SNC-Lavalin Group Inc. , Stantec Inc., and WSP Global Inc. “stand to benefit from a global infrastructure renaissance, the energy transition, and the re-shoring of manufacturing in North America,” according to Scotia Capital analyst Michael Doumet.
In a research report released Tuesday titled Defensives on the Cusp of an Upturn, he assumed coverage of all three firms, believing “the best is still in front of them” despite “strong” organic growth across the sector through the last year.
“Expanding trading multiples are likely the primary hurdle for investors; however, we believe strong projected (multi-year) organic growth profiles, capital-light features, and proven M&A capabilities will grow profits (i.e., double-digit EBITDA-per-share CAGRs [compound annual growth rates]) such that multiple expansion is unnecessary (but may occur) to create ample returns,” he said. “SNC is the exception – we see a mix of strong profit growth and multiple expansion (lower NTM FCF [next 12-month free cash flow] is an offset).”
Emphasizing “simple is better,” he added: “We think the Canadian engineercos are positioned to provide investors with GDP-plus top-line organic growth, above-average earnings visibility (given record backlogs), consistent margin performance (given the cost-plus nature of work), and a decade-long runway of M&A. For 20-plus years, the engineercos actively consolidated smaller players, expanding their platforms and capabilities. The industry still remains fragmented, and the benefits of being larger may be becoming increasingly important as companies look to take on “mega” projects and attract/retain talent. The “winning” M&A strategy for the engineercos has been to avoid construction businesses and focus on OECD/North American exposure. When it comes to M&A track records, we think WSP did it best by using its access to capital to optimize accretion and accelerate growth. MWH Constructors bogged down STN’s efforts for a while, but its divestiture in 2018 was rewarded with a positive re-rate; since then, it has been increasingly active with M&A. SNC is more focused on optimizing its portfolio; in the NTM, we believe it too will be generating improving FCF and begin to redeploy into M&A.”
Mr. Doumet said his picks in the sector are SNC and WSP, giving both “sector outperform” recommendation. His target for SNC shares is $51, while his WSP target is $216. The averages on the Street is $47.18 and $202.54, respectively.
He gave Stantec a “sector perform” recommendation and $99 target, which exceeds the $96.70 average.
“The engineercos are easy to like: they are defensive names with rising organic growth profiles and a proven ability to recycle capital accretively via M&A,” he concluded. “Industry tailwinds and improving organic growth outlooks have driven multiple expansion, such that we believe share price upside will be driven less so by multiple expansion (except for SNC) and more so by (1) upside surprises, (2) accretive M&A, and (3) roll forwards. With STN and WSP trading essentially in line, we prefer WSP given its higher likelihood of upside surprises. STN has the most exposure to the U.S. (which we like), but we believe it has tougher comps into 2024. For SNC, we think the large negative surprises related to lump-sum turnkey (LSTK) projects are behind it. Once it sheds lower-margin businesses (and potentially its stake in the 407 Highway), it should ‘look and feel’ like STN/WSP. Unable to pursue M&A for a while, we think SNC’s Engineering Services has developed an organic ‘growth muscle’ (effective employee hiring/retention and backlog build), driving strong organic growth; its Nuclear segment also appears poised for a decade-long period of solid growth.”