An essential power name earns a premium return as the backbone of the industry
Thanks to the unique geopolitical factors of 2022, the energy industry is experiencing a renaissance. At Valens, we have highlighted multiple O&G names, but we also recognize there is more to the industry than the drillers of the world.
This is where Quanta Services (PWR) comes in. It provides the infrastructure to support these companies—pipelines, fiber optic cables, and everything needed to run a well site.
Despite this critical service in 2022, GAAP would have you believe that the company hovers around 5% ROA…nothing special for a supposedly essential company.
When Uniform Accounting is used, however, a clearer picture of better returns and growth create a case for the strength of Quanta Services.
Also below, the company’s Uniform Accounting Performance and Valuation Tearsheet.
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With all the volatility in the market over the course of 2022—with fears of inflation and wars—it can be hard to discern exactly what trends to invest around.
Here at Valens, we’ve been pounding the table on how the supply chain supercycle will dictate the spending trends of corporate America for years to come.
To combat inflation, the Fed has been steadily ratcheting up rates to combat excess spending leading to inflation. However, this inflation can only be fixed by solving the supply side as well— capex.
This is what is driving the massive amounts of investment coming down the pipeline. Companies recognize they’ve underinvested since the Great Recession, which investment put off by the pandemic as well. Now to prevent losing out to the competition, they have to make up for lost time.
So, these tailwinds for the economy are creating large pockets of value. One of these pockets is the power industry.
The power industry is the generation, transmission, and distribution of energy. A wide-ranging industry accounts for anything like construction of power lines or supplying electricity to apartments.
Part of this investment wave is also the move to cleaner energy. Whether that be natural gas, renewables, or even nuclear power.
However, no matter what kind of energy spending occurs, Quanta Services (PWR) is going to benefit on the back of huge capex spending.
The company provides network infrastructure for electric power, pipeline, industrial, and communications services. Quanta, in essence, builds the infrastructure to deliver power to the country.
It is one of the key firms for power plants and other infrastructure. Because Quanta Services provides for this essential industry, it should be able to fetch a solid return. However, Quanta Services’ as-reported return on assets (ROA) has hovered around 5% for the last 5 years.
Returns at the cost of capital are below average and nothing special. This would wrongly leave investors to believe that the pipes and infrastructure Quanta provides for the energy industry are far from essential.
But, when Uniform Accounting is used to clean up any distortions in Quanta’s financial statements, a stronger picture emerges. Quanta Services’s Uniform ROA has instead hovered around 10% each year and is improving with demand.
Despite a weak year for power investment following the pandemic, returns for 2021 still reached 9% ROA, following a 14% ROA in 2020. This improved from 11% in 2017, and is a number Quanta Services should be able to hit again as demand increases through 2022.
The supply chain supercycle has led to trends such as the power industry investment we are seeing. Quanta Services, with stronger ROA than Wall Street will have you believe, is perfectly positioned to capitalize on this infrastructure investment. As an essential in infrastructure construction, it will be a clear winner as shown by Uniform Accounting.
SUMMARY and Quanta Services, Inc. Tearsheet
As the Uniform Accounting tearsheet for Quanta Services, Inc. (PWR:USA) highlights, the Uniform P/E trades at 28.0x, which is above the global corporate average of 19.3x, and its own historical P/E of 19.8x.
HIgh P/Es require high EPS growth to sustain them. In the case of Quanta Services, the company has recently shown a 37% growth in Uniform EPS.
Wall Street analysts provide stock and valuation recommendations that in general provide very poor guidance or insight. However, Wall Street analysts’ near-term earnings forecasts tend to have relevant information.
We take Wall Street forecasts for GAAP earnings and convert them to Uniform earnings forecasts. When we do this, Quanta Services’ Wall Street analyst-driven forecast is a 7% and 28% EPS growth in 2022 and 2023, respectively.
Based on the current stock market valuations, we can use earnings growth valuation metrics to back into the required growth rate to justify Quanta Services’ $142 stock price. These are often referred to as market embedded expectations.
The company is currently being valued as if Uniform earnings were to grow by 25% annually over the next three years. What Wall Street analysts expect for Quanta Services’ earnings growth is below what the current stock market valuation requires in 2022, but above the requirement in 2023.
Furthermore, the company’s earning power in 2021 is 2x the long-run corporate average. Moreover, cash flows and cash on hand are above its total obligations—including debt maturities, capex maintenance, and dividends. Also, the company’s intrinsic credit risk is 110bps above the risk-free rate.
All in all, this signals low dividend and moderate credit risk.
Lastly, Quanta Services’ Uniform earnings growth is below its peer averages, but the company is trading above its average peer valuations.
Joel Litman & Rob Spivey
Chief Investment Strategist &
Director of Research
at Valens Research