2024-01-02 17:02:41 ET
Summary
- Sterling Infrastructure, Inc. is a $2.7 billion market cap firm operating across E-Infrastructure (45%), Transportation Solutions (35%), and Building Solutions (20%) segments in the United States.
- Based on what I can see from the company's latest Q3 results, the management's words regarding end market tailwinds are indeed coming true.
- STRL does not look like a highly undervalued company today, but its success in terms of margin expansion against the backdrop of rapid backlog growth can only inspire admiration.
- STRL's strong margin expansion and backlog growth suggest underestimated EBITDA and EPS consensus estimates, possibly leading to a re-rating with a +19% upside.
- Therefore, I have decided to reiterate my previous 'Buy' rating.
Intro & Thesis
I commenced coverage of Sterling Infrastructure, Inc. ( STRL ) stock in mid-July 2023 when its share was trading at $59.11. Since then, the stock has experienced an impressive surge of nearly 50%, outperforming the broader market, which has grown by 6.75% during the same period. However, this upward trajectory has not been entirely consistent. Throughout the fall season, there was a notable consolidation in the STRL share price, prompting concerns among investors about the viability of holding this small-cap representative within the Industrials sector . In response to these developments, I conducted a comprehensive update of my coverage in mid-October and, after careful analysis, reaffirmed my 'Buy' rating. Following a brief period of volatility, STRL once again demonstrated its resilience, registering a gain of ~24%, outpacing the broader market's 15.23% growth.
Sterling is still one of the top-rated stocks here on Seeking Alpha:
In my opinion, STRL has this status quite rightly: this stock still looks like one of the most promising ideas on the market despite its 169% year-on-year growth .
Why Do I Think So?
Sterling Infrastructure, Inc. is a $2.7-billion market cap company operating across E-Infrastructure (45% of Q3 FY23 revenue), Transportation Solutions (35%), and Building Solutions (20%) segments in the United States. The company specializes in site development services, infrastructure projects, and concrete foundations. Notably, it strategically divested its partnership with Myers & Sons Construction in December 2022 to improve margins.
As I mentioned last time, Sterling Infrastructure's management foresees long-term growth opportunities in E-Infrastructure (data centers, manufacturing), Transportation Solutions (federal and state funding), and Building Solutions (residential and commercial demand).
Based on what I can see from the company's latest Q3 results, the management's words regarding end market tailwinds are indeed coming true. Sterling reported a record quarter with diluted EPS at $1.26, reflecting a significant 25% increase from the same period in FY2022. The company couldn't beat the revenue consensus , but it sustained strong growth of 13.7% (11.7% organically) and maintained a robust backlog, surging by 42% since the beginning of the year, exceeding $2 billion.
Operating cash flow reached $150 million, contributing to an impressive total cash position of $409 million (i.e. ~18% of the whole market cap as of today). At the same time, a look at the company's liquidity position shows that it is at one of the highest levels in recent years.
Emphasizing a strategic focus on acquisitions and adherence to the "Sterling Way" principles, the latest earnings call highlighted anticipated growth opportunities in E-Infrastructure, Transportation Solutions, and Building Solutions (kind of the same vision as in the past quarters). At the same time, the company does not want to sacrifice margins as it expands its operating activities; on the contrary, STRL is trying to push ahead with margin expansion.
Indeed, the company's profit margins were significantly better than in previous quarters and approached the highest in Sterling's public history:
I expect this trend to continue further because so far STRL's gross margin does not even reach the industry median .
Regarding future projects, the CEO mentioned that the large projects planned to bid in 2024 and 2025 are multi-billion dollar endeavors, similar in scale to the recently announced record bookings. He emphasized that the company's backlog is strong, up over 40% from the beginning of the year, indicating a positive growth trajectory.
With the company raising its full-year guidance, and projecting a 32% growth in EPS over FY2022, Sterling Infrastructure's management team looks optimistically toward continued success in FY2024, supported by a favorable financial outlook, a strong backlog, and a healthy cash position. And judging by how management’s words were implemented in the recent past, I have no reason not to believe in this outlook today.
As far as STRL's valuation is concerned, the stock still looks attractive despite the strong rally in recent months.
From a historical perspective, however, the STRL share looks somewhat overheated with an EV/EBITDA of 10.46x for the coming year [based on YCharts data].
However, I think the stock could continue to rise despite the already high multiples, as the Street appears to be ignoring the company's potential for margin expansion.
If we maintain the same EV/EBITDA level as today and with an EBITDA expansion to only 14% in FY2024, we get an implied enterprise value of ~$3.25bn. After deducting net debt, I calculate upside potential of ~19%, so I reiterate my previous 'Buy' rating on the stock.
The Bottom Line
Every investor should keep in mind, that buying Sterling Infrastructure stock involves risks, including the company's sensitivity to economic downturns and the cyclical nature of the construction industry, which can impact demand for its services. Dependency on government contracts exposes STRL to changes in government policies and budget allocations. Potential project delays, cost overruns, and intense competition in the construction industry are additional risks, along with the geographic concentration of operations. Material cost fluctuations, political and regulatory uncertainties, and the vulnerability to weather-related disruptions are also notable factors that investors should consider when evaluating the potential risks associated with investing in STRL stock.
Despite all the potential risks, STRL does not look like a highly undervalued company today, but its success in terms of margin expansion against the backdrop of rapid backlog growth can only inspire admiration. I believe that Mr. Market is still underestimating the prospects for its EBITDA and EPS growth today, which will ultimately lead to a re-rating and realization of the upside potential (+19%) I calculated in today’s article. Therefore, I have decided to reiterate my previous 'Buy' rating.
Thank you for reading!
For further details see:
Sterling Infrastructure: Still Top-Rated, Still Attractive