Quanta Services, Inc. (PWR) Earnings Call Transcript & Summary

Hi. Good afternoon. This is Noelle Dilts, I'm an industrial analyst here at Stifel, covering specialty engineering and construction. We're joined next by Quanta Services, which is a $5.9 billion market cap company. We are buy rated with a $46 target, and it is our select list pick. So on the line today, we have Duke Austin, CEO; Derrick Jensen, CFO; Paul Gregory, who is President of Pipeline and Industrial; as well as the Chief Strategy Officer and IR, Kip Rupp.

So we're going to jump right into Q&A. [Operator Instructions] And so with that, we'll kind of move into questions. So Duke, I thought kind of a place to start might be just around getting a bit of an update around how the coronavirus crisis is impacting your business. With the first quarter, the electric T&D business had been relatively unaffected by stay-at-home orders, but there was some -- potentially you might see more impact in the second quarter. The gas distribution business, on the other hand, did see significant impacts due to shelter-in-place orders. I'm kind of curious if these patterns are generally playing out as you expected in terms of some of the headwinds in the second quarter. And then as cities are reopening, are you starting to get back to work? And how is that trending?

Noelle, thanks for having us today. I think in general, we would say that the business is progressing as we thought, but I'll go into a little bit more detail. I think the overall demand for our services are certainly there and continue to be there. Most utilities have reiterated their capital spend plans for the foreseeable future, which is good. We're not seeing pull downs in that environment. The cities that were impacted, we talked about New York, Seattle, some in Pennsylvania and others. And I think, in general, for the most part, we're on plan to either -- we're fully back to work or getting back to work as we thought, maybe a little better in some cases, and we're not going the other way by any means. So I think it bodes well for us. Everybody has continued to talk multiyear on their programmatic spends, which we're in front of all those. So I think all the business lines and how we thought about the quarter -- in the first quarter, albeit we were somewhat reluctant to give guidance, we gave it. And I think we're doing well against the numbers that were posted, and obviously, there's some timing within the second quarter and third quarter, but in general, I think we're on track and, in my mind, are maybe a little better.

Okay. Great. That's really helpful. So then I wanted to move just kind of into strategy a bit. Since you've become CEO, of course, the strategic focus has been building out the space of small to medium project work that you expect to exhibit relatively steady market trends over time as opposed to the more lumpy project-based business. So I would say you've achieved this shift with 75%, 80% of your business coming from recurring utility customers. But I think that, given everything that's going on in the economy and with COVID, visibility is a key investor concern. So could you just talk for a moment about how to think about the visibility that you have given the shift toward MSA work? I know that customers kind of communicate their build plans to you, but to what extent are they able to -- or have they historically deviated from build plans as the economic situations have changed? And how do you think about the risk that, that could happen?

Yes. I think when you think about the utility sector, it's somewhat resilient. And as we think about it, in the past, probably 5 years ago, you would think we had load growth. And we've not seen load growth for some time now, and so everything that we were doing before COVID was not around load growth. It was around switching from coal to more renewables per se. And so as that switching occurred, that the need for transmission is still there, remains there. Every time you hear of another renewable project, it means more transmission. The system becomes more intermittent, so you have to back it up with more gas generation, batteries, whatever it may be. All those things create transmission, the need for transmission. On the distribution side, as we see storm hardening, wildfire effects, which affects both sides of the business, all those events are there, remain intact. And so the utilities are certainly looking out farther to modernize its systems for those effects of weather. And I think that's still in place, will remain in place for some time. And when they give multiyear-type guidance on our capital budgets, that's really the backdrop of the business. And that's also the case for the LDC business, which is around replacement of cast iron, steel, some plastic. And you can see it, it's very visible, it's regulated. And so as they go into their regulatory environments to get multiyear-type returns, that they have to certainly submit those plans. And we follow those plans with them, collaborate with them. I think the company has evolved to where we're looking at more programmatic spend, we're looking at larger things in nature, multiyear type, where in the past, we were looking at, call it, $1 million job to change 20 poles. And now we're looking at hundreds of millions over multiyear periods for thousands of poles, and also providing some engineering capabilities as well as some material and routing and constructability along with the customer, which is much more efficient for them and for us. And it really takes the middleman out of our business, which -- that's what the company set out to do years ago, and I think we're starting to see that pay off from telecom to electric, even into the LDC business.

