All right, I think we're going to get started here. For those who don't know me, my name's Brian Brophy. I cover the specialty E&C space here at Stifel.
Very pleased to have Sterling Infrastructure here with us today, both the CEO, Joe Cutillo, as well as the CFO, Sharon Villaverde . Welcome.
Thanks, Brian. Thanks for having us.
Absolutely. Thanks for joining us. So, first off, Transformation, big theme for Sterling over the past handful of years. Obviously the company has performed quite well, improving margins since the team joined in late 2015. Can you talk about the progress you've made on the transformation and where you think that stands today?
Think if you step back and take a look at the company today, it's a totally different business than it was in 2015 with our three segments of E-Infrastructure Building Solutions, and we still have transportation. But I think the more important piece is if you look at kind of 2016-2019, that's where we were really focused on turning the business around and starting to build the platform for future growth.
And then if you look at 2019 to today, that platform that we set up for growth is really starting to pay off. We've seen over 20% annual compounded growth rates through that timeframe.
We've built a very cash-flush business that is able to make acquisitions.
We got net negative debt today, and we think the platform is positioned perfectly for the next three to five years to rapidly grow that not only organically with the spaces that we're in, but by adding acquisitions to those three segments today, and eventually we'll find that fourth segment to add.
Yeah, that's great. Wanted to dig in deeper on all that. Going through the segments, starting with E-Infrastructure, obviously seeing a lot of benefit from data centers and onshoring, generally in that segment. On data centers specifically, can you talk about the demand trends you're currently seeing?
How important is that business to that segment at this point, and where do you expect this market to go over the next five years?
Yeah, let's start with where it's going over the next five years. Every time we think we've predicted kind of the growth rates, they seem to keep accelerating, and we're seeing more and more entries of players coming into the space to build out data centers.
The demand is greater than the current rate of build. As we sit today, about 40% of our backlog in E-Infrastructure is now data center-centric.
If you look at our first quarter of 2024, our data center growth is up over 100% of that segment, and we see those trends continuing as we go forward. The data center market is extremely strong, and we don't see anything slowing down with that.
As a matter of fact, we're in early conversations as we start talking with our largest customers on multi-year national kind of accounts or national coverage because there's becoming more and more of a concern on capacity to actually fulfill the demand that's coming out. It's very exciting for us on the data center front.
Yeah, that's great. Moving to some of the manufacturing-related opportunities, what are you seeing there as it relates to onshoring, but also some of the semiconductor opportunities that are out there?
Yeah, first of all, we didn't think manufacturing would really start to kick in until late 2025. We saw some very early activity around manufacturing as related to battery plants, solar panels, etc.
We still think the manufacturing onshoring's in the very early innings. There's a few chip plants that are up and being manufactured. They were started before any of the infrastructure funding really came into play. There's several plants coming up in 2025 and 2026 that we're watching. The funding is not there yet, but they're working on the funding piece and the project planning.
I think the thing that people grossly underestimate is the amount of time it takes from whether it's a Micron or an Intel or whoever it is to say, "We want to build a chip plant." To the time it takes to get it built between permitting, just getting a location.
To site development. There's a lot of politics, as you can imagine, with the state, local, and federal levels to get funding and resources. But once these things take off, they're very large and they're multi-year.
We think we're, again, at the early stages. We're excited about it. We think it's going to be we still have a lot of activity on battery. We're seeing chip stuff in early phases. Starting to see a little bit on pharma. There's more and more conversation seeing a little bit on food, and we'll see what else comes back.
I would just say we can't predict anything, but with all of the craziness in Taiwan and China and the Far East, if anything happens there, we're going to see a greater acceleration of stuff coming back that people aren't even talking about today. We're excited about it.
Yeah, no, that's great. Wanted to talk about trends from a geographic standpoint. Is there anything to call out currently? I'm specifically interested in the Northeast business. Are you starting to see trends there reaccelerate?
Yeah. With all the positive going on with data centers and manufacturing, and believe it or not, we actually saw a little uptick in the first quarter with e-commerce. And we said 2025 Amazon's program start kicking back in.
We're starting to see a little bit of an uptick with that. Not great, but almost double-digit. Where we're really seeing softness and weakness is around the private segments, and so the smaller warehouses, the smaller industrial facilities. That business is really slow.
