Tetra Tech, Inc.

Moat: 2/5

Understandability: 3/5

Balance Sheet Health: 4/5

Tetra Tech, Inc. is a leading global provider of high-end consulting and engineering services, focusing on water, environment, sustainable infrastructure, renewable energy, and international development projects, primarily for U.S. federal, state, and local government clients, with a growing commercial component.

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: Tetra Tech operates as a global consulting and engineering services company, providing a broad range of solutions across diverse industries. The company’s core competencies span water resource management, environmental services, sustainable infrastructure, renewable energy, and development programs, primarily for government clients (federal, state, local, and international) with a growing commercial component. They operate through two main segments: Government Services Group (GSG) and Commercial International Services Group (CIG).

  • Government Services Group (GSG): This segment provides various services to U.S. federal, state, and local governments, including infrastructure, water, environmental, and international development. It encompasses everything from planning, designing, engineering, to project management, and construction management.
  • Commercial International Group (CIG): This segment caters to commercial and international government clients, offering expertise in infrastructure, water and natural resource management, sustainable development, and renewable energy projects. Notably, CIG also offers a range of services to support private companies in the mining and energy sectors.

Revenue Distribution: Tetra Tech generates revenue from multiple sources:

  • By Client Sector: Historically, US Government clients were the largest part of the company, primarily via contracts with U.S. Federal agencies. However, over time, there has been a greater focus on local US governments (state and municipal), commercial contracts, and International contracts which made up nearly two thirds of the company’s income in 2022-2023. The international segment’s growth appears to be strong and gaining prominence in recent years. In the latest quarter, the US Federal government is 28%, US state and local is 30% and Commercial is 42% in their segment revenues, highlighting a well-diversified revenue streams.

  • By Contract Type: The company’s revenue comes from Fixed-Price, Time-and-Materials, and Cost-Plus contracts. Fixed price contracts provide revenue stability, Time and Materials provide profit margin stability.

Industry Trends: The markets for TTEK’s services are generally strong given increasing concerns about infrastructure development and the impact of climate change, and the need for more sustainable solutions. These trends are impacting government budgets and spending, which could impact the revenues of the company.

  • Infrastructure Investment: With aging infrastructure in many countries, and the push for sustainable energy solutions, there is increased demand for planning, design, engineering and project management services.
  • Water Resource Management: Companies focused on water resource management have an increasing importance given increased risk of droughts and natural disasters worldwide, which creates the need for more resilient systems and infrastructure.
  • Environmental Regulations: Heightened regulations on emissions and pollution control are also leading to increased spending on environmental services.
  • Renewable Energy: The increased push for more renewable energy sources also benefits TTEK by needing the type of consulting they offer.

Margins and Profitability: The gross margins are approximately 20%, which are relatively thin for a consulting and engineering company, because a large portion of their expenses are direct costs with their sub-contractors, which have to be expensed. They also have strong operating margins, hovering around 9%. The company’s profitability depends on their ability to control operating costs and winning project contracts. Net profit margin is approximately 6%.

Competitive Landscape: The industry is characterized by intense competition, with small to large sized local, national and international companies vying for a limited amount of project contracts. The main points of competition include project expertise, price, and ability to deliver high-quality results on time, and often times the companies try to compete with government entities, which may affect their overall market share.

  • Global Competitors: A few of their global competitors include Jacobs Engineering, AECOM, and Bechtel Corporation, which all have more diversified portfolios than Tetra Tech. However, TTEK benefits from strong client relationships and high-quality service.
  • Local Firms: In addition to multinational companies, many local companies are specialized in one specific area of consulting and engineering and compete for the local contracts.

What Makes Tetra Tech Different: The company differentiates itself with its highly trained and specialized engineers, who have extensive experience in the type of projects they offer, which allows them to produce high quality and technically complicated solutions. They also have a diverse portfolio that allows them to be resilient when certain segments are down. They also prioritize employee training and development, which reduces turnover, maintains high standards, and is a unique business model.

Legitimate Risks: These risks could erode the company’s moat and business resilience: 1. Economic cycles and government spending: As noted, government contracts constitute a large portion of their revenue, especially in a bad economy, or changes in budget or policy, which could negatively affect their revenues. 2. Price competition: While they are competing in the high-end engineering services, high price competition can impact the profit margins of the business. 3. Technological disruption: Although the company is providing infrastructure solutions, changes in technology such as automation and new manufacturing processes can affect their revenues. 4. Geopolitical and international events: Since a significant amount of revenue is generated from International markets, events such as local disputes, economic downturns, and changes in government policies could harm the business. 5. Project Delays and Execution: Since TTEK works on big projects, delays in those projects, caused by weather or other factors could impact their profits and revenue. Similarly, faulty analysis or execution may also cause severe profit problems. 6. Talent and employee retention: The company relies on highly trained employees, and if the company cannot attract and retain the best employees, this may affect the company’s ability to deliver successful projects. 7. Acquisition Risk: the company has made a few acquisitions in recent years, and this brings the possibility of overpaying for the acquisition, or bad integration of the acquisition.

Financials: The company’s financials reveal a stable and growing company. Some notes about recent financials:

  • Revenue Growth: The company’s revenue has shown consistent growth over the past few years. In the latest quarter of Q3 FY24 (reporting on July 2024) they had 22.4% growth compared to Q3 2023, driven by acquisitions and organic growth in their global segments.
  • Profitability: While gross margins are relatively thin due to sub-contractor expenses, their operating margins have been consistently improving.
  • Backlog: They have reported that their backlog increased substantially and are expecting this to translate to future revenue.
  • Free Cash Flow: They have positive cash flows, which they use for acquisitions and share buybacks.
  • Balance Sheet: As of the latest reports, TTEK has a good cash balance of about $150-$180 million, and the total debt in their books are around $400-500 million, with a majority of it on their revolving credit. Current assets are about double the amount of the current liabilities, which indicates good financial health. A large part of their assets is in goodwill from acquisitions.

Recent Concerns and Management Response: There has been increased emphasis and worries from analysts about increasing competition in the industry which is affecting company pricing and their profit margins. In a recent investor call, management has responded that these price competition concerns were mostly temporary, and that they will revert as the contracts get re-negotiated. Additionally, there has been worry about the high amount of intangible assets from acquisitions, which may lead to future impairments and lower stock prices. The management’s position was that these acquisitions made great return on invested capital. Moreover, there has been scrutiny on stock based compensation which management expects to bring into better alignment with their peer group.

Moat Rating: 2 / 5. While Tetra Tech has some competitive advantages like customer lock-in through strong relationships, expertise in technical field, and some regulatory approvals, the business is not one that generates the highest of return on invested capital, and is facing some headwinds from competition and a reliance on government spending. Understandability Rating: 3/5. The business model is relatively easy to understand, but there is a lot of complication in the type of projects that TTEK takes on, which may make it harder to estimate the earnings with accuracy. Balance Sheet Health Rating: 4 / 5. Good liquidity with increasing cash balance and low debt burden.