TTEK - Tetra Tech: Beneficiary Of Sustainable Megatrends And Government Spending

2024-01-02 04:11:44 ET

Summary

• Tetra Tech is an international company specializing in consultancy and technical services in water, environment, infrastructure, and resource management.
• Tetra Tech has experienced significant growth in sales and profitability, with a strong order book.
• Many doubt that this strong growth will continue, but even with very reasonable assumptions, in line with historic averages, the company looks attractive as an investment.
• By 2030 my model shows the company could grow its FCF and dividend significantly, while also buying back 10 million shares, which gives it between 44% and 100% upside at reasonable multiples.
• Potential Presidential Election risks seem overblown, and potential volatility in the stock should be followed closely as a buying opportunity.

Introduction

Tetra Tech ( TTEK ) is an international consultancy company founded in 1966 and listed in 1990. The company provides solutions to complex sustainability, environmental, and infrastructure challenges, and it works with clients across industries including government, industrial, mining, energy, and more. I believe Tetra Tech is a great company to own for the longer term due to its growth profile and strong free cash flow. Considering its impressive share buyback history, I believe the stock could double by 2030 even with conservative assumptions.

Here are some of Tetra Tech's key business activities and areas of expertise:

? Environmental Consulting: Tetra Tech provides environmental consulting services, including environmental impact assessments, soil surveys, ecological monitoring and risk assessments.

? Water Resources: The company is involved in water management projects, including water purification, water management, coastal protection, and developing sustainable water resources.

? Infrastructure and urban planning: Tetra Tech provides services in infrastructure planning, transportation, urban development and project management.

? Energy: The company is active in the energy industry and provides services in the areas of renewable energy, energy efficiency, and energy project management.

? Mining and conservation: Tetra Tech is involved in mining projects and provides environmental and conservation services to minimize the impact of mining activities.

? Aerospace: The company also provides services to the aerospace sector, including technical support and environmental impact consultancy.

As you can see, all of these activities are very important in today's world and will continue to gain in importance, considering the worldwide focus on reducing emissions and better managing/protecting the environment.

Tetra Tech carries out projects worldwide (more than 100,000 projects per year) and has built a reputation as a company that provides sustainable and innovative solutions to complex problems. The goal is often focused on helping clients achieve environmental goals, promoting sustainability and optimizing infrastructure projects. Tetra Tech's goal is to positively impact the lives of 1 billion people worldwide . The counter currently stands at 545 million.

Tetra Tech benefits enormously from several stimulation programs in the United States that have been created to renew infrastructure and make it more secure. In America, for example, the $1.2 trillion Infrastructure Investment and Jobs Act, the $280 billion CHIPS Act and the $369 billion Inflation Reduction Act are currently in progress.

Tetra Tech's main customers are the US federal government and local governments at State level. The company has 50 years of experience working with government and has the capacity to win up to $25 billion in government contracts per annum. 30% of revenue usually comes from the U.S. Federal Government, and 17% from local government or states. The rest comes from commercial or international (mostly Canada, Australia, and the United Kingdom).

In 2022, Tetra Tech acquired four companies that are leaders in digital transformation, data analytics and sustainable consulting. This has allowed the company to gather industry leaders who address complex problems with big data and water management. Due to these high quality acquisitions, I believe the company will be able to expand its footprint and has set itself up for further growth and margin expansion.

The company also benefits from a prolonged war in Ukraine. The company is being deployed by the EU and USA to secure and rebuild Ukrainians' energy supply, which is under constant fire from Russian forces. Tetra Tech also helps protect against cybersecurity attacks on important energy infrastructure, which is also a hot topic for the USA and other European countries.

Financial overview

Tetra Tech can be called a true sustainable compounder. Since 2006, sales have increased from $910 million to more than $3.7 billion today. Good for a CAGR of 8.68% .

You see that the company mainly performs less well in years when governmental agencies and certain industries have to make savings, such as in 2015 - 2016. Those were difficult economic years (recovery from the crisis, fewer expenditures by energy companies due to low oil prices at the time, etc.).

However, I believe that the risks for a downturn are now significantly reduced, given the strong order book and the high importance of Tetra Techs activities.