And we have, if you take a look, one of the things that is confusing people with kind of our growth rates is everybody likes to talk about top line growth.
We don't talk about revenue. We talk about bottom line growth. And if you look at our results, we consistently beat bottom line growth from top line growth. We focus our resources on the highest margin, best return jobs that are out there. With the smaller jobs slowing down, less jobs, lower pricing, as we say, we don't need to go practice and waste our assets and our cash and our capital. We'll just continue to do the big jobs.
We're starting to see those go through rebids for the first time. And I think when if interest rates, they don't have to come down a lot.
They just have to show a trend that they're go through rebids for the first time. And I think when if interest rates, they don't have to come down a lot. They just have to show a trend that they're going to come down. We think that activity will pick back up, and we'll see it spike in the smaller projects. But our big projects, very strong, backlogs up significantly on the big projects of the data centers, our highest margin stuff. We love that. The little fill-in work, which is really quick turns, we'll win a job. We'll start it two weeks later, finish it 90 days later. That stuff's very slow throughout not just the Northeast, but throughout the East Coast.
Got it. Interesting. Also wanted to ask you about Rocky Mountain Region. Obviously, you're leveraging some of your Transportation Solutions assets there to go after some E-Infrastructure projects. Can you talk about what you're doing there?
Yeah, I think it's a perfect example of a model we talk about, say, the brains and the brawn, right? We have great customer relationships to the point where when a Meta comes to us to do a job, not only do they say, "Can you reserve capacity in the third quarter of 2025?" as an example, but we want t his team on that project because they've worked with this project team on five, six , seven other projects, right? So it's that sort of level.
So they came to us and said, "We have a project in the Rocky Mountains up in Idaho." And we said, "Well. We're not going to ship equipment from the East Coast to Idaho for this is a big job, $100 million job, but it's too far for us to do, and we're pretty full. But what we can do is we can have our project management team leverage assets that we have in our transportation segment in the Rocky Mountains. And we can put the brains of the project management team and the estimating team with the brawn of the Yellow Iron in the Rocky Mountains. "
And we successfully did that job for them. They've been extremely happy. Not only have they been happy, but the GC that was doing that job is not a GC we generally work with. It's a different GC. They've pulled us into two other jobs within the Rocky Mountains doing data centers. So within one year, we picked up several hundred million dollars of data centers in the Rocky Mountains.
Just leveraging that relationship, showing we've got the capacity to build it effectively across the country. And that's what's got us into starting some of the conversations with, I'll call, the mid-tier and some of the bigger data center builders on saying, "Can we put something together that is a longer-term outlook?"
Meta doesn't wake up today and say, "We're going to build a data center tomorrow." They've got three- and five-year plans. QTS has three- and five-year. These guys have multi-year plans, right? So now they're finally starting to run into resource and capacity constraints where they're saying, "We need to look out more than 12 months. We need to look out multi-years in aligned capital planning projects." Or budgets, rather.
Yeah, makes sense. You touched on this a little bit. I wanted to talk about backlog specifically in e-infrastructure. It was about 30%. Over 30% in the first quarter. Can you talk about the degree of visibility that provides you as we look out to 2024 and how we should think about that translating to revenue growth?
Yeah, so not all of that hits 2024, depending on when the jobs start. The bigger the job, the longer the duration. When we got into this space, our average job duration was six months. Now it's nine to 12 months, depending on it. But what we're able to do with these larger projects is not only are they better margin.
But then, beginning of these projects, you see a huge ramp-up, so we'll see a nice big revenue spike, nice cash flow spike. But then, they kind of level off. But the thing that people miss is these are multi-year, multi-phase. So when we win a project, we just announce they kind of level off. But the thing that people miss is these are multi-year, multi-phase. So when we win a project, we just announce the first phase.
So if we announce a project that's $40 million, it's $40 million, but it may have three to five years of incremental $40 million-$50 million add-ons through the life of it. So at any given time, we have several hundred million dollars of backlog that's not in our backlog that we know are incremental phases that will take place down the road for those.
So that's another benefit of these big projects. The detriment of the small projects being slow is. Those are quick and easy to fill in. So if phase one ends today and phase two doesn't start for 90 days, I can go fill in one or two small jobs with those crews and it's kind of free money for us at that point in time. So when that picks back up, you'll see our revenue growth really climb again along with it. But we've continually grown the margin in that segment.
