Stantec (STN): Industry Tailwinds Vs. Valuation Headwinds

Stantec (NYSE:STN) is something of a hidden gem in the Industrials sector. A company specializing in sustainable infrastructure and building projects, it has seen double-digit growth in revenue, earnings per share, and EBITDA over the past few years while increasing its dividend between 6% and 8% over that time. The forward P/E of 26x is lofty but should fall back to the company’s historical averages if growth targets for 2025 and 2026 are met. I believe Stantec is positioned to thrive well into the future, and I have it on my watchlist. It may be a particularly attractive investment opportunity for those looking to augment their portfolio with small- to mid-cap dividend growth companies.

Screening Process

My exposure to Industrials is mainly through SCHD and DGRO, which hold the likes of LMT, UNP, and CAT in their top ten by weighting. Given the sector’s diversity and my interest in adding some small- and mid-cap companies to my portfolio, I screened for the following:

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Only two companies met this stringent combination: Franklin Electric (FELE) and Stantec. While both have performed incredibly well over the past five years, easily beating the broader market, Stantec stands out with a higher overall Quant rating and double-digit growth across virtually all metrics.

Business Model and Thesis

Stantec is organized into five core business segments: integrated building/architectural solutions, energy solutions, environmental services, infrastructure solutions, and sustainable water resources. This comprehensive scope enables the company to manage projects from initial planning and design through construction, administration, maintenance, and even decommissioning. Stantec operates throughout North America and has an ongoing presence in the UK, Australia, Saudi Arabia, and the UAE (among other countries), serving both public and private sector clients.

Stantec has a stated focus on sustainability and a history of attracting clients who prioritize environmentally conscious projects. As an example, the company was recently awarded a five-year, $104M contract to manage a critical infrastructure project for Los Angeles that will improve the quality and reliability of the city’s water supply. Stantec will oversee the entire process, from planning and design through to completion in ca. 2030.

Stantec should continue to benefit from an increasing demand for sustainable infrastructure, which is being driven by demographic trends (e.g., aging populations), urbanization, and global efforts to mitigate the effects of climate change. The company recently reported its largest project backlog in its seventy-year history ($7.2B) alongside double-digit organic growth over the past few quarters. In short, I see Stantec as a compelling investment opportunity because it operates in industries with long-term tailwinds and is recognized internationally for its ability to successfully manage complex projects from start to finish.

Recent Performance

Given the limited coverage of Stantec on Seeking Alpha this year, I’ll briefly recap its performance over the past two quarters:

In Q1 2024, revenue increased by 12% year-over-year, surpassing the 11% mark reported in Q1 2023. EPS rose by 23%, which was well above the comparable growth seen in the previous year. This was driven by a mix of organic expansion and strategic acquisitions, the latter including ZETCON (in Germany) and Morrison Hershfield (in Canada). Adjusted EBITDA also showed a modest improvement over the previous year.

Q2 results were likewise healthy, with a nearly 17% increase in net revenue, up from around 14% in Q2 2023. Once again, this was driven by a combination of organic growth (7.1%) and acquisitions (8.8%), this time including the purchase of Hydrock (in the U.K.) for an undisclosed amount. Cumulatively, these acquisitions increased Stantec’s business assets while also helping it mitigate labor shortages by retaining their skilled workers. The company also raised the low end of its net revenue guidance to 12% (from 11%) and slightly increased its EBITDA margin target to 16.5% (from 16.2%) for year-end 2024.

Looking ahead, the company has provided the following targets for FY2026, which suggest continued strong performance:

Valuation and Price Targets

Forward-looking EPS estimates through 2026 remain quite bullish:

Based on these projections, Stantec is currently trading at around 22.2x the FY25 consensus estimate of $3.61 and 19.9x the FY26 estimate of $4.02. Both are comparable to the sector median (a forward P/E of around 22) and are substantially lower than Stantec’s own five-year average P/E of 27. Were the share price to return to 27x earnings, it might approach $97 by the end of 2025. While this appears favorable, most of the company’s trailing valuations are higher than their own five-year averages, reflecting the 275% share price appreciation over that period:

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Based on the ambitiously projected EPS growth of around 15% annually through FY26, Wall Street analysts have an average price target of $91.50, suggesting the stock is undervalued by around 14%. This is just below my preferred margin of safety for the sector (15%).

I rate Stantec a hold. The company has shown terrific growth in recent years, and while the projected EPS growth rate appears to support the current share price, other valuation metrics are simply too far above their historical comps. I’ll keep Stantec on my watch list and wait for a more favorable entry point.

Risks

In addition to more general, industry-wide risks detailed in the company’s 2023 Annual Report, I see the following as potential threats to the investment thesis outlined above:

1. Government Contract Dependence – A significant portion of Stantec’s revenue comes from government-funded projects. While lucrative, these contracts are vulnerable to delays stemming from changes in government policies (to put it politely).
2. Reliance on Acquisitions – Over half of Stantec’s recent margin expansion has come from acquisitions. Looking ahead, I would prefer to see a focus on consolidating these assets and shifting the balance back to organic growth.
3. Integration Risks – Related to this, any acquisition may come with unforeseen integration challenges, and adding debt to finance these deals may pressure profitability.
4. Competitive Pressures – Stantec competes both with larger firms such as WSP Global (OTCPK:WSPOF) and AECOM (ACM) as well as smaller, more local specialists. Sized somewhere in the middle, it may not have any particular competitive edge in the future.
5. Valuation Concerns – The share price has been increasing steadily since March 2020. The current forward P/E of 26x may have already priced in much of the growth anticipated over the next year or two, limiting upside potential.

Summary

I consider Stantec an interesting investment opportunity based on its diversified business model, which enables the management of complex projects from beginning to end. The company seems well-positioned to capitalize on the increasing global demand for sustainable infrastructure, as reflected in its record-high project backlog. Strategic acquisitions have played an outsized role in Stantec’s growth, with its market cap rising from $2.4B to around $9.5B in just five years. Over this time, the company posted some of the strongest financial results in the entire sector, but that has coincided with a nearly 275% increase in share price. While an excellent company, Stantec’s current elevated valuation keeps it on my watchlist for now.