|Shares Out. (in M):||140||P/E||0||0|
|Market Cap (in $M):||5,300||P/FCF||0||0|
|Net Debt (in $M):||1,300||EBIT||0||0|
Thesis, Earnings, and Valuation
55-60% of Quanta’s sales are from the engineering and construction of transmission and distribution systems owned by the electric utilities. Quanta builds new facilities and up-grades existing grids. After decades of under-investing in their grids, the electric utilities are starting to materially increase their spending to (1) “harden “ their grids to reduce the chances of wildfires and to increase reliabilities, especially after wind storms, ice storms, and floods; (2) enlarge their grids to areas where windmills and solar installations will produce electricity; and (3) prepare for the large changes that will be required by the expected growth of battery powered vehicles. Last November’s “Camp Fire”, which seems to have been caused by faulty equipment owned by PG&E and which killed 86 individuals and which cost billions of dollars, seems to be a lightening rod that will force, or at least encourage, electric utilities to spend heavily to improve the safety of their grids. Duke Austin, Quanta’s CEO, recently said that “we believe that hardening initiatives for improved resiliency against wildfires are in the very early stages.” He also mentioned that the western utilities are planning for large capital expenditures, “with a significant portion allocated to grid modernization and fire hardening.” Simply, in the next several years, if another serious wildfire is caused by faulty electrical equipment, the utility that owns the equipment will be highly criticized and exposed to large civil (and possible criminal) penalties. For this reason, the electric utilities likely will spend heavily on their grids – and Quanta will benefit. And because utilities often earn a return on capital deployed, the industry is willing to increase investment if they receive fair remuneration.
Quanta’s revenues grew by 18% in 2018. Revenue growth in 2019 likely will be modest because of the timing of projects, but we would fully expect that revenues during 2020 and 2021 period will grow at least in the high single digits.
Quanta’s non-GAAP EPS last year was $2.81 per share. The company’s guidance for 2019 is $3.40-3.86 per share. Quanta’s management likes to under-promise and over-deliver. Our own analysis concludes that 2019 non-GAAP EPS could be at the very high end of the $3.40-$3.86 range. However, 2019’s EPS will benefit from $.30 of earnings that mostly were earned in 2018 (but which could not be recognized until a major project was closed out earlier this year). Excluding the $.30, we estimate that Quanta’s adjusted earnings in 2019 will be around $3.50 per share.
When investing in a company, we look out two years. Over the next two years, we project that Quanta’s EPS should benefit from (1) high single digit organic revenue growth; (2) positive leverage on fixed costs; (3) the ending of start-up costs on a newer business (the installation of fiber optic cable systems); and (4) the usage of free cash flow to repurchase shares or to make acquisitions. All-in-all, we project that non-GAAP EPS could increase at a 16-20% CAGR from an adjusted $3.50 this year to $4.75-5.00 in 2021. And, we emphasize, this growth will be largely independent from the direction of the U.S. economy.
A few notes:
- Non-GAAP EPS is before the amortization of some intangibles that stemmed from acquisitions and is before the cost of some stock-based compensation.
- The margins of the newer fiber optic communications business are expected to improve by 5 margin points. This would add about $50 million to pre-tax earnings and about $.25 per share to EPS after taxes at a 29% effective rate and based on 140 million shares outstanding.
- Quanta has been using its free cash flow to reacquire modest amounts of its stock and to make acquisitions, if any can be made at attractive prices (which has been difficult in recent years). The company’s diluted share count is expected to decline by about 4.5% this year – and we would project that the combination of share repurchases and smaller acquisitions will add at least 4% to the EPS growth rate over the next few years.
On balance, the breakdown of our expected 16-20% EPS growth is:
|Organic revenues growth||7-9%|
|Positive leverage on fixed costs||2-4%|
|Fiber optics margins ($.25 per sh over 2 yrs)||3%|
|Use of free cash flow (mainly repurchases)||4%|
|Total EPS growth rate 16-20%||16-20%|
When valuing Quanta, we consider the following:
- Management, in our strong opinion, is excellent.
