PWR - Energy Transition Will Power Quanta Services' Long-Term Growth Strategy

2023-05-17 16:36:52 ET

Summary

• Quanta Services issued a beat and raise at Q1'23.
• Grid modernization and renewables will power Quanta Services' growth through the next decade+.
• Long-term growth can justify Quanta's high multiples and opens the door for a buying opportunity.

Quanta Services ( PWR ) reported a phenomenal first quarter beat and raise for 2023 with reported revenue increasing 12% y/y to $4.4b. Guidance for FY23 is very robust with the top of the range sitting at 12% top line growth with a net margin of 4%. With estimated CAPEX coming in at $400mm, management expects to generate anywhere between $750-1,000mm in free cash flow for a forward FCF yield of 4%. Though Quanta’s valuation is significantly more expensive for an investment as a value investor, I believe Quanta’s growth story can justify an expensive valuation. Using the 18.5x EV/EBITDA multiple PWR currently sits at for FY22, we can expect the shares to appreciate by 20% to $204.60/share, holding all else equal. Given this baseline presumption and a heightened backlog of $25.3b, I provide PWR a short-term buy rating with a long-term strong buy rating.

Projects & Operations

Reviewing investor presentations, management expects that much of their future revenue will result from electrification megatrends that derive from grid modernization and renewables. Though there are many factors that go into the success of total energy transition adoption, including minerals sourcing, continued support by public policy, and consumer adoption of electric over gas, Quanta Services should benefit regardless of power being generated from solar, wind, nuclear, or natural gas. To avoid more technical details, Enphase ( ENPH ) is very public about the hereditary challenges in implementing intermittent power sources with traditional string inverters connecting to central inverters and the necessity for redesigns to carry such a load.

The biggest news to come out that day was the SunZia Transmission and SunZia Wind projects. Though the figures aren’t to be released until q2/q3’23, Pattern Energy has published their projections which suggest that total investment to be in the ballpark of $8b, as per their factsheet found on their website. Another major partnership announced is with Navistar to develop the charging infrastructure for their electric fleet. Quanta projects the TAM for public charging stations to be a $38b space. Despite EV charging being a relatively saturated market and capture may be limited, this partnership could be a foot in the door to cross-sell other renewable capacity and transmission services in the long-run.

Quanta also announced a new partnership at the end of 2022 with Xcel Energy ( XEL ) to build out 610 miles of 345kV transmission infrastructure for the Colorado’s Power Pathway high-voltage electric transmission project in Colorado. The estimated figures haven’t been released by Quanta; however, Xcel estimates an investment of $0.5-1b in transmission from 2023-2027. Xcel also included in their investor presentation the expectations to invest an additional $1.5-3b in renewable energy capacity between 2025-2030 with bids received in March 2023 with the expectation of the CPUC decision this fall. With Quanta’s expertise in renewable energy through their acquisition of Blattner, there could be some additional business flowing from Xcel in coming months.

By making some broad assumptions in revenue growth and constant margins for operating cash flow and free cash flow, we can build out some expectations for Quanta’s long-term trajectory, holding all else equal. With the assumption that Quanta can maintain strong revenue growth going forward and a 7% and 5% OCF and FCF margin, we can build out long-term projections that would suggest PWR is presently properly priced when discounted at 10.14% WACC.

Macroeconomics

As discussed in a previous article I published on SeekingAlpha covering Argan ( AGX ), there is roughly 40GW, or 21% of the installed capacity, of coal and natural gas capacity to be retired through 2030 that must be replaced by either renewables, nuclear, or natural gas. This along with the adoption of electric vehicles will push the demand for EPC services as provided by companies like Qanta Services. Public policy will also play a huge role in electrification and modernization of the grid, especially through the IRA. Though financing may cause some short-term challenges for new projects, the long-term opportunity stands strong as more utilities retire coal-burning power plants in favor of renewables with battery capacity and natural gas.

There are many challenges that Quanta Services will face throughout this journey, including materials sourcing, supply chain and logistics, labor management, and inflation and interest rates. Much of the current administration’s push through the IRA is to source minerals and materials domestically, and this may not be feasible in the near-term. It cannot yet be determined whether government-guaranteed loans will be issued as a result of foreign minerals sourcing under the IRA and this may not be apparent until projects begin to be challenged. Though there isn’t much language regarding minerals sourcing outside of EV batteries, it is challenging to infer that these requirements won’t stand for utility-scale battery capacity. Anti-dumping regulation relating to Solar PV sourcing can also pose a challenge as the US veers away from trade with Chinese-domiciled companies. Though there are many domestic providers of solar PVs, many of the materials still remain sourced from APAC countries and may pose some sourcing risk. Another risk hinted at by the Wall Street Journal involves acreage requirements by utility-scale wind and solar facilities, essentially causing an eyesore for neighbors. Financing can also pose a major challenge for new renewable capacity, as also released by the WSJ .

Conclusion

Despite these potential near-term challenges for renewables, Quanta Services’ operations shouldn’t be much affected as the majority of their business is generated from more traditional sources in electric power infrastructure solutions and underground utility and infrastructure solutions. Using the figures above and margin trends, we can discern forward valuations as found below.

With the assumptions made in this report, I give PWR a price target of $204.60/share based on management’s forward FY23 guidance and provide PWR a buy rating. I expect the EPC space to do extraordinarily well throughout the next decade+ as grid modernization and power generation is kept in focus and expect these benefits to trickle down to Quanta Services.

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