Okay. That's helpful. So I guess digging into those topics a little bit more and just shifting more deeply into the electric T&D market, as you know, we've been pretty bullish on the market here, and our opinion is that we agree with you, a lot of the drivers of the strength in transmission investment are intact. So some of the key things we think about are: one, that utilities think of transmission as the preferred avenue of investment because of its return profile. As you mentioned, grid hardening, renewables integration, reliability. When you look at us potentially entering into a weaker economic period, when you look at some of those drivers, are there any that are a little bit maybe more concerning? Or where you think there's some risk versus those that you think are firmly intact? Just kind of curious how you're thinking about which of those drivers are the most important as we look out over the next 3 to 5 years?

I think the economy, in general, is getting back to some normalcy. If you had a prolonged effect of depressed economy, years, I think that you could see some pullback. And if we see that and continue to see that, there's not a need for new transmission per se. So the new transmission piece of the build could fall off some. There's a lot of stuff beating the shale basins and things of that nature, we're not seeing any of that, but that could be an issue. I personally think the economy is starting to pick back up in general. And renewables are really something that -- I don't think that's going to stop. And as long as we continue to believe, as a nation, we want to be more carbon-free and go to more of a renewable system for generation, you're going to see bigger transmission because it's necessary to transmit that load into load centers. And where they build solar or wind is not where the load is. So that's going to be there, and then everything around that, the ancillary pieces around it, to keep out the intermittency is there. And so I think you'll continue to see the build. It's going to make a small impact. Well, in my mind, it would have to be around the economy.

Okay. And so obviously, the market has shifted significantly over the past few years toward small to medium project-type work. Now we've -- for a few years, we've been watching some of the larger projects that we think are closer. You guys have also mentioned that you're tracking still a number of large project opportunities. How are you thinking about that today? Do you think that the COVID crisis continues to push things to the right? Or do you feel like there may be some larger projects coming back into the market over the next, say, 6 to 12 months?

Yes. I mean I think when we look at the electric transmission, we are executing with probably the largest project in the company's history, and one that would be in the top 5. So 2 big ones. The company is just bigger, described generally, we're still executing on large projects. We don't talk about them as much as the 2 in Canada are quite good. And I think -- when we think about the U.S. markets, there's plentiful opportunity on larger transmission product, moving wind and solar and gateways, and you have the stuff to the west. I can't think of the names of them all, but in general, there's plenty of larger type project dynamics on the west, as well as the east for that matter. We continue to hear more renewable generation. And as long as you hear that, you're going to hear a lot about transmission movement. The grids aren't interconnected as the RTOs. And until that interconnection happens, it will be a long time, and you'll continue to see those larger projects.

Great. Right. We've heard some kind of positive things about the gateway projects in the west, so I'm not sure if that may be what you're thinking of but it seems like there will be some movement there.

Yes.

So then just I think kind of the last big picture question on T&D. Obviously, fire hardening work has been a big theme here over the past couple of year plus. You kind of have been talking about expecting that to accelerate in the back half. How are you thinking about that time frame today?

I think it remains intact. One of our biggest -- bigger customers out there, PG&E, is coming out of bankruptcy. I think that helps us get some more visibility into the build. But we've always thought it would be in the back half. We're seeing some ramp there now, and I think we'll continue to see that ramp as we move into later in the third and the fourth quarter. So in my mind, that ramp's intact. And those programs are large and we talk about the larger dynamics of transmission, but the programmatic spend, they're in the billions of dollars. And those are the type of things we're looking at across North America, even into Canada and Australia. So that's something that we'll continue to keep our eyes on and believe it's intact for the second half of the year.

Okay. Perfect. So just shifting over to telecom. We've heard from a few companies at the conference, both some of your competitors as well as suppliers, that they think -- they have this view that the coronavirus crisis has kind of increased the focus on the need for strong broadband connectivity, and ultimately could accelerate wireline broadband investment over the next few years. We also had a supplier yesterday talk about that they're actually seeing pretty strong orders for broadband-related products today. So how are you thinking about potential acceleration in terms of investment in this market? And I know you've communicated that your plan is to just grow in a way that's pretty gradual and measured, I should say, so that you don't get ahead of your skis, but just curious how you're thinking about the changes to this market following the coronavirus crisis.

