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RECOMMENDATION
Last Price Target Price Projected Return
BUY
$29.84 $35.73 19.73%
Market Data
52 week trading range Shares Outstanding ($mm) Market Capitalization ($mm) Enterprise Value ($mm) $24.70-$64.99 209.70 $6,353.99 $6,055.80 $309.15 $2.64
COMPANY OVERVIEW
Quanta Services Inc. (PWR) provides specialty contracting services and infrastructure solutions in North America and Canada through three segments. The Electric Power Infrastructure Services segment (EIP: 71.05% of revenue, 81.69% operating income) designs, installs, upgrades, repairs, and maintains electric power transmission, distribution networks, and substation facilities. The Natural Gas and Pipeline Infrastructure Services segment (NGP: 25.93%/8.69%) designs, installs, repairs, and maintains pipeline transmission and distribution systems, gathering systems, and compressor and pump stations. This segment also offers related trenching, directional boring, and automatic welding services. The Fiber Optic Licensing and Other segment (FOL: 3.02%/9.61%) designs, procures, constructs, maintains, and owns fiber optic telecommunications infrastructure. The company previously owned a Telecommunication segment that was sold to Dycom Industries Inc. at the end of FY12.
Industrials Sector
Earnings History
INVESTMENT THESIS
Quanta is a leading provider of contracting services of infrastructure solutions that is currently trading at a discount to itself, its peers, and the S&P 500 Construction & Engineering index. Quanta historically has traded at a 33% premium to its peers on an EV/EBITDA base, but is currently trading at 3.5% discount. Investors began devaluing Quanta after the company revised down earnings estimates due to a large pension related cost and the underperformance of its NGP sector in FY11. Since that year, Quantas price has shown little response to positive earnings growth, especially the substantial earnings and sales growth of FY 2012, driven by the boom in energy consumption and Hurricane Sandy. Quanta is still an industry leader with an economic moat that has been built through a scope advantage created from its diversified services, supplier power through its diversified customer base, and brand recognition through its superior performance and size. Quantas recent acquisitions (Performance Energy Service LLC and T.G Mercer Consulting Services Inc.), contract wins (PPL and TransCanada), and the expected industry tailwinds should expand margins, return the company to normal trading levels, and yield a 19.73% return.
Earnings Date FY12 Q4 FY13 Q1 FY13 Q2 FY13 Q3 Earnings Date FY13 Q4 FY14 Q1 FY14 Q2 FY14 Q3
EPS $ .51 $ .38 $ .38 $ .46 EPS $ .42 $ .40 $ .44 $ .52
Revenue $1,607 $1,378 $1,518 $1,681 Revenue $1,708 $1,698 $1,668 $1,846
Fall 2013
Catalysts /Positives
Contract Wins: In 2013, Quanta announced contract wins from TransCanadas Houston Lateral project, PPLs complex high voltage transmission project, and ATCO Electrics Eastern Alberta Transmission line project. Acquisitions: Performance Energy Service LLC and T.G Mercer Consulting Services Inc. were acquired last quarter. The deals were for $177.6 million in cash and stocks, and should help expand the services provided in the NGP segment. EIP Growth: Hurricane Sandy, and compliance with NERC and EPA standards has generated high levels of demand for electrical transmission, and distributions services. NGP Growth: Pipeline demand has been booming due to the increasing production and consumption of natural gas and oil. Growing Backlog: Total and 12 month backlog has grown to historically high values and are expected to continue growing at a double digit pace. International Expansion: The acquisition of Nacap Australia Pty Ltd is the first step of Quantas international expansion and growth strategy. The company is optimistic about the expansion and hopes to continue extending its reach at a conservative pace. Credit Facility: Quanta entered into an amended credit agreement to increase the capacity of its secured revolving credit facility to $1.325 billion. The agreement is on more favorable terms/rates, and provides Quanta with capital to expand capacity and continue acquisition activity.
Drag Factors
Government: Each segment is subject to government regulations such as registration, licensing, and pollution regulations. An increase in regulations, or an inability to comply, would delay current projects and add extra costs. Economic: Slower than expected economic growth/recovery in the US would lower the demand for Quantas services. Decrease in demand would hinder Quantas pricing power and future sales expectations. Labor: Quantas workforce is about 49% unionized primarily with the International Brotherhood of Electrical Workers and Canadian Union of Skilled Workers. Any conflicts could result in significant disruption in Quantas operations. Competition: Quanta operates in a highly competitive industry that operates through fixed pricing and contracts. Pricing pressure initiated by competitors would cut sales growth and contract margins. Commodity: Fluctuation in commodity/energy prices would decrease the demand and sales for Quanta. While fluctuation in raw materials prices would increase input costs and stunt margin growth.
