January 15, 2023
Industrial Products: 2023 Outlook
Anticipating choppy waters ahead, but there are opportunities
Our view: While the macro backdrop has become increasingly uncertain in recent months, we believe unique tailwinds/catalysts across some of our sub-sectors provide attractive opportunities for 2023. For our E&C firms, the outlook for infrastructure has (arguably) never been better, with our coverage well positioned to benefit from upcoming infrastructure spend. For our Dealers, we expect FTT/TIH to continue to execute well as they navigate a tight equipment supply environment amidst a strong demand backdrop. For our Automotive Aftermarket coverage, we expect BYD's margin profile to continue to trend toward historical levels and the pace of M&A activity to pick up. Lastly, we believe ATS will continue to successfully execute on its organic/M&A strategies despite macro headwinds and believe that the company is less cyclical today. In this report, we update our estimates/price targets for ACM (pg. 74), SNC (pg. 96), and ATS (pg. 127), and roll forward our valuation to 2023 figures for ARE (pg. 82). Among our Outperform rated names, our top picks for 2023 include WSP, SNC, BYD, and ATS.
Key themes for E&C firms:
Well positioned amidst key tailwinds in 2023 and beyond — Overall, the E&C space is well positioned with many companies sitting on record/near-record backlogs as Infrastructure Investment & Jobs Act ("IIJA"; ~US$550B of incremental/new spend) and CHIPS bill (US$53B) spending continue to ramp up (a number of global firms expect awards to become more meaningful in Q2/Q3 2023), while the Inflation Reduction Act (US$369B) is expected to be a late-2023/early-2024 event. We also believe the commitment to infrastructure investment across other major markets (e.g., the U.K., Canada, Australia) could offset the uncertain macro backdrop. In our view, the favorable outlook for infrastructure spending, the elevated focus on energy security/transition, tailwinds from re-shoring efforts, and the diversified exposure of the larger Engineering firms positions them well through the cycle.
M&A activity could accelerate — M&A is a core focus for most of our covered Design/Consulting firms as these global businesses continue to roll up the fragmented industry and add capabilities/headcount through acquisitions (particularly as balance sheets remain in good shape across the industry). While the industry has evolved over the recent years, the focus for M&A still appears to be on Environmental Services, Water, and now increasingly Energy Transition services. With the uncertain macro outlook and moderation in valuations over the past year, we believe that M&A activity could pick up over the coming year, particularly among the more well-capitalized companies.
Key themes for Dealers:
Tight equipment supply environment persists amidst supportive demand backdrop — Companies across the Dealer space have noted that prime equipment supply conditions remain tight amidst the supportive demand environment (despite the uncertain macro outlook, demand has remained resilient thus far given the strong commodity price and regional funding backdrops). Amidst this set-up, Finning/ Toromont have been successfully directing customers toward used equipment, rentals, or rebuilds in situations where new equipment has not been available. If supply chain pressures ease in 2023, we expect Toromont/Finning to be able to capitalize on their record/near-record backlogs.
Key themes for Diversified Industrials:
A number of moving pieces — For our Automotive Aftermarket coverage, the outlook for future insurance rate increases should benefit collision repairers (and by extension, Boyd) as the industry looks to get back to historical profitability, while we also expect supply chain conditions to continue to stabilize/improve and traffic patterns to continue to trend toward/beyond pre-pandemic levels (both of which we view as positive for Boyd and Uni-Select). For ATS, we believe the company will prove resilient through the cycle (given its end-market exposure has increasingly shifted to less cyclical industries).
WSP Global Inc. | Outperform | Price target: $190
Outlook
1. Good progress to-date on 2022-2024 targets
WSP’s 2024 targets include: 1) $10B+ in net revenue (implying at least +8.3% net revenue CAGR from 2021-2024); 2) at least +5% annual organic net revenue growth over this period; 3) a 17.5%-18.5% consolidated Adjusted EBITDA margin (margin was 16.8% in 2021); and, 4) 100%+ conversion of FCF to Adjusted Net Earnings. We believe the company is well on track to achieve these target, and for 2024 we forecast ~$10.5B of net revenue and ~$1,859MM of Adjusted EBITDA (margin of 17.7%). Note that these forecasts assume no further M&A beyond acquisitions closed to-date.
2. Recent M&A has meaningfully increased exposure to the attractive Environmental Services end-market
Following the recent ~US$1.8B acquisition of John Wood Group’s Environmental and Infrastructure business (“Wood E&I”), WSP has meaningfully shifted its end-market mix toward high-growth Environmental Services (while also largely preserving its desired geographic and public/private client mix). Pro-forma for the Wood E&I acquisition, WSP’s Earth and Environment (“E&E”) business will account for ~31% of its net revenue, of which ~75% will consist of front-end, high-margin consulting and advisory services. We view this mix shift favorably, not only for the positive effect on WSP’s growth and margin profile but also because we believe E&E work should prove more resilient through the economic cycle relative to traditional infrastructure end-markets, especially given the importance WSP’s clients have placed on sustainability initiatives and the Net Zero transition over the recent years.
3. Balance sheet well positioned for M&A, in our view
Having closed 6 acquisitions since June 2022 (including Wood E&I, Capita REI, and GL Hearn), WSP’s leverage stood at ~2.0x Net Debt/Adjusted EBITDA exiting Q3 with management guiding to ~1.4x-1.5x exiting Q4 2022. We believe that this leverage profile, coupled with WSP’s track record of rapid de-leveraging following major acquisitions (e.g., de-levered ~0.5x from 1.1x in Q2 2021 following the Golder acquisition to 0.6x in Q4 2021) positions the company to remain active on M&A as opportunities present themselves.