We think we still have 100-200 basis points of margin expansion that will take place in that segment through the course of 2024 and into 2025. So we really like where we're positioned.
Yeah, that's great. Really helpful. Wanted to switch gears and talk about Transportation Solutions a bit. That was another business where you saw some nice backlog growth in the first quarter, up over 60%. Can you talk about where you think we are in the cycle on Transportation Solutions, and how do you see awards trending over the next few years?
Yeah, so it's.
The federal bill, the five-year bill were about halfway through, but it's a little deceiving in the sense that year one. Not a lot happens. Year two, year three, year four, year five, and then year six, it kind of comes down as the next bill's coming up . So we're about halfway through the cycle, if I looked at it objectively.
The spend is very good. The projects are very good. Everybody underestimates that business today from what it was. That was a low single-digit growth margin. Never had seen a business with low single-digit growth margins in my life. That's where it started. We're up in the mid-teens now. On margin with that, we're best in class.
We think we still have another 100-200 basis points of improvement in transportation. As we've said all along, strategically, we've grown that business 3%-5% historically because the margin profile wasn't where we wanted it to be. It is now where we want it to be. So we are growing it at a much greater rate. So you're seeing that backlog grow. You're seeing revenue growth.
The other beauty of this business is we work 100% off customers' money. So that then enables us to fund acquisitions in the other higher margin, higher growth segments.
Yeah, that's helpful. This kind of feeds into my next question. You talked about margins improving from losses on an EBIT basis to mid to high single digits last year. Can you talk about some of the elements that drove that specific transformation to mid to high single digits last year, if you will? And you talked about where margins could go from here.
Yeah, I think, first of all, it's a philosophy. We believe, if we focus on margin and cash flow, we will not do stupid things with our capital or people or our money, right? So we go after the highest margin, best cash flow projects. When we look at acquisitions, we have very strong margin profile and cash flow requirements before we're even interested in acquisition.
So that's kind of the baseline of everything: profile and cash flow requirements before we're even interested in acquisition. So that's kind of the baseline of everything we do. So as a result, as we've seen this 20% compounded growth rates from 2019 on and a little less from 2016 - 2019, what people don't realize is we've taken businesses that were $300 million, $400 million and shrunk them down to $50 million, $60million, $70 million. So with the growth that we've seen, we have taken out hundreds of millions of dollars of revenue along the path. Because we just said we're not doing business with that customer, we're not doing business with that market, or we're not providing those services anymore.
And as a result, we've seen really good growth on the top line, which we really don't care about. We've seen significantly better growth on the bottom line.
Our EBITDA margins are close to 13%. Our operating incomes are north of 10%. Our gross margins are up 17%-18%. We're best in class in any of those areas because of that philosophy. So we look at everything we do , and we probe and say, "What is the weakest? Stop doing it. What's the best? How do we add to it or do more?"
It's really that fundamental and simple. As we go forward and look at what we had, that's critical criteria for us is, is it accretive? Is it got good cash flow? Does it move our margins up? Does it give it a stronger position with those customers? And if it does those things, we're very interested in it.
Yeah, that makes a lot of sense. Sticking on Transportation Solutions, the outlook. How are you guys thinking about top line, bottom line growth as we look out the next few years?
Yeah, again, we still have margin growth there. I think most people would never believe if you're teetering around 13%-14% gross margins there, that you could continue to grow that in transportation.
We do predominantly alternative delivery projects, very few low bid type projects anymore. The only time we're doing, excuse me, low bid projects is if we have a strategic advantage. I'll give you a perfect example. In Nevada, they have a program in place. I'll get it wrong, but I think it's every seven years. Instead of waiting for roads to wear out, they have a proactive program where they mill and pave on a regular rotation. So in rural Nevada, we don't do work in Vegas. We don't do work in a lot of the city. We have pits, strategically located throughout rural Nevada. We have a mobile asphalt plant, and we know this year they're going to do this stretch of highway.
So we moved the plant to the pit, and you got two choices. You either have us do the work or you buy the asphalt from us. The next closest asphalt plant's 200 or 300 miles away. We're very competitive at that point in time, and we don't care if we win it and do the whole project because we're going to make a lot of money on the thing. So those types of projects will continue to do the rest of them.