ECONOMIC MOAT
DESCRIPTION: NARROW and STABLE Capital Intensive: The Construction and Engineering sector is a capital/fixed asset intensive industry, which creates high barriers to entry for new competition. Scope: Quanta provides a wide range of services within each segment. The different services work together to spread out fixed costs, and creates scope within and between each operating segment. Brand: Quanta is an S&P 500 company and the leader in contract services of delivering infrastructure solutions. Therefore, Quanta is recognized as a superior company within the infrastructure service industry. Diversification/Customer base: The customer base is made up of a large number of big name customers where only one customer makes up more than 5% of its revenues. Therefore, Quanta is not overly reliant on just a few customers and maintains some supplier power.
Geographic Footprint
15%
US
85%
CAN
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Target Price
Peer Group Valuation: Using consensus NTM EBITDA estimate of $ 783.26mm. The peer group valuation indicates an EV/EBITDA of 9.13x. These values yield an enterprise value of $7,153.77mm Discounted Cash Flow: The WACC used is 9.96%. The industry analysis indicates an implied EV/EBITDA of 9.13x and a perpetuity growth rate of 4.00% These values yield an EV of $7,499.5mm and $6,966.6mm Cash ($309.2mm) is added and total debt ($2.64mm)/minority interest ($8.6mm) is subtracted to obtain the equity value. The equity value is divided by shares outstanding (209.7mm) to arrive at a target price.
Target Price: $35.73 Peer Analysis: Target Price = $35.54 Discounted Cash Flow Analysis: Target Price = $35.91
INDUSTRY REPORT
Electric Power Infrastructure Services
Prior to the recession of FY08, investments in the transmission infrastructure was growing at a consistent level due to the incentives provided by the Energy Policy Act of 2005, and the unreliability of the US electrical grid. During the recession, investments in this industry dropped significantly due to the uncertain outlook. Since the recession investments in this industry has picked up significantly, specifically after Hurricane Sandy. Hurricane Sandy led to the highest transmission project activity in over 30 years; doubling the electric transmission market from 20102012 from $11 billion to $22 billion. As coal generation is retired to comply with the Environmental Protection Agency's Mercury and Air Toxics Standards, utilities will need to modify existing transmission infrastructure to handle changes in energy flow to maintain grid reliability. Industry compliance with the new North America Electric Reliability Corporation (NERC) standards is driving growth in the smaller transmission market. The Edison Electric Institutes projected that the industry will have invested nearly $300 billion in the transmission system from 20102030, and expects growth to be in the high teens in FY13 and FY14.
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Revenue
TEL
FOL
NGP
EP
2008
2009
2010
2011
2012
The NGP segment has grown at a CAGR of 11.7% since FY08, due to the increasing US production of oil and natural gas. The NGP segment experienced a substantial increase of 40% YOY due to sales increases in projects related to unconventional shale developments in the US. The acquisition of Nacap Australia Pty Ltd also contributed a significant amount to the growth of the segment. Moving forward, the segment is expected to post double digit growth for the next few years driven by the growth of the pipeline industry and Quantas recent acquisitions. The FOL segment has grown at a CAGR of 23.5% since FY08. In the 3Q FY13, the segment reported a 10% decrease YOY due to lower levels of ancillary telecommunication revenues. However, the segment experienced larger growth in its Fiber Optic Licensing revenues, which is a higher margin business. The segment is expected to continue growing at high levels with licensing revenues driving the growth. Backlog/Orders: [refer to excel attachment] Total and 12 month backlog has shown consistent growth and reached historically $3,500.00 1.60x high levels last quarter. The book to bill 1.40x $3,000.00 ratio since FY11 has remained above 1.0x 1.20x $2,500.00 with the exception of 4Q FY12s .98x. 1.00x EIP $2,000.00 Quantas book to bill ratio and growing 0.80x NPG $1,500.00 backlog shows the consistently increasing 0.60x FOL $1,000.00 demand for the companys service. In the 0.40x B/B 3Q FY13, the 12 month backlog increased $500.00 0.20x 13% YOY due to growth in the EIP and NGP $0.00x 2Q11 3Q11 4Q11 1Q12 2Q12 3Q12 4Q12 1Q13 2Q13 3Q13 segments. The EIP segments 12-month backlog increased by 9% YOY; driven by the recent acquisitions, incremental transmission awards, and renewal of certain master service agreements. The NGP segments 12-month backlog increased 34.8% YOY, driven by higher than expected pipeline demand and the recent acquisition of Nacap Australia Pty Ltd. Management expects the backlog to continue experiencing double digit growth as a result of industry trends and booking momentum
