year adjusted (if applicable) net income return on average equity: | 16.2% |
| Adjusted (if applicable) latest four quarters return on market capitalization: | 4.0% |
| GROWTH RATIOS, OUTLOOK and CALCULATED INTRINSIC VALUE PER SHARE | |
| 5 years compounded growth in sales/share | 7.7% |
| Volatility of sales growth per share: | Strong, steady growth |
| 5 years compounded growth in earnings/share | 21.3% |
| 5 years compounded growth in adjusted earnings per share | 12.7% |
| Volatility of earnings growth: | steady growth |
| Projected current year earnings $millions: | not available |
| Management projected price to earnings ratio: | not available |
| Over the last ten years, has this been a truly excellent company exhibiting strong and steady growth in revenues per share and in (adjusted) earnings per share? | Yes |
| Expected growth in EPS based on adjusted fiscal Return on equity times percent of earnings retained: | 12.2% |
| More conservative estimate of compounded growth in earnings per share over the forecast period: | 7.5% |
| More optimistic estimate of compounded growth in earnings per share over the forecast period: | 10.0% |
| GROWTH OUTLOOK AND AMBITIONS: Stantec is targeting earnings per share growth of 9 to 13% and return on invested capital above 10.5% – which would lead to an ROE in the low to mid teens. | |
| LONG TERM PREDICTABILITY: While nothing in life is certain, Stantec seems likely to be able to continue to grow earnings through acquisitions as it has done for six decades now. And it has a long track record of profitability in all economic conditions. Its long-term predictability seems strong. However the growth is likely to be less than it was historically as it now takes much larger acquisitions to “move the needle”. It also grows organically even without acquisitions. | |
| Estimated present value per share: We calculate $55 if adjusted earnings per share grow for 5 years at 7.5% and the shares are then sold at a lower P/E of 16 and $76 if adjusted earnings per share grow at the more optimistic rate of 10% for 5 years and the shares are then sold at a P/E of 20. The company is now targeting 9 to 13% earnings per share growth. If that occurs then the P/E ratio may not decline much and so the valuation would be higher. This is a valuation calculation and not a share price prediction. These estimates use a 7.0% required rate of return. | |
| ADDITIONAL COMMENTS | |
| INDUSTRY ATTRACTIVENESS: (These comments reflect the industry rather than any particular company.) Michael Porter of Harvard argues that attractive industries are those that are relatively protected from competition based on 5 key tests or forces. Some barriers to entry in terms of reputation and critical mass of knowledge (pass) The industry is not subject to powerful suppliers (pass) or customers (pass) who could usurp the industry profit. The industry has no substitute product (pass) The industry has some reputation for competing on price but this should not be severe as it is not a high fixed cost industry and it would be false economy for clients to use the lowest cost provider to design expensive projects (pass) Overall, the industry seems moderately attractive for a large established incumbent like Stantec. | |
| COMPETITIVE ADVANTAGE: Stantec is becoming a larger player in its regions within its industry. Has acquired a critical mass of knowledge and a certain amount of brand reputation and significant repeat business. Presumably its clients that are happy with its work would be reluctant to take a chance on switching consulting companies. Operates across a range of geographies and practice areas. The company indicates it has high standards with a focus on providing “Stantec’s Sustainable Solutions” and wants to provide environmentally friendly solutions for its customers. Stantec’s practice of acquiring smaller private firms and folding them in has been a good strategy for decades. Private firms often tend to be cheaper than publicly traded firms and so Stantec is adding immediate market value in this fashion. It appears to have developed strong skills in how to have professionals in far flung offices work together. | |
| COMPETITIVE POSITION: Stantec is one of the larger engineering design companies in the world. It’s in the top ten. | |
| RECENT EVENTS: The dividend was increased by 9% in early 2022 and by a further 8% in early 2023. In 2021, Stantec made five acquisitions adding 3200 employees as it continues to grow. It added two small acquisitions in 2022 and now has 26,000 employees. | |
| ACCOUNTING AND DISCLOSURE ISSUES: With the U.S. now being its largest market, Stantec should probably be reporting in U.S. dollars. There is very good disclosure provided in the annual and quarterly reports. The divestiture of Construction Services has resulted in restating past revenue and earnings back to 2016. There are pros and cons to showing the past on a restated basis but overall it provides the best basis for forecasting the future. | |
| COMMON SHARE STRUCTURE USED: Normal common shares, 1 vote per share. | |
| MANAGEMENT QUALITY: Managed is focused on shareholder return and not on growth for growth’s sake. The successful growth of this company over the years has been driven by management ambition and ability. Other Canadian engineering companies could have done this, but most did not. (WSP Global did it even better and far more aggressively in recent years) Management has done what it said it would do by growing the company by acquisition very steadily over the years. Organic growth has also been good. We have a generally high opinion of this management. The company did stumble with the overall integration and management of the very large acquisition it made in 2016 and ultimately divested the problematic Construction services portion of that acquisition. The fact that they grew earnings during the pandemic is impressive. | |
| Capital Allocation Skills: Management has historically exhibited exceptional capital allocation skills. Stantec has increased its value for many years by retaining earnings and allocating that capital to acquisitions upon which it has on average earned ROEs in the order of 18% (although recently somewhat lower). This was a far better use of capital than paying dividends would have been and was a far better use of capital than buying back shares would have been. It did introduce a small dividend some years ago but has wisely kept the earnings payout ratio relatively low. It issued shares for a large acquisition in 2016 at $30.25. In Q2 2017 and in 2018 and in in 2019 it was able to buy back a portion of these shares at a relatively similar price up to $32.50. The wisdom of the large 2016 acquisition now seems questionable since a portion of it (Construction Services) was quite problematic and generated losses before being sold at a loss in Q4 2018. | |
| EXECUTIVE COMPENSATION: (based on figures from Spring 2020) Relatively modest salaries in the $440k to $850k range. Total compensation was $3.5 million for the CEO and ranged from about $1.2 to $1.5 million for the other four named officers. Given the size and profitability of the company the compensation does not seem excessive. | |
| BOARD OF DIRECTORS: (Spring 2020 information circular) There are eight directors including the current CEO and a former CEO. Board members are prestigious and well qualified particularly in accounting and governance. Possibly there should be more engineering experience on the Board. With total director compensation in the $250k range some of them might have difficulty exercising independence if it would put their Board membership at risk. | |
| Basis and Limitations of Analysis: The following applies to all the companies rated. Conclusions are based largely on achieved earnings, balance sheet strength, achieved earnings per share growth trend and industry attractiveness. We undertake a relatively detailed analysis of the published financial statements including growth per share trends and our general view of the industry attractiveness and the company’s growth prospects. Despite this diligence our analysis is subject to limitations including the following examples. We have not met with management or discussed the long term earnings growth prospects with management. We have not reviewed all press releases. We typically have no special expertise or knowledge of the industry. | |
| DISCLAIMER: All stock ratings presented are “generic” in nature and do not take into account the unique circumstances and risk tolerance and risk capacity of any individual. The information presented is not a recommendation for any individual to buy or sell any security. The authors are not registered investment advisors and the information presented is not to be considered investment advice to any individual. The reader should consult a registered investment advisor or registered dealer prior to making any investment decision. For ease of writing style the newsletter and articles are often written in the first person. But, legally speaking, all information and opinions are provided by InvestorsFriend Inc. and not by the authors as individuals. The author(s) of this report may have a position, as disclosed in each report. The authors’ positions may subsequently change without notice. | |
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