We were involved in the design process and the constructability of the project, which is very different than low bid or most highway work, where you get a design from some engineering firm you don't know.
It's about 60% complete. You got to guess on the other 40%. We don't do this stuff anymore. Focus more on aviation. There's a value proposition to aviation customers, and we're doing more and more on rail, predominantly rail bridges, where we have some specialty expertise in rapid bridge replacement or rapid bridge repair.
That's great.
Wanted to also touch on your other segment, Building Solutions. Obviously, you've seen a lot of demand in some of your core end markets there, core geographic markets, if you will: Dallas, Houston, Phoenix. Can you talk about the sustainability of growth in those markets?
Yeah.
We said all along our strategy was to focus in those markets and that we would outpace whatever the U.S. market was doing. And that's proven. But for two reasons. One, first of all, those three markets are all population growth markets. So if you go to Dallas or you go to Houston, if some of you live from there, g o try to buy a house. There's nothing on the market, and the population's growing, right? It's very, very complicated.
So when you run, it's just math. If you run the number of people that are coming in versus the number of homes that are available versus minus the number of people that leave, right , you need more homes. And if you look at the trajectory of those three cities over the next 10 years, that doesn't go away, right? So we like the markets we're in. Couple that with the fact that we have very low market share. Our customers told us our philosophy is we let our customers tell us where they want us to go. We started in Dallas. They brought us to Houston. They brought us to Phoenix. We have very low market share in both Houston and Phoenix.
So not only do we have a population growth, but every year we're picking up market share as we add capacity in those markets.
So we think that growth will continue to outpace and be very strong over the next several years. What we have seen a decline in is on the commercial side of our Building Solutions, which is really multifamily. We saw a great year last year, a record year, good projects. We're seeing that slow down. We've got that in all our forecasts. It hasn't slowed down as much as we thought, but we still think that's going to be a slowing factor as we go forward. Forecasts.
And how much of Building Solutions is multifamily?
It's a very small amount. It's 10%? Yeah. It's not a large amount. Doesn't move the needle .
Yep. And then wanted to touch on recent deal you guys did there, PPG. Can you discuss that acquisition strategic rationale and the financial profile there?
Yeah. It's a perfect example. Our customers have been asking us for the last couple of years, "Can you add more to your portfolio? You do the slabs. We love it. Can you do plumbing? Can you do electrical? Can you do heating? Can you do framing?" So we started looking at some different things.
The next logical step for us, we like to take one step at a time, not get too far over our skis from what we do. But the next logical step for us is plumbing. In a lot of cases, we're waiting for plumbings to do the rough-in when we build the slab. It's the next thing that happens after the slab. So it's a natural natural. It took us a year to find the right business.
We looked at a lot of businesses. We're very picky. We found PPG up in Dallas. It's a great business and accretive to us, right out of the chute. What we also liked is that about 90% of their customers had no overlap with us whatsoever.
So we brought on a plumbing business that's now adding capacity to customers that we have a customer base with us whatsoever. And now we're looking at, well, can we add slabs to the customer base that they're currently doing?
And our customers are already asking us, can we do that in Houston and Phoenix as well? So we're looking for acquisitions or potentially organically taking some folks from that business and growing that. It won't happen in 2024, probably be mid to late 2025. We want them to get their sea legs.
They're growing close to 30% right now organically, year-over-year. We like that. So we don't want to distract them and take them away from what they're growing close to 30% right now organically, year-over-year. We like that. So we don't want to distract them and take them away from what they really do well.
Makes sense. Wanted to touch on margins in that segment. How are you thinking about margins trending there in 2024?
Yeah. I think at a macro level, margins will go up. But if you look at the drivers to it, margins will be relatively flat.
And what I mean by that is commercial business has much lower margins than a residential business. So as commercial comes down, that portfolio shift goes to residential. So our total margins will go up. But if I looked at residential year over year, just on a margin basis, it's going to be portfolio shift goes to residential. So our total margins will go up. But if I looked at residential year over year, just on a margin basis, it's going to be relatively flat with where it is. That's a pretty stable business.
We saw some rockiness during COVID when it was just chaotic supply chain and rapid inflation. But it's come back and it's stabilized.
