Earnings Call Transcript - STN Q1 2023

Operator, Operator

Welcome to Stantec's First 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 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. 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 purposes 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 am pleased to turn the call over to Mr. Gord Johnston.

Gord Johnston, CEO

Good morning, and thank you for joining us today. I'm happy to report that we are off to an excellent start for the year. We delivered net revenue growth for the first quarter of 17%, reaching $1.2 billion. This was driven by over 12% organic growth. Market dynamics remained very favorable over the quarter, and through strong operational performance, we were able to deliver double-digit organic net revenue growth in each of our geographic regions. We also delivered solid organic growth in each of our business segments, most notably in Water, which generated over 24% organic growth, 11% in Buildings, and 16% in Energy & Resources. These results reflect our strong market positioning as we continue to build on the macro themes of aging infrastructure, climate change, and re-shoring of domestic production. Looking at our operating regions, net revenue in the U.S. increased 21% with organic net revenue growth of 14%. Robust public and private sector spending continues to drive growth. We also benefited from the strong U.S. dollar in the quarter, which contributed approximately 7% of the increase in net revenue. We saw double-digit growth in Water, Buildings, and Energy & Resources. Our Water business continues to be a leader in the U.S., achieving significant wins across all megatrends, including water reuse, climate resiliency, and large-scale water security projects. Buildings continues to be very active based on momentum from investments in healthcare, civic, industrial, and the science and technology sectors, and Energy & Resources continues to drive growth through the acceleration of mining and significant reservoir and dam projects. In community development, demand for industrial and residential units built specifically for rental have spurred growth. Overall, the U.S. had a very strong quarter with the key themes that we've spoken about previously continuing to play out. In Canada, we achieved 11% organic net revenue growth. Environmental Services was driven by project permitting, archaeological investigations, and environmental impact assessment work in the renewable energy sector. Our Water business continues to provide services for climate change resilience, including work surrounding Toronto's basement flooding program. Both Environmental Services and Water achieved close to 20% organic net revenue growth. Energy & Resources delivered double-digit growth, with strong activity related to the energy transition, including projects in power transmission and distribution, as well as a large renewable energy project in Western Canada. Our Global operations delivered another quarter of solid revenue growth. Net revenue grew 15%, with organic growth of over 10% and acquisition growth of 5%. Our Water business continues to capitalize on long-term water framework agreements and public sector investments in the UK, New Zealand, and Australia. Energy & Resources delivered robust organic growth through heightened levels of activity driven by the ongoing demand for copper and other metals that support the increasing imperative for the energy transition. Before turning the call over to Theresa, I want to share that our Buildings group was recently ranked #2 overall in Modern Healthcare's top construction and design firms. Modern Healthcare is the industry's leading source of healthcare business and policy news, research, and information. And this is a global ranking, which clearly demonstrates the great work our building team is doing in healthcare. And now I'll turn the call over to Theresa to review our financial results in more detail.

Theresa Jang, CFO

Thank you, Gord. Good morning, everyone. As Gord noted, we delivered solid first quarter results. We grew both gross and net revenue by 17% to $1.5 billion and $1.2 billion, respectively. Project margin for Q1 was 53.7%, in line with our expectations. Project margin in Canada and the U.S. remained strong, while we experienced a few challenges in our Global operations, none of which were individually material. We expect project margin in Global to strengthen in the coming quarters. Adjusted EBITDA margin was 14.6%, a 10 basis point increase over Q1 2022. As a result of very strong share price appreciation in Q1, we did have a significant mark-to-market expense related to the revaluation of our long-term incentive plan. Without this, our adjusted EBITDA margin would have been 15.2%. Strong revenue growth and lower administrative and marketing expenses as a percentage of net revenue drove first quarter diluted EPS of $0.59 compared with $0.40 in the prior year and adjusted diluted EPS of $0.73 compared with $0.61 last year, an increase of 20%. Excluding the mark-to-market LTIP revaluation expense, adjusted diluted EPS would have been $0.78 and would have resulted in an increase of 28% over the prior year. Looking at our liquidity and capital resources, operating cash flow for the quarter came in at $37 million, an increase of $31 million over Q1 '22. Operating cash flow was driven by the strong revenue growth we achieved this quarter, partly offset by our short-term employee incentive payments, which always occur in the first quarter. DSO at the end of March was 81 days, consistent with year-end '22, and our net debt to adjusted EBITDA was 1.6x in the middle of our target range and also consistent with year-end 2022. Before I hand it back to Gord for final remarks, I'd like to draw your attention to our 16th Annual Sustainability Report, which we released last month. Our sustainability report is a wonderful resource that reviews all of the amazing work we're doing to achieve our ESG ambitions. We're particularly proud to report that for the fourth straight year, we've increased the portion of our gross revenue that's aligned with the UN sustainable development goals. For 2022, we determined this to be 60%, up from 53% in 2021, a 13% increase. We also achieved our goal of operational carbon neutrality across our entire business, but there is so much more information contained in this report. I encourage you to take some time and look through it. With that, I'll turn the call back to Gord.

