2024-01-19 08:17:57 ET
Summary
- Sterling Infrastructure is an infrastructure services provider with a focus on e-infrastructure, transportation, and building solutions.
- The company has experienced significant growth in its share price and record-high EPS in 2023.
- Sterling's revenues have seen strong year-over-year growth, particularly in building and transportation solutions, driven by increased demand in residential and commercial real estate.
- Sterling will continue to be a beneficiary of massive government spending on infrastructure.
- Sterling is still relatively undervalued when compared to it's peers.
Investment Thesis
Sterling Infrastructure ( STRL ) is an infrastructure services provider with services in e-infrastructure solutions, transportation solutions, and building solutions. Their services vary from infrastructure projects like roads, bridges, highways, ports, and airports to concrete work for residential and commercial builders, to projects like data centers, e-commerce distribution centers, and next generation manufacturing. These are carried out through a roster of specialized and profitable subsidiaries that have been acquired by Sterling since its inception in 1955. Sterling, while headquartered in The Woodlands, Texas, operates most of its businesses in the Southeastern and Northeastern United States, as well as the Mid-Atlantic and Rocky Mountain states.
Founded as Oakhurst Company, Inc. in Sterling Heights, Michigan in 1955, Sterling Infrastructure was a company that was heavily civil engineering focused. In fact in 2015, not even 10 years ago, Sterling Infrastructure's operations were 95% civil engineering. However, since then, the company has successfully acquired companies that have led them into new markets and opportunities.
The company has seen its share price grow over 140% over the past year, with 2023 being a really robust year for the company. 2023 saw record high EPS with Q2 and Q3 reports reaching $1.28 , representing 49% and 31% YOY growth respectively. The industry as a whole had a great year amid massive increases in infrastructure spending such as the Infrastructure Investment and Jobs Act which promises $1.2 trillion allocated for infrastructure construction and improvement. With a valuable array of subsidiaries (and actively acquiring more), little debt, sizable cash on the books, and growing demand, I think Sterling is a "Buy" and could capitalize on this growth and provide a handsome return for investors over time. However, the current price point for Sterling is higher than I would like, and I advise to let the stock cool down before beginning exposure.
Revenues
As stated above, Sterling breaks down their business into 3 segments: e-infrastructure solutions, transportation solutions, and building solutions.
Sterling's Q3 Revenue Report (Sterling's 10-Q)
This three-pronged attack has proven very successful for Sterling, as they are able to take advantage of multiple opportunities simultaneously. The company has seen strong YOY growth across the board in the nine reported months of 2023. Specifically in Q3, there has been a large increase in building and transportation solutions YOY, with growth of 22.75% and 41.25% respectively. E-Infrastructure, although fell YOY for Q3, is still up 9.4% annually. However, it is important to keep in mind that some of this growth is attributable to price inflation rather than strictly volume.
Sterling's e-infrastructure solutions are their fastest growing part of their business, and has driven much of the revenue growth in recent years. Much of this growth comes from the increased demand for advanced manufacturing, data centers, and e-commerce distribution centers. The data center market has been the largest driver here , with technology such as AI and other technological advances increasing demand for data centers across the country. Sterling has seen the demand for e-commerce and small warehouses decrease over the past year, but that has been offset by continued increases in data centers and advanced manufacturing. McKinsey & Company expect the demand for data centers to grow at an annual rate of 10% until 2030, shining light on the continued opportunity for growth in this sector. Advanced manufacturing, a top priority of the National Science and Technology Council , will also continue to be a driver as governments and corporations strive to enhance environmental sustainability and strengthen domestic supply chains. This dedication to advanced manufacturing has been shown by the CHIPS Act passed in 2022, which allocates over $50 billion for domestic semiconductor manufacturing. All of this pent up demand for their services can be seen in the backlog (RPOs) for their e-infrastructure line of business which comes in at almost $900 million , up 47.7% YOY.
Sterling's transportation solutions business has been a steady and reliable part of Sterling's revenue since it acquired Road and Highway Builders LLC in 2007 . However, their revenue has been significantly boosted in recent years by the increased spending on American infrastructure such as the $1.2 trillion Infrastructure Investment and Jobs Act I mentioned in the introduction. According to the American Road & Transportation Builders Association , the overall value of state and local government transportation contract awards are up 10% YOY over an already record breaking level in 2022. Highways have specifically been a large focus of the infrastructure investment, as about 39% of 2022 federal transportation and infrastructure spending was for highway transportation. This has led to a record backlog (RPOs) for their transportation solutions line of business of over $1 billion , up 43% YOY. Sterling and their subsidiaries look poised to continue to receive their fair share of contracts in the payday that has been hitting the transportation infrastructure sector.