I mean I think the company has put itself in a really nice position. And we talked about $500 million this year. I think we, every bit, will do that and could exceed it. I agree with the comment that we see a more robust environment in the broadband side. I do think we'll push fiber deeper to the home than we had -- than we thought we would quicker. So that being said, delay in 5G may be delayed some, but the fiber piece of it will certainly make up more than we thought. So you'll get more fiber closer to the home quicker. And we see the same thing everyone else sees, is that fixed spends, and we're all having conversations with our customer -- with our end customers to develop those plans. So I like it. I like the environment, the COVID, how you work. And everybody else included is thinking about how does this change on the way we work from the office standpoint? And things that -- our cross-skilled laborers in the field, so they'll remain pretty much like they are. But from engineering and office standpoints, how do we go forward? And everyone is certainly struggling with that or thinking about it in a different manner than they ever have. And that will certainly drive infrastructure.

Okay. That's useful. So then can you comment quickly on just revisiting the Latin American exit. In the first quarter, you talked about the cost and some of the COVID-related headwinds there being a little bit deeper than you expected. Are things kind of trending in line with your expectations? Are there any -- or are there any incremental headwinds that you're not facing?

No. I think from the first quarter comments, I think we're intact at this point. We continue to make progress, handing over the network. And I think we're very, very close to having all that behind us, and be more about litigation at this point. We continue to like our case there. We continue to think that we're on the right side of that, the more we find out the better. We continue to think that, for the most part, we'll be out of Latin America, Peru, Colombia, Chile this year. We could have some ancillary spillover, but it would be very small in nature. And our intent is the same, to exit and then it will be down to the litigation.

Okay. Great. So shifting over to your P&I segment. Clearly, this is the segment that's bearing the brunt of the oil and COVID impacts in the first and second quarter. So curious, with oil rebounding a bit, if that's changing at all, how you're thinking about the outlook for the balance of the year and into next and the kind of other P&I business that's more exposed to upstream and oil directly.

Yes. I'll give a little bit of overview, and let Paul comment. I think in general, when we think about the business, in our mind, where it's less and less about oil-related and more and more about the LDC business and things of that nature, albeit the catalyst in the high voltage side of our industrial business is very much intact. The turnaround business has seen some pullback. And I'll let Paul comment, too, and he's closer to it.

Yes. I think it's the -- I think on the industrial services part of our business, it's the one piece that is suffering from a supply and demand issue. It's a global issue for our clients. So the demand for jet fuel, gasoline and diesel, which is kind of the primary products coming out of our refinery clients, it's just off significantly. I think it's a shock to the system in a lot of ways. As the world comes back from -- sort of reopens from the pandemic, we're already starting to see gasoline demand go up, jet fuel, not so much yet, but it will follow. And really, it's a matter of time, how long does it take for sort of the supply and demand equation to sort of get back into parity, and that's when our refinery clients will start spending money on capital projects again, spending money on their turnarounds. The things that they're delaying in the turnaround side of the business usually create larger programs because they're kicking the can down the road on maintenance. And so we expect that to be the case next year as we start to sort of do more of the turnaround as network comes back. The capital projects, we'll have to wait and see. But again, when the refiners see that demand for their products is coming back, they'll all anticipate that and start back the capital projects. So that's where we're hurt the most. That's our largest impact, on that part of it. The other place we've been impacted is in gas distribution, but that's kind of the light-switch effect. We had about 5 places -- cities, where we were just shut down. The utility and the city, county officials just decided that, that needed to happen. Those are places like New York, D.C., Detroit, Seattle, places like that. In all 5 of those markets, we are back to work. We are starting to ramp up at different pace in each of those. But we suspect, by the start of the third quarter, we'll be back pretty much at full speed on all of those markets. The other markets we were in, really, the gas distribution work continued, kind of like the electric work distribution, it's just -- there was really no impact. But those markets did impact us. But they're coming back. That was a onetime kind of phenomenon. We think we'll be back to full speed.

Okay. So I just did want to kind of circle back to the industrial services, what your outlook and what you're seeing there. Because I think when you issued guidance, which, again, I think the entire investment community appreciated, but there was, I think, some expectation that you saw some recovery in Stronghold as you get into the back of the year. From -- based on my understanding of the industry, it also seems like it's very difficult to get any really great visibility, just given that some of the customers can, it seems like, change plans very last minute. So I guess the 2 questions there would be, are you getting any more comfortable with how to think about the back half of the year? And second, at what point will you have some visibility or comfort around what's coming through?

Yes. I think I would just say that we still -- it's coming back about like we anticipated. And so the guidance that we gave on the -- in the last call, we still feel pretty good about. Like we think we're -- it's right in there somewhere. I would tell you that probably by the August, September time frame, we'll have a much better idea if that's improving a little more than we thought or not. But as it stands today, I would tell you that we still feel like what we guided to is pretty much where we are. So I don't think we would see any reason to change that up or down. Probably August, September, we'll have a better idea.