Gord Johnston, CEO

Thanks, Theresa. In Q1, we grew backlog to $6.2 billion, in line with our previous all-time high. This is an increase of 15% from Q1 2022 and an increase of 6% since the end of last year. Our U.S. segment delivered over 9% organic growth in backlog this quarter, with most of that growth in Environmental Services, Water, and Buildings. Growth in Environmental Services backlog stems from strong tailwinds in the marketplace, augmented by robust cross-selling and collaboration with our other business units to provide services such as environmental permitting and archaeological work for large infrastructure projects. Backlog in Water was driven by wins related to wastewater treatment solutions and water requirements for power generation that will support the energy transition. Buildings also had strong backlog growth in the quarter, generated through wins in advanced manufacturing, education, and healthcare. Our backlog represents approximately 13 months of work. As our backlog demonstrates, momentum continues to build based on investments spurred by government stimulus around the world. Looking at some of our major project wins, each of these follows the key trends that we've been discussing. In Q1, we won additional work on semiconductor fabs and in advanced manufacturing, including the Q-Cells project, which we mentioned back in February. The Coire Glas 1,500-megawatt pumped storage project in Scotland is the first large-scale pumped storage project to be developed in the UK in more than 40 years, with more than double the current existing storage capacity, greatly supporting the energy transition and the climate change and sustainability imperative. The Veterans Memorial Bridge in Kentucky was constructed back in 1936, and it currently carries more than twice its intended daily capacity. The redesign of this bridge will strengthen the aging infrastructure and provide a safe, multimodal crossing for vehicles, bicycles, and pedestrians. And just last week, we announced our appointment to the Homes England development and regeneration technical services framework. We expect this appointment will bring us a significant amount of work over the next four years in community development as we continue to support Homes England in building sustainable and resilient communities. These are just a few examples that demonstrate the continued momentum that's driving public and private investments. Looking at the rest of the year, we remain confident that we will achieve the financial targets that we set out in February. This includes delivering mid to high single-digit organic net revenue growth, driven primarily by our significant position in the U.S. While the U.S. remains our top growth market for the year, we continue to expect solid growth in our Global segment and high levels of activity in Canada. We are focused on driving bottom-line growth that meets or exceeds our top-line growth. 2023 is shaping up to be another excellent year for Stantec. And with that, I'll turn the call back to the operator for questions.

Operator, Operator

Our first question comes from Chris Murray with ATB Capital Markets.

Chris Murray, Analyst

Gord, could you expand on your comments regarding organic growth and the backlog? While the U.S. market is performing strongly, Canada and Global showed weakness in the last quarter. What are your thoughts as we progress further into the year regarding these regions outside the U.S.? Should we be worried about anything or is it simply a timing issue?

Gord Johnston, CEO

Yes. I think it's mostly a timing issue, Chris. We had strong organic growth in both of those regions, both over 10%. And there's going to be a little bit of lumpiness when you look between organic growth and backlog. So we're not really concerned. In Global, we had the backlog was a bit retracted a touch there, primarily due to the timing of AMP cycle stuff in the UK. So we're not really concerned with backlog in other locations. We're really confident in our projections for 2023. We think we have a considerable number of opportunities really that we're working on in all of our regions.

Chris Murray, Analyst

So just, even though the Global backlog is going a little bit negative, you don't feel like you're going to burn the backlog faster than you can replace it, at least in the medium term, right?

Gord Johnston, CEO

No, we're feeling actually really good about that Global business as well.

Operator, Operator

Our next question comes from Sabahat Khan with RBC.

Sabahat Khan, Analyst

Could you provide some insights into the current backlog in the U.S. market, specifically which end markets are driving the most growth? Additionally, in light of the current macro environment and pending legislation, where do you see new opportunities related to your backlog that may not yet be reflected?