12- month Backlog
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Fall 2013
Margins Analysis: Margins
20.0% 18.0% 16.0% 14.0% 12.0% 10.0% 8.0% 6.0% 4.0% 2.0% 0.0%
GM EM NM
2007
2008
2009
2010
2011
2012
Quanta has historically maintained higher margins than its peer groups with the exception of the FY11. In FY11, Quanta incurred a $32.6 million charge from the withdrawal of the Central States Pension Plan, and the NGP segment reported negative operating margin. As a result, margin growth has stagnated where gross margin in LTM was 16.3% vs. FY09s 17.9%, and EBITDA margin was 10.8% in LTM vs. 11.3% in FY09. Net margin has recovered and has increased to 5.3% for LTM vs. 4.9% in 2009 since. Margins have been recovering since FY11 and are expected to grow due to the expected sales growth of each segment.
Margins: Segment
60.00% 50.00% 40.00% 30.00% 20.00% 10.00% FOL 0.00% EP NGP
The EIP Segment operating income has slowly increased from 9.43% in 2008 to 12.38% in FY12 due to the demand for the high margin emergency restoration services created by Hurricane Sandy. In 3Q FY13, operating margin returned to normal levels at around 11.7% as the spike in emergency restoration services pulls back. The operating margin is expected to continue growing due to Quantas recent acquisitions and contract wins.
2007 2008 2009 2010 2011 2012 The NGP segment reported a -7.74% operating margin in -10.00% the FY11 due to project delays, less than profitable -20.00% projects, lower demand, high fixed costs, and extra cleanup costs. The segment has since recovered to post a 3.61% operating margin in FY12. With Quantas recent acquisitions and expansion into different services, the operating margin for the segment is expected to be 8%-9%.
The FOL segment has always operated at a high operating margin. In the 3Q FY13, this segment reported operating margin of 31.8%, YOY growth from 30.7%. The growth is due to the Fiber Optic Licensing revenues becoming a larger proportion of as a percent of total revenues. Operating margins will remain high as revenue breakdown begins to shift towards the high margin business of Fiber Optic Licensing. Earnings: Quanta consistently beats quarterly earnings estimates by an average of 24% and has only missed on 3 occasions. Net income doubled in value between 2011 and 2012 due to a 41.17% YOY sales growth that was driven by electric distribution services demand created from Hurricane Sandy, new contract wins in the NGP segment, and the completed payment of its pension plan withdrawal liability in FY11. EPS growth has been sporadic due to the events in 2011, and higher than expected sales growth in FY12. FY13 EPS is expected to be about $1.61, with the consensus EPS estimates growing by 18.11% to $1.79 in 2014, and 18.15% to $2.11 in 2015. Liquidity/Receivables: Quanta has always maintained strong liquidity levels with a current ratio and a quick ratio above well above 2.0x since its conception. The company has also maintained a capital structure with almost no debt since 2010, but its receivables make up about 60% of total current assets. Day sales outstanding (DSO) has increased to 93 days as of June 2013 vs. 81 days in June 2012, due to Quantas efforts to attract large transmission projects with favorable terms. To ensure there is enough cash inflow, Quanta has established a revolving line of credit to finance any short term liabilities and capital expenditures. In October 2013, Quanta increased the capacity of the revolving facility from $700 million to $1.325 billion. The amended credit facility offers more favorable terms and rates, and a provision to increase the amount available under the facility by an additional $300 million. Management expects to use to the extra capacity to purse acquisition, capacity expansion, and new contract opportunities.
