Stantec Inc. (NYSE:STN) Q3 2023 Earnings Call Transcript

Stantec Inc. (NYSE:STN) Q3 2023 Earnings Call Transcript November 10, 2023

Operator: Welcome to Stantec’s Third Quarter 2023 Earnings Results, Webcast and Conference Call. Leading the call today are Gord Johnston, President and Chief Executive Officer; and Theresa Jang, Executive Vice President and Financial — Chief Financial Officer. Stantec invites those dialing in to view the slide presentation, which is available in the Investors section at stantec.com. Today’s call is also webcast. Please be advised that if you have dialed in while also viewing the webcast, you should mute your computer as there is a delay between the call and the webcast. All information provided during this conference call is subject to the forward-looking statement qualification set out on Slide 2, detailed in Stantec’s management’s discussion and analysis, and incorporated in full for the purpose of today’s call.

Unless otherwise noted, dollar amounts discussed in today’s call are expressed in Canadian dollars and are generally rounded. With that, I’m pleased to turn the call over to Mr. Gord Johnston.

Gord Johnston: Good morning. Thank you for joining us today. I’m very pleased to report that Stantec has delivered another quarter of record earnings. We continue to see very strong market demand across all of our geographies, with Canada in particular showing remarkable resilience. We met this demand with excellent operational performance, driven by high utilization and augmented by our effective workforce management strategies and strong talent attraction and retention. Organic hiring remains robust. This was the busiest Q3 we’ve ever experienced in terms of hiring. And we are hiring at two times the rate that we were pre-pandemic. And our North American — sorry, and our employee retention rates remain amongst the best in our industry with voluntary turnover in North America returning to pre-pandemic levels.

These were some of the key drivers that led to our Q3 earnings exceeding our expectations. Looking at our financial results, we grew our net revenue by 14% to $1.3 billion, with organic growth of 9%. For the seventh consecutive quarter, each of our regional and business operating units delivered organic growth, with double-digit growth in the U.S. region and in our Water and Environmental Services business segments. We drove significant margin expansion and delivered record-high adjusted EPS of $1.14. On the strength of our performance to date and our expectation of continued favorable tailwinds, we’ve raised our guidance for the second time this year, and I’ll speak a little more about this a little later in the presentation. Our U.S. business delivered a very strong third quarter.

This included net revenue growth of 20% in the quarter, with 13% organic growth and 5% acquisition growth, driven primarily from our acquisition of ESD. We achieved organic growth in each business line with Water, Buildings, and Energy and Resources, all delivering double-digit growth. In particular, our U.S. Water business delivered 26% organic growth, driven by public sector and industrial project demand as well as large-scale water security projects in the Western U.S. We continue to see strong demand in healthcare, industrial, and science and technology end markets for our Buildings business. Within our Energy and Resources business, work continued on the major power grid upgrade project in Puerto Rico, and we’ve started to ramp up on our rare minerals energy transition project in California.

Our Infrastructure and Environmental Services teams also remained very active in the U.S., delivering high levels of growth. In Canada, we delivered over 7% organic net revenue growth with double-digit growth in Environmental Services, Infrastructure, and Water. Environmental Services delivered strong growth on the back of demand for services in permitting and archaeological work in the midstream and transportation sectors. Activity on environmental impact assessments also increased in the renewable energy sector. Infrastructure remained robust, driven by heightened activities around bridge and roadway work in Western Canada. And our expertise on large wastewater infrastructure projects drove growth in Water. Our Global business delivered 6% net revenue growth quarter-over-quarter with 2% organic growth.

Our industry-leading Water business delivered high single-digit organic growth. The teams remained very active in the UK on AMP7 and have also begun assisting clients with their AMP8 program submissions. Work supporting long-term framework agreements and investments in Water infrastructure in New Zealand and Australia also continue to drive growth. Double-digit organic growth was achieved in Energy and Resources. Work on the Coire Glas pumped storage project in the UK continued to ramp up, as did mining activities in Latin America around copper and other metals that will support the energy transition. And now, I’ll turn the call over to Theresa to review our financial results in more detail.

Theresa Jang: Thank you, Gord, and good morning, everyone. As Gord mentioned, our third quarter results exceeded our expectations. Factors that contributed to our outperformance include: stronger-than-anticipated demand in Canada, higher utilization in Canada and the U.S., robust hiring, disciplined cost management, and a higher-than-normal volume of change order approval. Gross revenue was up 15% in the quarter at $1.7 billion, while net revenue grew by 14% to reach $1.3 billion. Project margin increased 70 basis points to 54.8%, benefiting from disciplined project selection and execution. Our strong operational performance drove a 160 basis points increase in our adjusted EBITDA margin. For the quarter, diluted EPS was $0.94 compared to $0.61 in Q3 last year.

