Should Stantec Inc.'s Weaknesses Concern You?

Company size, ability to integrate acquisitions, and high valuation should give investors reason for concern.

Mar 22, 2014 at 10:00AM

In the second of a four part series examining Stantec's strengths, weaknesses, opportunities and threats, or SWOT, we take a close look at the company's weaknesses.

In a previous article, we documented many of Stantec's strengths, including its strong balance sheet, growth-enabling business model and ability to penetrate the U.S. market by leveraging its strength delivering public private partnership, or P3, projects in Canada.

The following three weaknesses are worth deliberation for existing and potential investors alike.

Bigger is better
Stantec dominates its home market of Canada, but is the proverbial "small fish in a big pond" in U.S. and international markets.

The U.S. represents the biggest growth opportunity for Stantec. Unfortunately, it competes against giants, namely AECOM (NYSE:ACM), Fluor (NYSE:FLR), CH2M Hill, and Tetra Tech (NASDAQ:TTEK) -- all ranked in the top 10 for revenue. Stantec ranks 24th and accounts for just 2% of the U.S. market.

When selecting a company to complete a large, and highly visible engineering or architectural project, clients prefer to work with the biggest and most accomplished. Stantec has done a great deal of impressive work in Canada that will need to be fully leverage to grow its share of the U.S. market. However, there will always be clients that only consider U.S. based projects when evaluating a design firm for a high risk, complex project. And that may just slow down Stantec's U.S. growth aspirations.

Acquisition integration
Stantec acquired five companies in 2013, seven in 2012, and five in 2011. Stantec has demonstrated an ability to identify and acquire firms that complement its business model in areas where it may be weak, namely geography, practice area or project delivery phase.

However, the value of an acquisition, particularly within professional services, is a function of how effectively it gets integrated. Existing projects of the target firm are important, but the ability to retain people and their expertise is where the greatest value exists for Stantec. Generating significant, long term value requires the retention of the talent that made the firm worth acquiring in the first place.

Glassdoor.com, an online tool for job seekers and HR recruiters, maintains a growing database of 6 million employee reviews and CEO approval ratings. It provides some insight into the challenges Stantec may face as it integrates newly acquired companies.

Stantec's CEO, Bob Gomes, receives an approval rating of 62% with 45% of employees recommending the company to a friend. Not bad in the broader context, but compared with its direct competitors, Stantec has some work to do. David T. Seaton, Fluor's CEO, enjoys a 90% approval rating. And his company get the endorsement of 83% of employees.

Stantec has approximately 30 firms in its acquisitions pipeline at different stages of discussion. Their ability to fully assimilate these firms, and retain the best talent over the long term, is an area that needs to be monitored by investors as it's key to maintaining their impressive growth trajectory.

Rich valuation
Over the past year, Stantec's stock has appreciated nearly 57%. And over the past five years, it's up almost 220%. Great for existing stockholders, but an area of potential concern for investors considering an initial investment in Stantec.

Today, Stantec's price-to-sales ratio is 1.7, a 53% premium to its five year average. And the company's forward price-to-earnings ratio of 18.8 equates to a 40% premium to its five year average.

Stantec's stock is not cheap by historical standards, but quality companies do go "on sale" from time to time. 

Foolish bottom line
As a relatively small design company with big U.S. ambitions, Stantec will needs to overcome client concerns with their size, excel at integrating acquired firms and grow sales and profitability faster than their share price in order to make their stock more attractive to prospective investors. 

The next article, the third in our four part series, will examine Stantec's opportunities.

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Justin Lacey has no position in any stocks mentioned. The Motley Fool owns shares of Fluor. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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