3 Threats Facing This Engineering Giant

Can Stantec overcome these three threats and become one of the world's 10 top design firms?

Mar 31, 2014 at 6:45PM

In the last installment of our four-part series examining Stantec's (NYSE:STN) strengths, weaknessesopportunities, and threats, or SWOT, we take a close look at three challenges that must be overcome for the company to achieve its goal of becoming one of the world's top 10 design firms. 

Alternate project delivery
Design-build and public private partnership, or P3, are two examples of alternative project delivery, and both are becoming more common. They offer innovative ways to finance large public infrastructure projects during a time when much of North America's infrastructure needs repair and government budgets are strained. However, these two types of project delivery create additional risk for engineering firms like Stantec.

Traditionally, Stantec charges based upon a fee-for-service model -- a very low-risk proposition. However, more clients are demanding alternative project delivery methods that provide greater cost and schedule certainty, but carry additional exposure for engineering firms.

For example, by joining a consortium for an alternative delivery project, an engineering firm must guard against its contractual relationship with the contractor being expanded to include services excluded in their original scope of service. Expanded liability is also a concern. Though engineering firms have traditionally enjoyed protection from third-party claims for economic loss, joining a design-build or P3 team carries the risk of being included as a potential defendant should the owner decide to pursue members of the team, as opposed to the consortium, for damages.

Being selective about which projects to pursue, and creating strong project management expertise, are two steps that Stantec is taking to mitigate risk and maintain project profitability. However, Stantec will be forced to assume additional risk or miss out on significant revenue opportunities as more projects are completed by employing alternative delivery methods.

Lack of geographic diversification
Stantec generated 97% of its 2013 revenue in North America, with the balance being earned by a few international offices. This lack of geographic diversification is clearly a concern.

As goes the North American economy, so goes Stantec. During economic downturns, the ability of both private entities and governments to fund capital projects may decline significantly, hurting Stantec's revenue and profitability. In comparison, Fluor (NYSE:FLR) and AECOM (NYSE:ACM) rely on North America for just 50% and 68% of their global revenue, respectively.

North America has not experienced the pace of growth normally seen after a recession. During the fourth quarter of 2013, the U.S. grew at an annualized rate of 2.4% and Canada at 2.9%. Though both the U.S. and Canadian economies are performing better of late, over the long term it's a near certainty that developing regions of the world will grow more quickly and become a primary revenue driver for design firms like Stantec, Fluor, AECOM and URS (NYSE:URS). Stantec's strength in North America has served it well over its first 60 years, but may become a liability in the future if it does not grow its presence outside of North America.

Lack of public infrastructure spending
Apart from the performance of the broader North American economy, there is a risk that governments may simply shift their spending priorities and invest less in desperately needed infrastructure repair.

Governments across the U.S. are deep in debt. The Congressional Budget Office projects our nation's debt as a percentage of GDP at approximately 73% -- the highest it's been since WWII. Add in government debt at the state and local levels and the figure climbs to 106% of GDP. These figures, however, do not take into account unfunded liabilities that occur due to the difference between expected future government spending and revenue on programs like Social Security and Medicare. According to usdebtclock.org, the federal government's unfunded liability is just over $128 trillion, or an incredible $1.1 million for each taxpayer.

Financially strapped governments and massive unfunded liabilities could very well necessitate a fiscal rebalancing. This could result in government spending less on infrastructure and more on health care and entitlement programs. This is a possibility, and a definite risk to Stantec and other engineering firms that rely on government spending on infrastructure to grow revenue and profits.

Foolish bottom line
Managing risk is nothing new to Stantec. They have successfully done so for the past 60 years, and shareholders have reaped the rewards. The increasing use of alternative project delivery methods, lack of geographic diversification and possibility for lower government spending on infrastructure are just the latest risks this planning, architecture, and engineering company must address to accomplish its goal of becoming one of the top 10 design firms in the world.

In the last article in this series, we will recap Stantec`s strengths, weaknesses, opportunities, and threats, and provide potential investors with a few thoughts on the future of Canada's most successful design firm.

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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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