That's great. Wanted to shift a little bit to cash flow balance sheet. Can you talk about your capital allocation? You touched on this a little bit, but you have almost $500 million of cash on the balance sheet. You're in a positive net cash position. How are you guys thinking about deploying capital?
Yeah. You want to answer that? Sure.
Yeah. Sure. So I mean, first and foremost, we focus on organic maintaining the business, buying equipment as needed to support the existing business. After that, we're looking at M&A, obviously, with the balance that we have currently on our balance sheet over $480 million-ish in cash. We definitely want to go out and find businesses that can be immediately accretive as we've become more profitable.
That becomes a little bit more challenging because we want to find businesses that are going to complement us and increase our margins. After that, we are doing share repurchases opportunistically as it makes sense to do that. We will buy shares back.
And touching on acquisitions, are there some areas where you're more focused in terms of potentially pursuing a deal?
Yeah. Yeah. It's – I'll never say never, but we're really not looking at anything in transportation unless it was a real niche that fit and highly accretive. E-Infrastructure's first. We believe, based on our customer base and our relationships, if we could start adding incremental services to that portfolio, we will immediately get work with that. So whether that's electrical, mechanical, piping, some inside r igging to do equipment placement, those sort of activities that happen immediately following the work we do, we think that's a natural fit for us.
And the key to that is we want it to be fungible, so we don't care if it's a manufacturing plant, a data center, e-commerce distribution center, right? There's activities that take place in all of those, and we can use that and leverage across the portfolio.
Then Building Solutions is second, right? We talked about plumbing. We've looked at some other ancillary stuff, whether it's heating, HVAC.
We're also starting to think about everything we focus on as new builds, as the number of homes becomes greater and greater. The backend service side is growing very rapidly.
Should we get into the backend service, whether that's HVAC, plumbing, then the backend service side is growing very rapidly. Today, a lot of those are conglomerates of all of those activities, but that gives us a nice recurring revenue stream.
Because housing will slow down at some point in time in our lives. If that slows down, we've got the backend revenue stream.
Yeah, it makes a lot of sense. Wanted to also touch on free cash flow. Free cash flow conversion at Sterling is great. It was strong in 2023 . Expectations going forward continue to be strong. Can you talk about free cash flow generation on a go-forward basis for this company?
Yeah, I think generally speaking, you should think about our free cash flow being equal to our operating income. As we've had some of these large infrastructure projects and some in transportation, but mostly infrastructure. Y ou get a huge amount or a large amount of billing and access, right? And that happens generally towards the beginning of these projects.
To the extent that that changes, right? That can have an impact, but I think just strategically, I would consider our ongoing operating cash flow to be equal to operating income.
Makes a lot of sense. Have a couple of minutes left. I did want to ask you. You touched on this briefly, but Building Solutions, probably the more cyclical business that you have. Can you talk about, I guess, philosophically, why you guys are attracted to that business when you start thinking about other areas to potentially allocate capital as well?
Yeah, well, the beauty is it takes virtually no capital, right?
It's 15-day cash cycles. We spend couple hundred thousand dollars, maybe $500,000 a year in CapEx in the business. The labor force is probably 80% subcontracted, so we have very low variability or risk with labor or equipment. That's why we really like it. And we believe when the market was down 30%, we grew. And we believe that even in a down housing market, that enables us to pick up more market share in Houston and Phoenix because capacity becomes available and the demand becomes the need becomes available.
What people don't realize is builders, our big customers, Pulte, Horton, Lennar, they don't build anything. They design and they hire people to build everything. And the majority of their contractors are what we call two men in a truck. So if their volume goes up 20%, they can't handle it. If it goes down 20%, they disappear.
They still need to build homes, right? So the value proposition we bring them is we're there to support you through your growth.
And if it goes down, we're not going away. We'll support you and we'll pick up everything else that everybody disappeared on and went away from. So when we went back and looked at Tealstone in 2008, in 2009, some of the worst years in the housing market, they picked up more market share, they picked up more market share over that two to three-year period than they had in the prior 10 years, right? And that's kind of what we think will happen in the next downturn.
Hopefully, we don't see that for a long time. And again, these growing markets, we don't have fear of that. But that's strategically where we've positioned ourselves to do.
Makes a lot of sense. I think we'll wrap it up there. Thanks, everybody.