Sterling Infrastructure

Moat: 2/5

Understandability: 3/5

Balance Sheet Health: 4/5

Sterling Infrastructure, Inc. is a leading provider of infrastructure and e-infrastructure solutions, operating through several segments including Transportation, E-Infrastructure, and Building Solutions, mainly in the US.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview

Sterling Infrastructure, Inc. (STRL) operates in the infrastructure sector, offering services in three main segments: E-Infrastructure Solutions, Transportation Solutions and Building Solutions.

E-Infrastructure Solutions: This segment focuses on infrastructure projects essential for the modern economy, including wastewater treatment facilities, water delivery systems, and data centers. These projects often involve advanced technology and intricate engineering.
Transportation Solutions: This segment is primarily focused on building critical roadways and highways, as well as airport infrastructure including runways, taxiways, and terminal expansions. Projects in this segment can be publicly funded, and often require complex multi-year planning and large-scale execution.
Building Solutions: This unit handles construction for single and multi-family homes, industrial structures, and other types of building projects. Projects in this segment are generally more sensitive to economic cycles than projects in other sectors.

Industry Trends and Competitive Landscape

The construction industry in which STRL operates is highly competitive, with many companies, both large and small vying for projects. The competition is intense and companies tend to bid on jobs at very low margins. The markets are generally fragmented and regional, with local players often having an advantage because of proximity, customer connections, or other factors. However, given the increasing complexity of projects, bigger and more integrated firms are capturing increasing market share. The industry is sensitive to macro economic factors, including interest rates, government spending, and cost of labor.

What Makes Sterling Unique?

What makes the company different is the range of projects they do across the transportation, industrial, and building sectors. This diversification is coupled with a willingness to handle large and complex projects. Also they state they have a focus on technology and innovation. The management also highlights the importance of their employee base, as well as their strong ability to get large, multi-year contracts.

Financials Analysis

Revenues: STRL’s revenue is mainly dependent on the Transportation Solutions and E-Infrastructure sectors. For 9 months ending 2023 revenues were ~600 million for transportation and ~ 500 million for e-infrastructure. Building solutions came in around 300 million. Overall, revenues were around 1.5 billion for 9 months ending September 30, 2023. While this looks quite diversified across 3 segments, the majority of revenues are coming from very few projects.
Gross profit and margins: STRL’s gross profit margins are quite good in general, with a gross profit margin around 16%. Margins tend to vary across business segments, with building solutions having the lowest and infrastructure having the higher ones.
Cash flows: During the first 9 months of 2023, their operating cash flow was 333.3m. From an investor viewpoint, FCF is a far better measure to calculate a business performance and it was around 200m, which is still quite solid. The company seems to generate lots of cash which is used in investments, acquisitions, and some debt repayment.
Debt: The company has significant debt as can be seen in the balance sheets. While the business is generating significant cash flow and earnings, this debt is of concern. Debt was ~ 1.4B on Sep 30 2023 compared to 1.2B in Dec 31 2022.
Profitability: Overall, the company generates decent and positive profits. Net income for the first 9 months of 2023 was ~68 million. The profitability is quite volatile with high dependence on project execution.

Moat Assessment (Rating: 2/5)

The company does benefit from economies of scale in terms of being able to bid for large and more complex contracts, but it’s not clear that it gives the company any sustained competitive advantage.
Some level of local and regional knowledge is essential in the business, which provides somewhat of a limited moat in the markets they operate in.
The ability to secure long term contracts, however, makes the business relatively predictable and can be considered somewhat of a moat.

Based on these factors, STRL receives a moat rating of 2 out of 5. While there are some elements that contribute towards some form of competitive advantage, most of them do not offer a strong or wide enough moat.

Risks to the Moat and Business Resilience

Competition: The industry is highly competitive, and price competition can be fierce. Competitors could also attempt to gain market share by replicating STRL’s cost structure and technologies.
Project Risk: The company works on large and complex projects, and a number of issues can derail the project execution - such as delays, cost overruns, supply chain issues, etc. Poor project management can directly impact revenue and profitability.
Economic Sensitivity: STRL’s performance is tied to economic activity, government spending, and interest rates. A major economic slowdown could have a significant impact on the business.
Dependence on Key Employees: The business relies on some key employees to source and execute contracts. Departure of these people can have a major impact.
High Debt: The company’s debt levels are high, leading to financial risk especially when considering interest rate rises. They may find it difficult to renew debts under unfavorable terms. This would have a significant negative impact on the business as well.
Reliance on Acquisitions: Although management emphasizes that their growth is primarily organic, a portion is attributable to acquisitions. Acquisitions can expose the company to integration challenges, cultural clashes, and unforeseen liabilities.

Understandability Rating (3/5)

Sterling’s business model is relatively straightforward in that it provides construction services. The business operations are fairly predictable, but there are some parts that are more complicated:

The company is involved with multiple sectors, each with its own unique dynamics,
A number of their revenues come from few key projects,
The accounting and revenue recognition policies require more understanding.

For these reasons, STRL has a “Understandability” rating of 3 out of 5.

Balance Sheet Health (4/5)

The company has significant debt which may be a cause for concern. A debt-to-equity of ~ 2 times seems a bit high for a company in an industry with cyclicality.
The company has a good current ratio, which shows that it is able to pay off its near term liabilities with short term assets.
The company seems to be generating significant cash flow, which reduces some concerns regarding its ability to cover its debts.

Given these positives and negatives, STRL’s balance sheet health is given a rating of 4 out of 5.

Recent News and Concerns

Revenues & Margins: The company beat the estimates for its last quarter results by a wide margin, but missed the overall consensus. However, revenue growth continues to be strong. There was a slight compression in margins, however.
Cost Overruns: In recent earnings call, the company has acknowledged that inflationary costs and issues with contracts for some specific projects resulted in margin compression, while these issues will continue to plague the industry.
Acquisition: Company recently acquired a 55% stake in a company called Simon & Sons, LLC for 51 million. It will be a key focus of management to ensure smooth integration while creating synergies.

In summary, while STRL is a business with its own inherent risks and challenges, it is important to also note its positives and strengths. The management has been able to execute well on most of its contracts with reasonable profitability. However, the risk is high and any new issues with projects or with its financials may cause significant volatility. It is of utmost importance that investors stay on top of the company’s results and future plans.