The U.S. market for engineering, architecture, and construction services is huge -- in excess of $90 billion annually. But with 50,000 firms of all sizes challenging for a piece of the pie, competition is fierce.
Canada's Stantec (STN +1.10%) is one of the largest and most successful firms in this sector. With its stock having risen 47% during 2013, now is the time to ask if it will continue delivering for investors. In four previous articles, we completed an in-depth look at Stantec's strengths, weaknesses, opportunities, and threats. In this final article, we provide a summary of each, and offer some thoughts on whether Stantec's stock deserves a spot on your watch list.
Strengths
Home ice advantage: Stantec's strength in Canada is being successfully leveraged to grow U.S. and international revenue. Part of Stantec's Canadian success is due to its capabilities delivering public private partnership, or P3, projects. Becoming more prevalent in the U.S., a P3 involves companies delivering a public project while taking on substantial financial, technical and operational risk.
Rock solid balance sheet: When competing for very large, complex projects, a successful proponent must have a balance sheet that gives a client confidence. A company's debt-to-capital ratio, a measurement of leverage, is often used to assess financial strength. Stantec's debt-to-capital ratio is just 4.86%, much lower than competitors Fluor (FLR +1.72%) and AECOM (ACM +0.02%).
A model for growth: Stantec has a "three-dimensional" business model -- providing services across multiple geographies, practice disciplines and all phases of a project life cycle. The diversity of their business model provides a natural shock absorber as decreased demand for services in one area of the business is often offset by growth in other areas.
Weaknesses
Bigger is better: Stantec is relatively small in U.S. and international markets. Its U.S. market share is estimated at around 2%. The U.S. represents the biggest growth opportunity for Stantec, but it competes against giants, including Tetra Tech (TTEK +0.79%). When selecting a company to complete a large, and highly visible engineering or architectural project, clients often prefer to work with only the most accomplished design companies.
Acquisition integration: Stantec is skilled at identifying and acquiring firms that complement its business model. However, the value of any acquisition is a function of effective integration. Glassdoor.com, an online tool for job seekers, provides some insights into potential challenges for Stantec. CEO, Bob Gomes, receives an approval rating of 62% with 45% of employees recommending the company to a friend. In comparison, David T. Seaton, Fluor's CEO, enjoys a 90% approval rating.
Rich valuation: Over the past 12 months, Stantec's stock has appreciated nearly 57%. And over the past five years, it's up almost 220%. 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.
Opportunities
International expansion: During its last fiscal year, Stantec's international revenue was just $78 million, or 3% of total revenue. Its international segment may be small, but it's growing fast. Revenue increased by more than 30% in two years, up from just $58.8 million in 2011.
They've got energy: In 2013, 43% of Stantec's revenue came from its Energy and Resources operating unit. Continued global demand for energy and robust oil prices will support strong demand for Stantec's engineering services from large, international clients that need to transport oil and gas.
A falling Canadian dollar: During 2013, Stantec recorded a $26.1 million foreign exchange gain as a result of the Canadian dollar falling in value in relation to the U.S. dollar from $1.01 to $0.94. Stantec does not hedge for this type of foreign exchange risk and earns a tidy little sum when translating its foreign operations into Canadian dollars during times of weakness in its reporting currency.
Threats
Alternate project delivery: In addition to P3, design-build is an example of alternative project delivery and both are becoming more common. They offer innovative ways to finance large public infrastructure projects. However, these two types of project delivery create additional risk for engineering firms like Stantec.
Lack of geographic diversification: Stantec generated 97% of its 2013 revenue in North America. 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 and AECOM rely on North America for just 50% and 68% of global revenue, respectively.
Lack of public infrastructure spending: With local and state governments across the U.S. deep in debt, they may shift their spending priorities and invest less in desperately needed infrastructure repair. A fiscal rebalancing could result in government spending less on infrastructure and more on health care and entitlement programs. This is a credible threat to Stantec, and other engineering firms, that rely on government infrastructure spending to grow revenue and profits.
Foolish bottom line
Like all companies, Stantec has strengths to leverage, weaknesses to manage, opportunities to exploit and threats to address. However, over the past 60 years, it has established an impressive track record of excelling in all of these areas, and delivering marketing beating returns in the process. Stantec is a quality company and its stock should serve investors well over the long term.