And adjusted diluted EPS increased 33% to a record $1.14 compared with $0.86 last year. As has been the case all year, the significant increase in our share price for the year-to-date has resulted in a material increase in our admin and marketing expenses due to the quarterly revaluation of our long-term incentive plan. The impact of revaluing our LTIP was 60 basis points as a percentage of net revenue or $0.05 per share for Q3. Year-to-date, the revaluation was 60 basis points or $0.15 per share. Now, turning to our liquidity and capital resources. We generated $281 million of operating cash flow year-to-date, compared to $95 million over the same period last year. Cash flow this year has benefited from increased revenues and strong operational performance, partially offset by an increase in working capital investment to support growth, higher tax installment payments driven in part by the impact of U.S. Section 174, and higher interest payments.

Last year’s operating cash flow reflected the impact of the Cardno financial system integration. At the end of September, DSO was 83 days, a couple of days higher than the previous quarters. It is fairly typical for DSO to rise in the third quarter due to seasonality. And our net debt to adjusted EBITDA ratio was 1.5 times, well within our internal leverage range of 1 time to 2 times. With that, I’ll turn the call back to Gord.

Gord Johnston: Thanks, Theresa. Backlog in the third quarter remained very strong at $6.4 billion, an increase of 8% from December 2022. Backlog has grown organically by 6% and continues to grow in each of our geographic regions. Backlog growth was most pronounced in Water, which is up 23% organically. Water continues to increase with project wins around water security, wastewater treatment solutions, and water requirements for power generation to support the energy transition. And of course, with AMP7 still underway, we continue to add to our backlog as new task orders are issued. We’ve also started to secure backlog for AMP8 with Northumbrian Water announced earlier this year, and South West Water, which was just announced this week.

Buildings backlog saw solid organic growth. Buildings has captured wins in all of their sub-sectors, the majority of which continues to be in healthcare, civic, industrial, and science and technology. Buildings is also benefiting from backlog brought in through the position of ESD, which primarily relates to data centers and mission-critical facilities. Environmental Services backlog reflects additional project wins related to environmental assessments, including natural resource service — surveys, regulatory permitting, and environmental monitoring for construction projects. While difficult to precisely quantify, we do know that our backlog includes projects that are backed with IIJA and IRA funding. Our backlog represents approximately 12 months of work.

Providing reliable water supply requires investment in water management and water infrastructure, and we’re proud to partner with clients around the world to get water to where it’s needed. Recently, we announced that we were awarded a continuation of our contract with Tampa Bay Water for the final design and construction management of a new water supply pipeline. We’ve been working with Tampa Bay Water since 2009 to help meet the growing demand for potable water. Stantec has been appointed as a civil engineering design consultant for extensive upgrades to Belfast Wastewater Treatment Works, the largest wastewater treatment plant in Northern Ireland. We look forward to working with the integrated partners to provide cutting-edge innovations for flood mitigation, doubling the capacity of the plant, and improving the water quality for the community.

We continue to provide our expertise for energy transition projects. As the primary environmental consultant for the recently announced Community Offshore Wind project, we will develop a construction plan and assist with permitting along with other consultant services. This project has the potential to provide power for over 1 million homes in New York and New Jersey. Looking towards the remainder of this year, we expect to drive towards a strong finish. We’ve raised our guidance again for the full year as a result of our strong third quarter results. Activity remains robust in the fourth quarter, taking to account its typical seasonality. We’ve raised our net revenue growth target for the year to 12% to 14% and expect organic revenue growth to be in the high single-digits.

In the U.S., we expect low double-digit organic revenue growth. In Global, we expect mid to high single-digit organic growth. In Canada, we’re raising our guidance to mid to high single-digit growth. We’re also increasing our EBITDA margin target for the year in the range of 16.7% to 17.1%. And finally, we’re raising our guidance for adjusted diluted EPS growth to 22% to 25%, which reflects the remarkable operating leverage we’ve been able to achieve so far this year. While the targets I’ve just spoken to you exclude the impact of our long-term incentive plan revaluation, we’ve also included the targets with the expected impact, which is how they will be reported in our financials. You can view these on Slide 13 of our Q3 presentation and in our earnings news release.

Looking beyond 2023, we remain very confident that our diverse business model and engaged workforce are ideally positioned to continue creating industry-leading results. We continue to closely monitor projects in our backlog for indications of a recession or economic slowdown, but our backlog remains solid. We’re not seeing any significant delays or cancellations. As well, bid activity remains very robust. In developing our upcoming new three-year strategic plan, we’ve been doing a deep dive across all areas of our business, and I can say that we remain very optimistic and excited about the future. We look forward to sharing our vision for the next chapter of our journey on December 5th when we announce our new plan, and we hope that you’ll be able to join us.

And with that, I’ll turn the call back to the operator for questions. Operator?

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Q&A Session

Operator: Thank you. [Operator Instructions] And our first question comes from the line of Benoit Poirier with Desjardins. Your line is open. Please go ahead.

Benoit Poirier: Yes. Good morning, everyone, and congratulations for the outstanding results. Looking at the EBITDA margin, 18.3% in the quarter, very impressive. I was just wondering about what were the main drivers behind this strong performance. And it looks like that this is the biggest margin you’ve post in recent history despite the LTIP impact. So — and it looks like that it implies a much weaker margin in Q4. So, any thoughts about what drove the performance and the implication for Q4? Thank you.