Water supply, managing the impact on the environment, and security of critical infrastructure are more important than ever in a less globalized world with geopolitical tensions. Plus the green agenda of the EU and USA will continue for decades to come, which should support Tetra Tech, even during a down turn.

So even if there were to be a dip in its short term results, it would not make a big change to the positive prospects for this company in the longer term.

The fact that the FED is expected to lower interest rates in 2024 and possibly 2025 should also help with any potential economic slowdown.

When looking at the average shares outstanding, Tetra Tech creates a lot of shareholder value by regularly purchasing its own shares. For example, we see in the graph above that almost 18% of their own shares have been purchased since 2014. This is something I, as an investor, am very pleased to see.

The current free cash flow of $341 million seems large enough to support both a rising dividend (current cost: $52 million per year) and to buy back its own stock, while keeping its balance sheet healthy.

Tetra Tech's latest results are particularly impressive. Fiscal 2023 saw net sales of $3.75 billion (a record), operating profit of $358 million (also a record) and order book increasing from $3.7 billion at year-end 2022 to $4.79 billion at year-end 2023. Also a record. In short: this company is on fire.

There was growth in all branches of the company during fiscal 2023.

US Federal government spending in particular helped, causing this branch to grow by +46% in Q4. Excluding the contracts for work in Ukraine, there was healthy growth of +19%. Contracts were also won internationally, and TTEK was able to benefit from the RPS takeover, which resulted in growth of +78% for its international division.

Balance sheet

When we look at the balance sheet, we see a healthy situation. The company has a net debt leverage of 1.4x . This has already fallen sharply compared to the 2.2x that was achieved after the acquisition of RPS. RPS is a large consulting and engineering company from the UK. This acquisition cost around £636 million, but is easily digested by Tetra Tech thanks to its strong free cash flow of more than $340 million per year.

The company has a convertible debt term until August 15, 2028, at a 2.25% coupon. A very low interest rate with a very long time to pay off the debt. Only if the stock price reached $260 per share would there be dilution upon conversion of the convertible debt. This seems fine to me, as the stock has to go up with more than 60% first.

For fiscal 2024, Tetra Tech expects growth between 5% and 15% in all branches. In total, turnover would increase by about 11% and earnings per share by 15% . And that after a record year, which is very impressive.

Future assumptions

With very conservative assumptions, such as 10% growth in normal years and a slowdown to 5% and even 0% growth every 3 years, turnover could reach $6.34 billion by 2030 . And with an annual dividend growth of 10% (payout ratio of about 16% by 2030), there is still a lot of room to buy back shares.

I have assumed in my model that 50% of TTEK's FCF will be used for purchasing shares in normal years. This would mean that the number of outstanding shares would drop to 43 million by 2030.

At that time, the share would then be trading at a price/free cash flow multiple of 11x at the current price. (7.1 billion market cap vs. 630 million FCF)

This seems low for such a high-quality company, which is why I certainly do not consider the shares to be too expensive. The current price/free cash flow is 26x.

If we use a conservative 20x multiple on FCF for the future, then the share price could rise 44%.

If we keep the same multiple (26x), then shares could double.

Hence, I think Tetra Tech is worth a BUY rating, and I'll be on the lookout to purchase shares on any dips towards $130 during 2024.

Conclusion

Tetra Tech operates in a sector that is desperately needed and will be relevant for decades to come.

The company has a proven track record in growing its business. It just achieved fantastic record results and 2024 will again be another record year with record revenue and 15% earnings growth.

However, there is a real chance that we will see less growth after 2024. I'm very realistic about that. Much depends on government spending and the strength of the economy. Its current strong order book should at least give the company some runway into 2025.

The Presidential Election at the end of 2024 certainly poses a risk, where we could see increased volatility in the stock. But even if another president comes along who focuses more on budget management and less government spending, I don't think the megatrends Tetra Tech is benefiting from are reversible. Plus, de CEO has already stated in the latest conference call that maybe one president will focus less on the environment, but another might focus more on security. Money will always be spent by the government, and Tetra Tech will benefit either way.

In my view, dips in Tetra Tech are buying opportunities that we should monitor closely.

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