Okay. Okay. That's great. And so Paul, there's kind of this additional topic I wanted to explore as it relates to the mainline side of the business. I know that's a small percentage of your sales now, at about 4% of sales. But there's still some sizable opportunities out there for you in the market. So a couple of things we've been thinking about. First, the one topic I wanted to explore was this NWP 12 issue, which basically is part of the ruling on Keystone as to why it can't proceed forward in the near term, basically in validating the broad water crossing permit used on many projects. So our concern from a high level is that this could cause work to just shift to the right as some of these permitting issues are resolved. So curious how you're thinking about that dynamic. And then I think, again, when you -- in the first quarter, you communicated that you still needed to book a bit of additional work to get to that $500 million revenue target for the year, but that you felt pretty confident in your ability to do so, curious, again, if in the context of this NWP 12 issue, if that's more at risk.

Yes, good question. So I just would broadly say, we have been forecasting a slowdown in the big pipe business for quite a while now. And we've been sort of strategically maneuvering for that reality, which is, in many ways, kind of upon us now. And so yes, the business is less than 5% of what we do at this point in time. The $500 million that we guided to, I'll take that one first. We still feel okay about that. I mean I think we'll hit it. And if we don't, like if we do $400 million instead of $500 million, well, we may do another $100 million in smaller or medium-sized work that's a little bit more base business and that's under $75 million, which is where we draw the line between a big pipe contract and base business. So I don't think, from a sort of earnings standpoint, whether we do $400 million or $600 million or $500 million, it will change our bottom line really. So I would tell you, I still think we're on track, and we'll see how everything falls. We still need to book some more work to get there, but it's okay. As far as the Nationwide 12 (sic) [ Nationwide Permit 12 ] goes, yes, I do think it's going to create some push to the right. This is all being challenged in the courts and it will take some time to get through all of that. But since we've already kind of planned for a slowdown in big pipe work, we're not too concerned about it, and really, for a couple of reasons. As the pipe grid has largely been completed, the realignment of it with the shale plays, and it's a natural gas-driven change, transmission issue, but it's largely completed, with the exception of a handful of big projects that are tied up in regulatory delays and tied up in the court. So that's going to be ACP and things like Mountain Valley. And we think those will go, and we think those will probably go in 2021 or if they get some -- they get greenlighted, there's environmental windows and things will change that a little bit. But if those projects go, that's a really nice shot in the arm for Quanta and for the industry as far as big pipe goes, as it kind of cycles down, those are some of the last big projects in the Northeast to probably get built for a while, kind of the megaprojects. And then also in Canada, there's quite a backlog of large gas transmission pipe that needs to get built in Canada. It's also been held up in the Canadian regulatory cross-sell. And we're starting to see some of that free up. We're starting to bid some work, some larger projects up there that are 2021, 2022 build. So we think that's a nice way to sort of soften the roll-off of large pipe. And just strategically, so it's clear, we've not invested any capital in our large pipe businesses in a number of years. We're as big as we want to be. Where we've invested capital is things like our acquisition of Hallen, beefing up our repeatable, sustainable businesses, that was a nice gas distribution add for us. And so strategically, I think we're well positioned to handle sort of the roll-off in big pipe, at least in the markets we play in. And -- but there's some nice bright spots out there with those big projects, Keystone included, that if those go, it will be very good for us and the industry.

Great. That's really useful. So you guys have touched on this gas distribution business a few times in your comments. I guess a couple of questions there, very much longer-term around strategy. Are you feeling pretty comfortable with your footprint here? Or do you feel there's more opportunity to expand geographically? And then the other question I have is just around the margin profile of this business, which I think is better than I expected. So -- but I think it kind of ties into the bigger picture question around P&I segment margins, obviously, given the sort of change in outlook, how are you thinking about the long-term targets? And the associated question would be what role the gas distribution margins play in that margin expectation for the segment overall?