Theresa Jang: Sure. Hi, Benoit. So, you’re right, we had a very, very strong quarter from an EBITDA margin perspective, and really reflective throughout our financial results. And so, as you — I’m an accountant, so I think of things as you roll your way through the P&L, and it really starts with the quality of our revenue, our ability to execute well, that has driven a stronger project margin. And as we work through to our EBITDA, the primary driver, as I’ve always said, is our ability to maintain high utilization. And so that compounding effect of high utilization that’s driving higher absolute dollars, it means that you have a lower proportion of your workforce that is not utilized and sort of dropping those costs into the unrecoverable line or our admin labor.

It also means that there’s been a little less time for folks to spend time on marketing and business development, not to the degree to which we would neglect that, of course, but it just means in real time that there is a focus on addressing current projects and getting that work accomplished. And we combine that with, again, a continued focus and discipline on our spending, and we have seen a rise in the use and the hiring in our high-value centers, in Pune, in particular. So it’s really, I think, a matter of doing all the things that we’re supposed to be doing all at the same time and driving to a really strong result. As we look towards the fourth quarter, it does typically moderate and that is our expectation. It tends to be a little bit slower, so utilization is not as high because of weather-related reasons, field season is largely over in colder climates, it’s a busier holiday season.

And we do expect and want people to take time off to refresh, to take their vacation time as we work into the fourth quarter. And so that is fairly typical and that is why you’d see that fourth quarter EBITDA margin as well — is expected to come down.

Benoit Poirier: Okay, that’s great color, Theresa. And just looking at your organic backlog, it’s declined 4% quarter-over-quarter, was mostly driven by the U.S. and Canada. Is this mostly due to project timing and the confirmation of funding flow from government infrastructure programs? And on a high level, what are you seeing on your hand in terms of speed for funding coming out?

Theresa Jang: Yeah, so maybe I’ll address the first piece and Gord can talk about the timing of funding. But part of what you described is what drove the drawdown of backlog from Q2 to Q3. It was in Canada and the U.S., and again, that correlates directly with the outperformance of organic revenue growth. And it means that we drew down that backlog faster, we were busier, and again, that’s reflected in the revenue growth. So, it’s not a trend that we would find concerning at all. I think it is just sort of the advancement of what you typically see in the back half, usually more in the fourth quarter. But activity level remains very high on the bidding front. And as you referenced, the timing within which we actually have everything completed so that we can record it in backlog, it’s a snapshot in time. So, we’re confident that backlog remains very solid and has a great trajectory.

Gord Johnston: Yeah, completely agree. We’re not concerned with that reduction in backlog on a quarterly basis, Benoit. But on the timing, we are seeing that some funding starting to flow. It’s always — we’ve been talking about this IIJA now for a couple of years, and it’s always — we’ve been optimistic as an industry that it’s this quarter, the next quarter, this half, the next half, but we are seeing that those — about 23% of the IIJA funds have been dispersed. We’re getting ready for the ’24 allocations now. So that’s starting to hit the street now. So, I think that’s only going to continue to strengthen. The interesting thing is that when you look at our strong performance year-to-date, that’s been without really any of the funding from IIJA or some of those other things. So that’s, I think, just going to further strengthen as we move into ’24 and the years beyond.

Benoit Poirier: Okay. So, thank you very much, and looking forward to seeing you in Boston on December 5th. Thanks.

Gord Johnston: Thank you.

Operator: Thank you. And one moment as we move on to our next question. And our next question is going to come from the line of Michael Doumet with Scotiabank. Your line is open. Please go ahead.

Michael Doumet: Hey, good morning, guys.

Gord Johnston: Good morning.

Theresa Jang: Good morning.

Michael Doumet: Good morning. So on the margins, obviously, really good margin expansion in Q2, Q3. A little bit of a follow-up on the last question. But — now you’re exiting Q4 flattish versus the big Q3, Q4 margin expansion — sorry, Q2, Q3 margin expansion, how do we square the moving parts into 2024, given the above-average margin expansion in ’23, but the flattish margin exit?

Theresa Jang: So I think when we look at our margin and we consider it on an as reported basis, so throughout this year, because of the impact of LTIP revaluation, we pulled that piece out so we can identify what our performance has been relative to the baseline we set at the start of the year. But of course, as Gord noted in his remarks, the LTIP impact is in our admin and marketing costs and that does reflect in our EBITDA margin. And so, when we come out of this year, we do expect that the margin will be higher than it was last year. And as we look towards the coming years, we continue to expect to be able to grow that margin, recognizing that if our share price stays where it is and continues to expand that there will continue to be this dynamic of a growing impact on our cost, but notwithstanding that, we do expect that the margin will continue to expand.

So, it’s not something that we’re concerned about in terms of our ability to drive that margin growth. And again, it’s all those levers that I talked about earlier and a few other things thrown in that are going to help us to continue to grow our margin.