- The company is run conservatively.
- The company is the leader in its field and enjoys an excellent reputation.
- Close to 90% of the projects are smaller jobs that entail less risk of engineering problems or cost over-runs.
- Long-term organic growth potential seems well above average.
- We believe that the cost of the stock-based compensation (which may be as high as $.35 per share in two years) should be considered when valuing the company.
All things considered, our 2021 valuation is 16 X our projected EPS of $4.75-5.00, or $76-80. Were it not for the stock-based compensation, we would have valued the company at 17 X.
There are only a few other engineering and construction companies that concentrate on smaller projects and therefore are comparable to Quanta. Jacobs Engineering’s shares currently are selling at about $77, or 16.5 X projected 2019 EPS of $4.65. MasTec, a smaller company with revenues of about $7 billion, is selling at only about 11.5 X projected 2019 EPS, but its balance sheet is not nearly as strong as Quanta’s – and we favor strong balance sheets.
The company was founded in 1997 by John Colson, who in 1971, took a “temporary” job with Par Electric Company (which built transmission lines, distribution lines, and substations for electrical utility companies). Starting at a low position, Colson worked his way up the company, becoming Par’s president in 1991. About the time he became president, Colson purchased control of Par, which was still a small company with about $30 million of revenues. In 1997, Colson merged Par with three other companies to form Quanta.
Colson wanted to grow Quanta through acquisitions. To do this, he needed an equity currency. In February of 1998, he brought the company public at $9 per share. Over the years, many acquisitions were made as Colson tried to roll up the business. A few of the larger acquisitions were:
- 2007 InfraSource in an all stock deal
- 2009 Price Gregory (gas pipeline construction) for $350 million.
- 2010 Vatard (electrical power line constructors in Canada) for $219 million
As a result of the Price Gregory acquisition, Quanta became a material competitor in the construction of gas pipelines.
John Colson retired as Chairman in 2011 and from the board in 2013. James O’Neil became CEO in 2011, but only lasted until March of 2016, when he was replaced by Duke Austin. Importantly, while O’Neil came from outside the engineering and construction business, Austin grew up in the business, working for a family firm that was acquired by Quanta. We met Duke Austin several times and are extremely impressed by his apparent skills, passion, ambitions, and conservatism. His appointment as CEO is one reason we are enthusiastic about the future of Quanta’s shares. We believe that management is critical for the success of a company – and we believe that Duke Austin is a gem.
Duke Austin is interested in continuing Quanta’s strategy of adding M&A growth to organic growth – and in July of 2017, Quanta acquired Stronghold, a company that maintains and builds oil and gas downstream facilities. Stronghold, which has revenues of about $600 million and EBIT margins of close to 9%, was acquired for $483 million (plus an earnings contingency payment of up to $100 million).
Currently, Quanta’s revenues break down roughly as follows:
|Engineering and construction services for electric utilities||$6.6 billion||
|Installation of fiber optic systems (a new business)||.5||5|
|Installation of oil and gas pipelines||3.6||32|
|Stronghold (downstream oil and gas projects)||.6||5|
|Projected 2019 revenues||$11.4 billion||100%|
Quanta’s 10-K contains a more detailed description of the company’s services.
After decades of under-investing in their grids, the electric utilities are starting to materially increase their spending to (1) “harden “ their grids to reduce the chances of wildfires and to increase reliabilities, especially after wind storms, ice storms, and floods; (2) enlarge their grids to areas where windmills and solar installations will produce electricity; and (3) prepare for the large changes that will be required by the expected growth of battery powered vehicles. Last November’s “Camp Fire”, which seems to have been caused by faulty equipment owned by PG&E and which killed 86 individuals and which cost billions of dollars, seems to be a lightening rod that will force, or at least encourage, electric utilities to spend heavily to improve the safety of their grids.