And I'll get this one. I think in general, when you look at the business, it's a portfolio, and we talked about adjusted EBITDA of double digits, and I think that remains our goal and certainly -- and is achievable. The LDC business, as we look at it today, I think it incrementally gets better. The more scale we get out of certain offices, that allows us to get in the kind of upper single digits, as we discussed. And we were well on our way to do that. And I think that whole utility business has a really good backdrop. The LDC business is part of it. It's long in nature. You can see the CapEx, OpEx budgets. And it's a nice return that it delivers. And as you look at the programmatic expense of it, whether the margins are there exactly the way -- I mean, we see the double digits already in the electric side, the gas is moving up. But there's also the component of the pull-through with our engineering services, our right-of-way services, some of the material that runs through there, all of the pull-through that we get that we're continuing to see, and I think that will get bigger and bigger with the invested capital, and that's nothing. And so your returns grow, and so your return on invested capital moves way up. And I think that's what we're all after, is the free cash and return on invested capital. So the -- while the margins are maybe -- somebody was talking today around, what it was, could it get to 12? I don't know if it can get to 12. But what I do know is that we can get more return as the pull-through comes with less invested capital. So we really like the segment. We really like the utility backdrop. It's certainly resilient, as you can see now, and I think it will remain.

Okay. Perfect. That's useful. So in the interest of time, with a few minutes left, Derrick, I was hoping that you could just give us sort of a review of how you're thinking about your balance sheet and liquidity, cash flow for the year, impacted a bit by coronavirus, but also, you tend to free up working capital as things slow down. So curious kind of how you're thinking about your positioning and also your capital priorities given the change in market conditions.

Yes. So I mean, we stick very much to our expectations of trying to maintain a balance sheet leverage profile in that 1.5 to 2x EBITDA position. That, for us, has expanded from a few years ago. We were probably pressing into the kind of just the 1x leverage, and that's grown to 1.5 and now 1.5 to 2. And that's largely in response to having increased levels of overall EBITDA and translating into increased levels of overall free cash flow. 5, 6 years ago, we were running at $500 million of adjusted EBITDA. Now you can see that, ex kind of a COVID impact, and looking more like repeatable, sustainable kind of business as usual, returning to normal, you can see adjusted EBITDA levels of $1 billion type levels. That's giving you free cash flow conversion improvements. And so you're seeing in this 40% and 50% type ranges, which is, as you've seen, against adjusted EBITDA, our guidance is for 2020. We maintain that guidance of $400 million to $600 million, which was what we guided at the beginning of the year. And while you made reference to it, it is very true, what drives our free cash flow is working capital demands. We've grown our revenues at double-digit type CAGRs over the last 10 years, and that really draws on working capital for us. However, when you see flattening of the curves and/or even a level of downtick like we've seen here now with the COVID impact on '20, that frees up working capital. Unfortunately, in '20, with the impact so distinctly on the light-switch effect of the pipeline segment, and therefore, decreasing our adjusted EBITDA expectations markedly, that's eaten up some of that capital with those lower margin profiles coming through, but offset partly due to lower CapEx. Passing reference that we -- I think we've tried to be a little conservative this year in free cash flow expectations because of -- get cautiously positioning as though that there's a chance that some could slow pay. We've not seen that dynamic yet, so we still think our free cash flow will be largely intact. And then relative to overall capital positioning, look, we do not like to choose. We want to be able to lean into double-digit growth opportunities. We want to lean into opportunistic M&A, opportunistic share repurchases and investments, and still position ourselves conservatively to allow for disruptions, COVID disruptions, large utility bankruptcy disruptions, things like that, so that we can always be positioned to not have to choose how we deploy capital because we have just a bit of conservatism in the way we're positioned. And I think you should anticipate that on a kind of go-forward basis.

Okay. Great. We're basically out of time. But curious just, Duke, if you had some closing comments around what you think are the maybe 1 or 2 most important factors that investors should be thinking about as they look at Quanta over the next few years. And kind of what you're considering as the most important drivers of your business as we look beyond the current crisis?

Thanks, Noelle. I think in general, when we think about the business, we believe that over the past 4, 5 years, we've really transformed it into a more resilient business with the utility backdrop, less projects. And look, there's no loss of the large project capability within the company, and certainly here, and we certainly see those opportunities as well. We've talked about Puerto Rico. I think it's very, very unique there. It's something that -- I don't believe the investment community has seen it yet. But in general, the resiliency of the company and what we've been able to accomplish with the backdrop and the macro environment that we see going forward and demand for our services is something that is significant. And we look forward to putting numbers up there and getting the valuations that we believe are prudent for the company.

All right. Well, thank you guys so much for joining us today. And if anyone on the line has questions that would like me to pass on to Quanta, feel free to e-mail them to me at [email protected], and I'll be sure to get them answered for you. Thanks.

Thanks so much.

Thank you.