Stantec (STN): Sector Advantages vs. Valuation Disadvantages

Stantec (New York Stock Exchange: STN) is a hidden gem in the industrial sector. A company specializing in sustainable construction and infrastructure projects, it has experienced double-digit growth in revenue, earnings per share and EBITDA in recent years, while increasing its dividend between 6% and 8% over that time. The forward P/E of 26x is high, but should return to the company’s historical averages if growth targets for 2025 and 2026 are met. I believe Stantec is positioned to thrive in the future and have it on my watchlist. It may be a particularly attractive investment opportunity for those looking to grow their portfolio with small- and mid-cap dividend growth companies.

Selection process

My exposure to industrial stocks is mainly through SCHD and DGRO, which have LMT, UNP and CAT among their top ten weightings. Given the diversity of the sector and my interest in adding some small and mid-cap companies to my portfolio, I looked at the following:

Market capitalization	Maximum 10 billion dollars
5-year revenue CAGR	min. 8%
5-year EPS CAGR	min. 8%
Operating Income 5-Year CAGR	min. 10%
Future dividend yield	min. 0.5%
Dividend growth in 5 years	min. 6%
Years of growth	min. 8 years
Payout ratio	Maximum 30%
Beta	Maximum 0.9

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Only two companies met this strict combination: Franklin Electric (FELE) and Stantec. While both performed incredibly well over the past five years, easily outperforming the broader market, Stantec stands out with a higher overall Quant rating and double-digit growth across virtually every metric.

Business model and thesis

Stantec is organized into five primary business segments: Integrated Building and Architecture Solutions, Energy Solutions, Environmental Services, Infrastructure Solutions, and Sustainable Water Resources. This comprehensive scope enables the company to manage projects from initial planning and design through construction, management, maintenance, and even decommissioning. Stantec operates throughout North America and has a permanent presence in the United Kingdom, Australia, Saudi Arabia, and the United Arab Emirates (among other countries), serving both public and private sector clients.

Stantec has A declared focus on sustainability and a track record of attracting clients who prioritize environmentally conscious projects. As an example, the company recently received the A five-year contract for 104 million dollars To manage a critical infrastructure project for Los Angeles that will improve the quality and reliability of the city’s water supply. Stantec will oversee the entire process from planning and design to completion in approximately 2030.

Stantec should continue to benefit from increasing demand for sustainable infrastructure, driven by demographic trends (e.g., aging populations), urbanization, and global efforts to mitigate the effects of climate change. The company recently reported its largest project pipeline in its seventy-year history ($7.2 billion) along with double-digit organic growth in recent quarters. In summary, I view Stantec as an attractive investment opportunity because it operates in industries with long-term tailwinds and is internationally recognized for its ability to successfully manage complex projects from start to finish.

Recent performance

Given the limited coverage of Stantec on Seeking Alpha this year, I'll briefly recap its performance over the past two quarters:

In the first quarter of 2024, revenue increased by 12% year-on-year, exceeding the 11% recorded in the first quarter of 2023. Earnings per share increased by 23%, well above the comparable growth seen in the prior year. This was driven by a combination of organic expansion and strategic acquisitions, the latter including ZETCON (in Germany) and Morrison Hershfield (in Canada). Adjusted EBITDA also showed a modest improvement compared to the prior year.

Second quarter results were also positive, with net revenue up nearly 17%, up from 14% in the second quarter of 2023. Again, this was driven by a combination of organic growth (7.1%) and acquisitions (8.8%), this time including the purchase of Hydrock (in the UK) for an undisclosed amount. Together, these acquisitions increased Stantec’s business assets while also helping it mitigate labor shortages by retaining its skilled workers. The company also raised the low end of its net income guidance to 12% (from 11%) and slightly increased its EBITDA margin target to 16.5% (from 16.2%) by the end of 2024.

Looking ahead, the company has provided the following targets for fiscal year 2026, which suggest continued strong performance:

Valuation and price targets

Forward-looking EPS estimates through 2026 remain quite optimistic:

Based on these projections, Stantec is currently trading at around 22.2 times the fiscal 2025 consensus estimate of $3.61 and 19.9 times the fiscal 2026 estimate of $4.02. Both are comparable to the industry median (a forward P/E of around 22) and substantially below Stantec’s five-year average P/E of 27. If the stock price were to return to 27 times earnings, it could approach $97 by the end of 2025. While this looks favorable, most of the company’s valuations over the past five years are higher than their own five-year averages, reflecting the 275% share price appreciation over that period:

Valuation	Current	5 year average.	Difference
Non-GAAP P/E	27.6	24.2	+14.0%
GAAP	36.0	34.9	+3.1%
EV/EBITDA	19.9	17.5	+13.3%
Dividend yield	0.75%	1.12%	-33.1%

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Based on the ambitious projected EPS growth of around 15% annually through FY26, Wall Street analysts have a Average target price of $91.50suggesting that the stock is undervalued by around 14%. This is just below my preferred margin of safety for the sector (15%).

I rate Stantec as holdThe company has shown spectacular growth over the past few years, and while the projected EPS growth rate appears to support the current share price, other valuation metrics are simply way above their historical comparisons. I will keep Stantec on my watch list and wait for a more favorable entry point.

Risks

In addition to the more general risks affecting the entire industry and detailed in the company's report, Annual Report 2023I see the following as potential threats to the investment thesis outlined above:

1. Dependence on government contracts – A significant portion of Stantec’s revenue comes from government-funded projects. While lucrative, these contracts are vulnerable to delays resulting from changes in government policy (to put it politely).
2. Procurement dependency – More than half of Stantec's recent margin expansion has been driven by acquisitions. Looking ahead, I would prefer to see the focus on consolidating these assets and shifting the remainder to organic growth.
3. Integration risks – Relatedly, any acquisition can bring with it unforeseen integration challenges, and adding debt to finance these deals can put pressure on profitability.
4. Competitive pressures – Stantec competes with larger companies such as WSP Global (OTCPK:WSPOF) and AECOM (ACM), as well as smaller local specialists. With a mid-size footprint, it may not have any competitive advantage in the future.
5. Concerns about valuation – The stock price has been rising steadily since March 2020. The current forward P/E of 26x may have already incorporated much of the expected growth over the next year or two, limiting upside potential.

Summary

I find Stantec to be an interesting investment opportunity due to its diversified business model, which allows for the management of complex projects from start to finish. The company appears well positioned to take advantage of the growing global demand for sustainable infrastructure, as reflected in its record-breaking project pipeline. Strategic acquisitions have played an outsized role in Stantec’s growth, with its market capitalization increasing from $2.4 billion to about $9.5 billion in just five years. During this time, the company has posted some of the strongest financial results in the entire industry, but that has coincided with a nearly 275% increase in the share price. While it is an excellent company, Stantec’s current high valuation keeps it on my watch list for now.