Gord Johnston, CEO

Yes, thanks, Saba. In the U.S., we experienced over 9% organic backlog growth in the quarter, with all our business operating units contributing to this increase. The strongest growth was seen in Water and Buildings & Environmental Services, both reaching well into double digits. We're observing broad-based growth across all groups, which makes us very optimistic about U.S. growth. Much of the work related to the Infrastructure Investment and Jobs Act has not yet been fully integrated into our backlog, but we expect to see that increase. Recently, the EPA announced funding of approximately $7 billion for the Water group, with $6 billion of that being from the IIJA. This will further enhance our backlog growth in Water going forward.

Sabahat Khan, Analyst

And then just looking, I guess, on the M&A front, I didn't see a lot of mention of Cardno, assuming the integration there is largely done. How are you looking sort of at the M&A horizon right now? One of the things we've noticed across the industry is some of the medium to large-sized transactions have quieted a bit. Is it just the valuations aren't at the right place? Is there more of the company, such as yourself, in the integration phases? Kind of what are you seeing on the M&A horizon? Curious where the private sector multiples are at and just your appetite for a transaction at this point looking beyond Cardno.

Gord Johnston, CEO

Yes. So in addition to focusing on backlog growth, operational efficiency, we're really focused on our M&A program. And you said that and you're right, there's been a little bit of slowness in some of these transactions, but I think that's just timing issues. The market remains quite robust. The M&A funnel also quite full. So I think that we're continuing to stay active. You can see we've got some dry powder that's ready to take action when the right opportunity comes along for us. Again, we're maintaining our discipline. But yes, we're ready to transact when the right opportunity comes along.

Sabahat Khan, Analyst

And then just one last quick one for me. I guess, given your U.S. exposure, obviously, there is a bit of noise on the U.S. side with the government potentially hitting a bit of a wall on the debt ceiling side. The organic growth there looks good. The backlog is building. But I guess as you look over the medium term, is that something that could potentially be an issue? Or given the funding that's in the system, you don't necessarily see it as a near-term concern, given all the bills, et cetera, that are already in the works?

Theresa Jang, CFO

Yes. I think that last part you mentioned, Saba, is where we are at. So we don't see that there would be any short-term impact. The projects that are underway are funded, funds have been disbursed. And so it's a bit of a question around if there is a shutdown, how long will that last? Our expectation is that it wouldn't be prolonged. And so there might be a slight impact over the medium or longer term concerning projects that are coming to market, but we really don't anticipate that there would be any significant impact to us.

Operator, Operator

Our next question comes from Ian Gillies with Stifel.

Ian Gillies, Analyst

Gord, the employee count corporately has kind of been around 26,000 employees as reported for the last three quarters. Can you maybe talk about some of the dynamics with respect to adding people and what's transpiring there and how it pertains to backlog growth and revenue, et cetera, and how you're managing that dynamic?

Gord Johnston, CEO

We are hiring significantly more people than those leaving, leading to a continuous growth in our headcount. In fact, we achieved our highest hiring quarter ever in the first quarter of this year. We anticipate our numbers will increase in the summer, typically exceeding 27,000 as we bring on seasonal staff, before dropping to around 26,000 when those seasonal employees return to school. We are optimistic about our ability to recruit and retain employees, which will assist us in addressing the backlog. We are also noticing a reduction in wage pressure compared to previous periods, suggesting a shift towards a more balanced situation for both employees and employers. Our voluntary turnover rates have stabilized over the last few quarters, which makes us feel positive about our headcount. We are also expanding our offices and delivery centers in Pune, India, where our workforce has grown to well over 700, approaching 750, nearly doubling in size over the past couple of years, presenting further growth opportunities. Overall, we feel confident about our staffing situation and continue to prioritize it as our most valuable asset.

Ian Gillies, Analyst

Maybe switching gears to Canada. Q1 organic growth was very strong. Guidance obviously hasn't really moved there. You've reiterated your confidence. But is there potential that there's revenue or contraction as we move into the back half of the year in that region? I'm just trying to tell you what happened in Q1 versus what may transpire for the remainder of the year.

Theresa Jang, CFO

Yes. I mean, I think Ian what we saw in Q1 was certainly positive, and we're really pleased with the performance there. And I think what we saw was some carryover effect from the momentum we saw in Q4 and some projects a little bit less sensitive to seasonality or the cold weather. And so that was very helpful for Canada. And so we haven't changed our guidance for the rest of the year. It's still early in the year. And we do have some projects that are kind of reaching that run down phase and others that we're expecting to ramp up in the year. So that always causes a little bit of slowdown and restart. So it is currently our expectation that we will see that growth moderate a bit over the course of the rest of this year. But we'd be happy to just see it continue to be as strong as it was in Q1. So we'll see how it plays out.