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Fall 2013
Ratio/ Profitability Analysis:
Profit Ratios
10.0% 8.0% 6.0% 4.0% 2.0% 0.0%
2008
2009
2010
2011
2012
2013
Quantas profitability ratios decreased significantly postrecession and especially in FY11 due to the underperformance of a few major projects in the NGP segment, delay in due government regulations, and pension liabilities. Quantas ratios are now currently lower than its competitors even though its margins are higher than the peer groups averages. These ratios increased significantly towards pre-recession levels due to the overwhelming growth in revenues in earnings during the FY12. Moving forward, these ratios should continue to grow as Quanta continues its acquisition activities, win new contracts, and ride the industry tailwinds.
Acquisition/ Goodwill: [refer to the excel attachment] Quanta is acquisitive by nature and strives to stay 2-3 years ahead of its competitor through its acquisitions. Since its conception, Quanta has been involved in 69 different M&A deals (65 acquisitions, and 4 divestures). On average Quanta has paid a 16% premium for its acquisitions, represented in the companys goodwill of $1.650 million. The recent acquisition of Performance Energy Services LLC, and T.G. Mercer Consulting Services Inc. are expected to diversify the services that Quanta offers in the NGP segment, while the Nacap acquisition gives Quanta exposure to a new geographic segment in Australia. Quanta has had no impairment of goodwill since 2006 which shows that Quantas acquisitions have not lost any value. Quantas most significant divesture would be the divesture of its Telecommunication segment at the end of 2012. Quanta sold this segment to Dycom Industries, Inc. for $275 million due to a lack of synergies and a declining outlook. Capital Expenditure: Quantas capital expenditures goes into the expansion of network capabilities of its FOL segment, expanding its vehicle fleet, and establishing facilities in new business sub-segments. Capital expenditure has been increasing at an 8.1% CAGR since 2009 from $164.98 million to $243.52 million in the LTM. Management expects total capital expenditures for FY13 will be $260 million to $270 million; where about $45 million to $50 million is allocated to the FOL segment, and $24millin in the vessels to enhance its offshore oil and gas infrastructure sub-segment. Cash Flow: From FY09 to FY2012 CFFO increased at a CAGR of 5.12%, however CFFO did decrease in FY2012 to $166.84 million, the lowest since FY06. The decline was due to increased short term spending and more flexible terms on receivables for its larger ongoing projects. With the completion of some major projects during the year and the significant sales growth, CFFO was reported to be $440.85million for the LTM. CFFO/CAPX increased from .8x to 1.85x YOY, showing that Quanta has the ability to grow its capital expenditure. With a Depreciation/CFFO of 3.33x, Quanta has a more predictable cash flows that will not ride the highs and lows of market conditions. FCF has stayed positive with the exception of FY 2012, where significantly higher working capital costs from ongoing larger operations caused a sharp decrease in CFFO. As sales continues to grow and as larger projects near competition Quanta is expected to experience increasing FCF, where FCF for FY13 is expected to be over $200 million; the first time since FY09.
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Price Target
For the EV/EBITDA method, the implied EV/EBITDA of 9.13x is derived from the relative valuation. This method yields an enterprise value of $7,499.5, an equity value of $7,797.73, and a price target of $37.19 per share. With US GPD expected to grow at a 2%-3% rate, a 4% rate is used for the growing perpetuity method to account for the volatility and cyclicality of Quantas sector. This method yields an enterprise value of $69,966.6, an equity value of $7,264.8, and a price target of $34.64 per share. The average of these two values yields a price target of $35.92.
Target Price
$35.73
Page 8
Fall 2013
APPENDIX
PWR vs Peers 3 year EV/EBITDA
14.00x
12.00x
10.00x
8.00x
6.00x
4.00x
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Fall 2013
DISCLAIMER
This report is prepared strictly for educational purposes and should not be used as an actual investment guide. The forward looking statements contained within are simply the authors opinions. The writer does not own any of the Quanta Services, Inc. stock.
TUIA STATEMENT
Established in honor of Professor William C. Dunkelberg, former Dean of the Fox School of Business, for his tireless dedication to educating students in real-world principles of economics and business, the William C. Dunkelberg (WCD) Owl Fund will ensure that future generations of students have exposure to a challenging, practical learning experience. Managed by Fox School of Business graduate and undergraduate students with oversight from its Board of Directors, the WCD Owl Funds goals are threefold: Provide students with hands-on investment management experience Enable students to work in a team-based setting in consultation with investment professionals. Connect student participants with nationally recognized money managers and financial institutions
Earnings from the fund will be reinvested net of fund expenses, which are primarily trading and auditing costs and partial scholarships for student participants.
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