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Quanta Services, Inc (NYSE:PWR) has been growing steadily in the past decade, especially in the past three years since the signing of the Infrastructure Investment and Jobs Act in 2021. However, due to the significant increase in remaining performance obligation and uncertainty around its ability to deliver projects on time and on budget, despite Quanta’s potential for further growth and strong cash flow generation last year, Quanta’s valuation is fairly rich at 28 times earnings. As a result, I recommend a “Hold” rating for Quanta Services.
Introduction
Established in 1997, with over 52,000 employees, Quanta Services is a leading provider of comprehensive infrastructure solutions for the electric, gas utility, renewable energy, communications, pipeline and energy industries in the United States, Canada, Australia and other international markets. Quanta provides engineering, procurement, construction, upgrade and repair and maintenance services for infrastructure within each of these industries.
Financial Results
On February 22, 2024, Quanta Services reported its 2023 full-year financial results, which are very positive overall. Notably, considering that Quanta’s annual revenue for 2023 was $20.9 billion, Quanta reported a total backlog of $30.1 billion as of December 31, 2023 suggesting an extremely strong demand for Quanta’ specialized infrastructure services.
In addition, Quanta’ revenue growth has been very impressive since the signing of the Infrastructure Investment and Jobs Act on November 15, 2021.
In 2022, Quanta’s revenue grew by whopping 31.5% to $17.07 billion from $12.98 billion. Then, in 2023, Quanta’s revenue grew again by 22.3% to $20.88 billion.
Similarly, EBITDA grew by 40.8% and 15.1% respectively in 2022 and 2023 and is expected to grow another 20% in 2024.
Despite the strong growth trend, Quanta’s management team did a good job at managing investors’ expectation and provided fairly conservative forecast for 2024 anticipating only about 7.7% in revenue growth.
As part of Quanta’s comprehensive infrastructure services, repair and maintenance services are typically inflation adjusted based on the market value of services for a given year and revenue is recognized as services took place. However, other projects are typically in longer term and revenue is recognized based on percentage of completion. The rate of inflation is usually built in the initial project quote to its customers. So, at any given time, Quanta will have performance obligation as well as backlog. Performance obligation refers to work specified as part of a contract that needs to be delivered by Quanta. Backlog refers to work that likely needs to be delivered by Quanta but has not yet been materialized as part of a contract.
One major risk to Quanta’s financial results is that Quanta may take longer than expected to complete a project and has to absorb higher than expected cost of inflation given these projects’ labour intensive nature. This risk is quite important to consider given Quanta’s relatively narrow margin on each project. To put into perspective, for electric infrastructure project, Quanta’s operating margin is about just 10%. If a project is delayed by one year, the average inflation of 3% would reduce Quanta’s operating margin by almost half.
As of December 31, 2022, Quanta’s remaining performance obligation and backlog were $8.8 billion and $24.1 billion respectively. As of December 31, 2023, the remaining performance obligation and backlog went up significantly to $13.89 billion and $30.11 billion, respectively, an increase of 57.9% and 25% compared to 2022. This increase, if not managed well, can result in significant overrun on budget for Quanta lowering operating income margin. This is already shown in 2023 as the operating margin has declined to 10.5% from 10.7% for the electric power segment and has declined to $7.7% from 8.1% for the renewable energy segment. This also explained why a revenue growth of 22.3% in 2023 only led to 15.1% growth in EBITDA. If this trend continues, growth in revenue may not positively contribute to growth in EBITDA or earnings.
To manage this risk and complete projects for Quanta’ customers in time and with the same quality standard, Quanta needs to be able to retain existing talent, recruit new employees quickly, provide sufficient training for these employees.
As a labour-intensive services provider in the infrastructure space, Quanta’s employees are the most important intangible assets. As of December 31, 2022, Quanta had 47,300 employees, which suggested that each employee at Quanta generated about $361,000 in revenue on average. As of December 31, 2023, Quanta had 52,500 employees, which suggested $398,000 in revenue on average per employee. It is promising to see that Quanta was able to recruit 5,200 new employees, an increase of 11% in headcount. However, Quanta’s employees may be stretched too thin and overwhelmed and Quanta will need to hire significantly more quality employees to help reduce the remaining performance obligations.