Operator, Operator

Our next question is the follow-up question from Sabahat Khan.

Sabahat Khan, Analyst

I guess maybe this one is for Theresa. Just given where your share price is at currently, we talked a bit about M&A earlier, just curious how you're looking at capital allocation at this point for the remainder of the year given kind of the options out there?

Theresa Jang, CFO

Yes, the philosophy has not changed. We are pleased with our current share price. Our primary focus remains on mergers and acquisitions as our main strategy for deploying capital. We are committed to pursuing accretive M&A transactions and will act when we see suitable opportunities in the market. At the same time, we are dedicated to maintaining solid leverage, ensuring that we direct our cash flow towards reducing our revolver whenever possible. There is no shift in our strategy.

Sabahat Khan, Analyst

And then there's a bit of discussion earlier around the U.S. side. I want to switch a bit more over to UK; the AMP programs obviously are contributing for you, but I'm curious how the demand trends and the outlook is for some of the other end markets in that region where you operate?

Gord Johnston, CEO

Certainly. You mentioned the AMP program, and we are currently in the middle of AMP7, experiencing strong growth. We are hiring to meet the demand from AMP7. Additionally, some clients are starting to re-compete for AMP8, and we have successfully secured some of those contracts. In other parts of the UK, there is ongoing discussion about the housing market. Recently, some reports suggested cutting back on the required numbers for construction, while others believe we need to maintain those numbers. This has introduced a bit of softness. However, we have previously noted that the permitting process for housing in the UK is quite complicated and time-consuming. Once you initiate a project, you typically continue until the permits are approved. We are optimistic about the UK housing market, especially with our appointment to the Homes England four-year framework, which aims to increase housing stock. This should positively impact us over the next four years. Our two main markets in the UK are the community development group and Water. On the transportation side, we are achieving some strong wins with Highways England. Overall, we are feeling reasonably positive about the UK market, but we are certainly monitoring the situation closely.

Sabahat Khan, Analyst

And just one last one for me. On the U.S. side, obviously, the other big bill out there is the IRA. I think you've announced a large solar project win there. Just curious, what are some of the other buckets within the IRA where you're pursuing projects or opportunities, whether span market or type of project? Just some color there, please?

Gord Johnston, CEO

Yes. The IRA really is supportive of a transition to green and more renewable power. So there's a number of different projects that we're talking to our clients about. There's opportunity in the extension of project start dates and production tax credits for wind and solar and geothermal, biomass, hydrocarbon, hydropower projects, carbon sequestration. So we're in discussion with clients on all of these. There's also the IRAs expand credits for clean hydrogen, renewable fuels, and EV charging infrastructure. So there's a lot of opportunities there, and we're in discussion with clients on really any number of these projects.

Operator, Operator

Our next question comes from Frederic Bastien with Raymond James.

Frederic Bastien, Analyst

I have a big picture question. If everything remains the same, where would you consider investing your next dollar in mergers and acquisitions? Additionally, if we look five years ahead, will Stantec's revenue profile change in terms of geographic exposure?

Gord Johnston, CEO

Yes, we've discussed various opportunities worldwide, but I believe some of the most significant chances are still in the United States. We are actively exploring options and engaging in discussions within the U.S., while also maintaining conversations in Canada and on a global scale. If I were to decide right now, I would prioritize investing in a company in the U.S. However, we are in a strong position financially, with more than one dollar to consider. We continue to have multiple discussions with firms around the world. Regarding the expected revenue profile, we feel confident in our current stance, especially with the major programs we can leverage in Infrastructure, Water, Buildings, and Environment. We will keep focusing on the megatrends, but I do not anticipate significant changes in our revenue profile over the next five years.

Operator, Operator

And I'm not showing any further questions at this time. I'd like to turn the call back over to Gord for any closing remarks.

Gord Johnston, CEO

Great. Well, thanks, everyone, for joining us this morning. We're really pleased with our Q1 results and are very optimistic about the remainder of 2023. So thanks again for joining us, and we look forward to catching up with you as the year progresses.

Operator, Operator

Ladies and gentlemen, this does conclude today's presentation. You may now disconnect, and have a wonderful day.