Sterling's building solutions consist mainly of their concrete foundational building companies, specifically Tealstone, which they acquired in 2017 . The growth in building solutions can be attributed to an increase in residential and commercial real estate and development demand YOY, led by the forecasted easing of interest rates which has eased mortgage rates. Sterling reported that they poured a record high number of concrete slabs in Q3 of 2023, with the majority of the growth coming from increased residential demand. The growth was also spurred by an additional $9.8 million in quarterly revenues from an Arizona concrete foundation business acquired in late 2022 . Sterling expects this part of their business to continue growing as commercial and residential demand for real estate climbs its way back from their sky high interest rates lows. Sterling also purchased Professional Plumbers Group for $50 million + incentives , in November of 2023, and integrated the company into their business solutions segment. The company is a provider of plumbing services for residential home builders in the Dallas region and has annual revenues upwards of $50 million. Sterling again seems eager to capitalize on this home building increase as it snaps up another link along the home building chain with this move of vertical integration.
Valuation & Financials
Sterling has rock solid books, with high cash on hand, low debt, and hefty accounts receivable. Sterling ended Q3 with $409 million in cash on its books, compared to its total debt of $415 million. That represents a 179% YOY increase in cash on its books, setting up the company with stability and flexibility as we enter uncertain times. Their accounts receivable also showed an improvement in their collection rates with a decrease of 10% YOY to a still hefty $448 million. Their debt shrunk to $415 million representing a decrease in 16% YOY and is the third straight quarter of double digit debt decreases. This is where I think Sterling truly sets itself apart from its peers. Sterling is able to finance acquisitions and grow operating activities using very little debt/leverage and has been able to grow quite rapidly with their debt falling (and without share dilution). That is a very promising combination, and Sterling outshines its peers in this category.
Even after the superb run of growth Sterling has had over the past year, the stock is still relatively undervalued in comparison to its peers. The stock boasts an impressive EV/EBITDA of 10.11x which is almost 19% lower than the sector average. Not only are the earnings of the company very robust, but the cash flow into the business is very high. In Q3, the company received cash inflows upwards of $130 million , a 78.8% increase YOY. This impressive cash flows reveals some deeper value with a Price/Cash Flow of 5.97x which is 52.42% below the sector average.
Even though these metrics seem to indicate that the stock is undervalued, a lot of stocks that are seemingly "undervalued" never reach their "fair" value, and vice versa. However, Sterling has seemingly gained the momentum to reach its "fair" value, hence the over 100% YOY increase in share prices. I think Sterling has been, and still is, relatively undervalued for its projected earnings and track record thus far. They have put up the numbers to justify such an increase, showing promising growth throughout the year and on all fronts. This momentum is great and shows that investors have confidence in the value of this company but can also be a bad thing when confidence goes too far. I believe that the share price of nearly $80 is fair, given the financials of the company, I believe there will be better entry points in 2024. As construction begins to cool down in the winter months, I believe some of the hype surrounding the stock will fall off. I believe some of this has already been happening, with Sterling falling 12% so far in 2024. I wouldn't be too worried about this as long as you have a long term focus. When a stock grows over 100% YOY it attracts a lot of kinds of investors, some of who are looking to make short term profits. This can be an additional fuel for share price growth but can also be a catalyst for price dips. This is one of the few cases where I think that the 100% YOY growth was not only justified, but not enough.
However, I do think there is a good amount of support at the $75 mark but wouldn't expect a pop over that to last until Q4 earnings come out in March. Worst case scenario is it breaks the support at $75 and falls down to the $60 price range where the next support is. The $60 range is where I see Sterling sliding more towards as construction hype slows, and I think it provides a much better opportunity for profit than the current price point.
Risks
Sterling's biggest challenge will be the competition for their operating markets and sectors. They have no real moat surrounding their company besides their track record of good work and the expertise of their personnel. As the government beings and handing out more contracts, and the housing market starts getting into full swing, we might see increased competition for Sterling in a lot of their markets. This could squeeze revenues and margins for Sterling as they attempt to cement their place in the infrastructure hierarchy. A lot of their competition could also come from outside their current competitors, with defense companies trying to get in on the recent infrastructure and engineering push. However, Sterling seems to have a full and growing backlog of projects, which leads me to think that Sterling has more of a pull in their local/regional markets than previously thought. The good news is that Sterling has been doing everything in its power to eliminate this risk, such as diversifying its lines of business and specializing. They are doing the right thing by not trying to take the whole cake, as they know the limitations of their size and scope. They are specializing in very specific areas and spots along supply chains and phases so that they can make they can get a piece of the cake, sort to speak. This is bolstered by the financials of Sterling, which allows it to be much more flexible than its competitors in the case of a loss of market share. This could come in the form of acquiring a competing company, or investing more in certain areas of their business, etc.
Conclusion
Overall, I would say that Sterling definitely deserves a "Buy" due to its potent three-pronged business approach, a ton of cash on the books, very little debt, great cash flow, and pre-existing roles in multiple fast growing industries. We have been and could continue to see a slide in the share price, but I believe that only provides a better opportunity for exposure into the company. I think the company could easily end 2024 near or over $90/share if current market conditions hold.
For further details see:
Sterling Infrastructure: Long-Term Winner, Better Entry Points