2023-05-08 02:03:48 ET
Summary
- Sterling Infrastructure's revenue should benefit from a healthy backlog and good end-market demand.
- Margin should benefit from a focus on higher margin project wins.
- Valuation is attractive.
Investment Thesis
Sterling Infrastructure, Inc. ( STRL ) is expected to benefit from a healthy backlog level and good end-market demand. Management recently raised the guidance indicating that the company is not seeing any impact of the broader macroeconomic slowdown. In addition to growth in backlog, the quality of projects in the backlog has also improved which is getting reflected in the company's improved backlog margins. The stock is available at an attractive valuation and, in addition to good earnings growth, I believe there is a potential for P/E multiple re-rating as well. Hence, I believe the stock is a good buy at the current levels.
Q1FY23 Earnings
Recently, Sterling Infrastructure Inc. announced its first-quarter 2023 results, which exceeded expectations. The company's revenue increased by 10.3% YoY to $403 million, surpassing the consensus estimate of $376 million. Additionally, the adjusted EPS grew by 8% YoY to $0.64, higher than the consensus EPS estimate of $0.56. The gross margin increased by 20 bps YoY to 15.3%, and the operating margin increased by 10 bps YoY to 8.1%. The company's strong revenue growth was driven by good end-market demand and a healthy backlog, while the increase in adjusted EPS and margin was due to high margins in backlog and price increases.
Revenue Analysis and Outlook
In my previous coverage of Sterling in November, I expressed optimism about the company's future growth prospects given the favorable end-market demand resulting from an increase in infrastructure funding. Since then, the stock price has increased by ~32%.
The company recently reported its earnings for the first quarter of 2023, and as I had anticipated, similar growth trends were observed. Revenue growth was driven by good backlog execution and healthy demand for infrastructure projects across the country due to an increase in federal infrastructure funding, such as the Infrastructure Investment and Job Act ((IIJA)). This led to a 10.3% YoY increase in revenue to $403 million.
The E-infrastructure segment, which accounts for 51% of total revenue, was the main contributor to the company's good end-market demand, with activities related to data centers, e-commerce distribution centers, and warehouses increasing significantly. However, the Transportation segment reported a YoY revenue decline due to the company's strategic shift away from low-bid heavy highway projects. Additionally, a shift of resources from the Transportation segment to the E-infrastructure segment to accelerate high-margin work also pressured revenue for the segment. Lastly, the Building segment saw growth due to increased commercial activities in multifamily markets and price increases, partially offset by a slowdown in the residential market.
Looking ahead, I believe that Sterling Infrastructure Inc should continue to achieve good revenue growth thanks to healthy backlog levels and favorable end-market demand.
The backlog is a key indicator of a company's future revenue growth potential, and in the first quarter, STRL's backlog remained at a healthy level. As of the end of the first quarter, the backlog totaled $1.62 billion, up 6% YoY and 14.6% year-to-date (from December 31, 2022), with a book-to-burn ratio of 1.6x. YoY growth in the backlog reflects a 35% YoY increase in the E-infrastructure segment's backlog due to robust demand. This was partially offset by a YoY decrease in the transportation backlog as the company focused on shifting from low-bid heavy highway projects to high-margin and low-risk projects like alternative delivery highway, aviation, and rail projects. However, it's worth noting that the year-to-date Transportation backlog increased by approximately 12% due to an increase in end-market demand in the segment from IIJA. The unsigned low bid awards were $131 million at the end of Q1 FY23, resulting in a combined backlog of $1.75 billion, up 5% YoY.
I expect backlog levels to continue to increase further as we progress forward in the year due to strong demand momentum across all end markets. The company's E-infrastructure is well positioned for growth thanks to secular trends for building new data centers, e-commerce distribution centers, and warehouses, as well as the onshoring of manufacturing activities in the U.S.
Given the continued strength in the end market and healthy backlog levels, I remain optimistic about STRL's revenue growth prospects. Earlier this year, management guided for $1.9 billion to $2 billion in revenue in 2023, implying a 10.2% growth at the midpoint. However, after a strong first quarter, the company's CEO Joe Cutillo commented that management is now projecting revenue growth towards the high end of the guidance range, i.e., around 13% revenue growth in 2023. So, clearly, the company is executing well and is not seeing any impact of the macroeconomic slowdown.
Margin Analysis and Outlook
Over the past year, STRL has faced negative impacts on margins due to inflationary input costs and supply chain issues. To counter these challenges, the company has taken measures such as implementing price increases, shifting resources to higher-margin projects in the E-infrastructure segment, and selectively bidding on high-margin projects for the backlog. These efforts have had a positive impact on gross and operating margins in the first quarter. However, there were some headwinds last quarter due to an increase in commercial activities with low-margin projects within the building segment and seasonal weather impacts on operational execution. Despite these challenges, the company achieved a 20 bps YoY increase in gross margin to 15.3% and a 10 bps YoY increase in operating margin to 8.1%.
Looking ahead, I anticipate the strong potential for margin expansion at STRL. The company has made a strategic effort to shift away from low-bid heavy highway projects towards more selective bidding on high-margin, low-risk projects. As a result of this shift, STRL has been able to increase margins in its backlog.
I anticipate that STRL's selective bidding process and healthy margins in the backlog should bolster gross and operating margins in the future.
Valuation and Conclusion
Currently, Sterling is trading at a FY23 consensus EPS estimate of $3.52, representing a 12.14x P/E multiple, and a FY24 consensus EPS estimate of $4.11, representing a 10.41x P/E multiple which looks attractive given the company's growth prospects. Management is doing a good job in terms of improving the overall company's growth and margin profile by focusing on the E-Infrastructure solutions business. Moreover, even in its legacy Transportation Solutions business, management is being selective and focusing only on winning higher margin projects business. As a result, there is potential for a P/E multiple re-rating in the future. Therefore, I believe the stock can continue to outperform and is a good buy at the current levels.
For further details see:
Sterling Infrastructure: Good Growth At Attractive Valuations