Quanta Services: Renewable energy could drive stock price higher (NYSE: PWR)
Quanta Services, Inc. (NYSE:PWR) reported optimistic sales growth in 2022 and improved EBITDA margin. In my opinion, if investors also notice the new investments being made in the renewable power generation industry, future estimates might improve as well. I see the risk of accidents, changes in labor markets and failed acquisitions. However, my discounted cash flow models implied significant upside potential in Quanta’s fair valuation.
Quanta Services provides specialized contract infrastructure solutions primarily for customers in the electricity and gas industry in the United States. Additionally, management intends to expand its services to clients in many other industries in addition to operating in Canada, Australia and other international markets. In my view, greater diversification will most likely lead to less volatility in revenue growth.
There are two main reasons to review Quanta’s business model. First, the company operates in an industry that is expected to grow at a CAGR of 5% to 8% and has recurring and visible renewable energy generation projects. In my view, Quanta’s future revenue growth will most likely resemble that of the market.
The second reason is the recent guidance given in May 2022. Management expects adjusted EBITDA margins to reach 10% and to generate growing adjusted earnings per share. In my opinion, if the company really does deliver the expected numbers, the stock price will likely head north.
The total amount of financial debt is not small, so I took enough time to assess it. As of March 31, 2022, long-term debt equals $3.8 billion and short-term debt equals $21 million.
The company pays an interest rate between 0.95% and 3.05%. The senior bonds are payable in 2024, 2030, 2031 and 2041, and current net debt / adjusted EBITDA is 2.3x. In my opinion, Quanta will have to pay most of its debt after a few years. Also, with leverage of 2.3x Adjusted EBITDA, I think Quanta will most likely be able to pay.
Standard case scenario: Renewable energy generation will likely increase revenue growth
In my base case scenario, I assumed that Quanta would continue to grow in the renewable power generation business. After the acquisition of Blattner, in my opinion, you can really say that the management is quite ambitious in this regard.
The Renewable Energy Infrastructure Solutions segment was added primarily due to our acquisition of Blattner Holding Company and its operating subsidiaries in 2021, as further described below. The acquisition of Blattner has significantly expanded and enhanced our existing services to the renewable power generation industry. Source: 10-k
If Quanta continues to invest organically or inorganically in the renewable power generation market, Quanta’s revenue growth will likely increase. Keep in mind that the global renewable power generation market is expected to grow at a CAGR of over 7.9%, which is higher than the growth shown by other targeted markets.
The global renewable power generation market demand was estimated at 6890.7 TWh in 2019 and is expected to grow at a compound annual growth rate of 7.9% from 2020 to 2027. Source: Market Size Report renewable energy production
I think the company is well diversified and will likely be more so as Quanta expands geographically. In my opinion, if the number of customers increases in the future, more investors are likely to be interested in Quanta’s business model. Demand for the stock could increase, which could drive up the company’s stock price:
For the year ended December 31, 2021, our largest customer represented 7% of our consolidated revenue and our top ten customers represented 38% of our consolidated revenue. Source: 10-k
Under normal circumstances, I think sales growth between 4% and 12% seems reasonable. Moreover, with an EBITDA margin of around 12%, an operating margin close to 8% and investments/sales of 2.25%, the 2026 free cash flow would amount to 1.476 billion dollars. Note that I assumed a change in working capital to sales ratio of 2%, which is close to numbers reported by Quanta in the past:
In the end, using an 8% discount and with an EV/EBITDA ratio close to 11x, I obtained an equity valuation of $35 billion and a fair price of $247. Notice I’m not that optimistic about my exit multiple. The industry is trading at 10.3x EBITDA.
Failed acquisitions, accidents and lack of workers could result in $50 per share
Quanta acquired Blattner for $2.37 billion in cash and 3,326,955 shares. The acquisition wasn’t small at all, so I hope the post-merger acquisition went well. There are risks. If management has paid too much, or if the expected synergies are not obtained, accountants may have to write down the goodwill. As a result, I think some shareholders might sell their shares, causing the stock price to drop:
The success of our acquisition of Blattner will depend, in part, on our ability to realize the anticipated benefits of a successful integration of Blattner’s businesses. We plan to devote significant management attention and resources to integrating our business practices and operations with those of Blattner so that we can fully realize the anticipated benefits of the acquisition. Nevertheless, the business and assets acquired may not succeed, achieve the anticipated financial results or continue to grow at the same rate as when operated independently or may require greater resources and investments than originally anticipated. The acquisition of Blattner could also result in the assumption of unknown or contingent liabilities. Potential difficulties we may encounter in the integration process. Source: 10-k
Quanta Services could suffer a significant number of accidents, including fires, explosions or any other type of damage. In the worst case, service delivery could be impossible, resulting in lower revenue growth. The Quanta brand could also be damaged, which could very negatively affect the valuation of Quanta’s shares:
Due to the nature of the services we provide and the conditions under which we and our clients operate, our business is subject to operational risks and accidents that can result in significant liability. These operational risks include, but are not limited to, electricity, fires, explosions, leaks, collisions, mechanical failures and damage caused by extreme weather conditions and natural disasters. In addition, some of our customers operate energy and communications infrastructure assets in locations and environments that increase the likelihood and/or severity of these operational risks, including due to climate change and other factors in recent years. Source: 10-k
Quanta Services can also suffer significantly if the number of skilled workers willing to work for the company decreases. Management may have to pay higher salaries, resulting in lower free cash flow margins. As a result, I think the stock valuation could decline significantly:
The pool of skilled workers in some of our industries has also been reduced, and may be further reduced, primarily due to the aging of the utility workforce and labor availability issues at higher term, including experienced program managers and qualified line mates available for our Electric Power Infrastructure Solutions and experienced supervisors and foremen for our Underground Utility and Infrastructure Solutions segment. Source: 10-k
Under adverse conditions, I assumed sales growth of -15% in 2024, -5% in 2025 and 5% in 2026. EBITDA margin was also assumed at 10% with EBIT/Sales of 6 %. The resulting 2026 EBIAT is $705 million.
Additionally, assuming conservative changes in working capital and capital expenditures, free cash flow would be between $790 million and $668 million. The free cash flow margin would be close to 4%, which is significantly lower than the expectations reported in the previous case scenario.
With the previous growth in net earnings, Quanta is unlikely to find many stock buyers. In the worst case, I think the cost of equity would increase significantly. Therefore, I used a 10% discount in 2023. The results with an exit multiple of 7.85x include a stock valuation of $7.2 billion and a fair price of $50.
Quanta Services announced optimistic EBITDA margin figures for 2022. With the most recent acquisition, management is now investing a significant sum in the renewable energy industry, which will likely lead to further revenue growth. In my view, if management continues to expand its geographic footprint and the number of customers increases, revenue volatility may decrease. I see some risks related to acquisition failures and labor risks. However, the current stock price seems too low.