Dividend Policy
Since 2021, Quanta has increased its dividend by $0.04 per share each year representing a 16% increase in 2022 and 13.8% in 2023. Although the current dividend yield is fairly low at just 0.15%, Quanta has allowed itself to continue increasing its dividend in the coming years.
For 2022, the dividends paid represented about 9% of its free cash flow. For 2023, the dividends paid were just 5% of its free cash flow.
However, if Quanta can’t manage to deliver remaining performance obligations profitably, the current level of dividend may represent a much larger share of free cash flow next year.
Other Tailwinds
Increased Infrastructure Spending
Quanta mainly operates in the United States, Canada and Australia where infrastructure has generally been aging and requires significant upgrades if these nations want to maintain competitiveness, attract talent and capital in the global stage compared with nations such as China and Japan.
As a result, the demand for Quanta’s infrastructure services is expected to continue growing in the foreseeable future. However, the Infrastructure Investments and Jobs Act are only valid for another 3 years. Afterwards, it is uncertain whether the United States federal government still has the appetite to fund large infrastructure spending, especially under a potential Trump Administration.
In addition, 6G Technology is currently under development and will eventually replace 5G network, which will require significant work on existing infrastructure.
The development and implementation of digital electricity are also to further propel Quanta’s growth in the coming decades.
Climate Change
Climate Change is a double edged sword for Quanta, but mostly positive.
Quanta’s services are well needed for the transition from Oil and Gas to Renewable Energy in terms of setting up the renewable infrastructure. Quanta’s emergency restoration services are extremely important in the face of natural disasters.
However, more frequent natural disasters may render certain projects more difficult or impossible to complete. New government-imposed climate change measures may increase the cost of projects leading to narrower margin.
Valuation
Quanta’s market capitalization is at $34.16 billion with a PE ratio of 28 as of February 23, 2024, compared to its peer such as AECOM, Quanta’s valuation is quite high. AECOM is currently trading at a PE ratio of 19.
Quanta has a revenue multiple of 1.63 compared to AECOM’s revenue multiple of only 0.85.
While Quanta’s remaining performance obligations and backlog have increased significantly in 2023, its competitor, AECOM, has had a fairly consistent level of backlog in 2022 and 2023.
All in all, for investors interested in exposure from the infrastructure services sector, AECOM poses as a better buy from a valuation perspective. However, further analysis on AECOM is required.
Other Risk Factors
While the demand for Quanta’s services is strong, its customers’ ability to make payments may become questionable as economic downtown is in the horizon. As witnessed already in the growing Accounts Receivable balance to $4.4 billion as of December 31, 2023 from $3.67 billion in 2022, this issue looks a bit concerning. However, Quanta’ management team has done a good job managing payment terms with its vendors to align with the increase in Accounts Receivable balance as part of its cash management strategy. Accounts Payable balance increased significantly as well to $3.06 billion in 2023 from $2.15 billion in 2022.
As mentioned earlier, Quanta’s ability to recruit talent in time to reduce the remaining performance obligation is crucial to not only manage project costs, but also provide satisfactory services with its customers to win more contracts. While Quanta does have a higher score on Glassdoor (4.1) compared to AECOM’s 3.8 score, for some odd reasons, Quanta only has 137 open jobs as listed on LinkedIn compared to AECOM’s 4,467 open jobs. It is a bit concerning how Quanta plans to recruit another 5,000 employees in 2024 to deliver the remaining performance obligations.
Conclusion
Quanta Services has demonstrated impressive growth in recent years, capitalizing on the opportunities presented by the Infrastructure Investment and Jobs Act of 2021. The company’s significant backlog and robust demand for its specialized infrastructure services demonstrates its potential for continued expansion. However, challenges related to delivering on remaining performance obligations, cost management, and talent acquisition highlight significant operational risks. Despite Quanta’s solid financial performance and promising growth prospects, the combination of operational risks and high valuation supports a “Hold” recommendation. Investors are advised to closely monitor Quanta’s ability to efficiently manage its project backlog and maintain operating margins.
