How Stantec and WSP became Canada’s unlikely stock market stars — and made engineering sexy

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Half a decade ago, Edmonton-based Stantec Inc. STN-T was scrambling to defend its reputation.

At the time, the engineering consultancy had spent seven years and a significant amount of capital buying up design and architectural firms across Canada and the United States, and it made a name for itself in North America. Yet, at the tail end of the buying spree, Stantec got overzealous with a large acquisition, ultimately inheriting a construction business with some horrible contracts.

In a flash, all the goodwill Stantec built up started to disappear. Management turned over. A strategic review was launched. The troubled construction division was sold off.

What has transpired since is a turnaround story for the ages. Stantec’s shares have soared 242 per cent over the past five years, and the engineering firm is now one of Canada’s hottest stocks.

Even more remarkable: Stantec isn’t alone. A sister firm, Montreal-based WSP Global Inc. WSP-T, is in the same boat, with its own shares jumping 197 per cent over the same time period. Both companies’ returns beat U.S. technology stars such as Netflix Inc. NFLX-Q, Meta Platforms Inc. META-Q, which owns Instagram and Facebook, and Alphabet Inc. GOOGL-Q, the parent company of Google.

How’d they do it? There’s no single answer. Instead, Stantec and WSP put more emphasis on per-hour consulting fees that rise with inflation, instead of banking on fixed-price construction contracts that are notorious for going over budget, and they leaned less heavily on energy projects, expanding instead in businesses such as water, which includes building levies, flood wall systems and water pumping stations to protect coastlines.

Both businesses also benefited also from the environmental, social and corporate governance (ESG) wave, as well as from pandemic-fuelled stimulus spending, which poured unbelievable amounts of money into infrastructure projects. Transportation contracts in particular were lucrative because they plan and design rail systems, city transit networks, highways and bridges.

But crucially, Stantec and WSP used acquisitions to diversify their revenue mix by both geography and business line. WSP used to be called Genivar but adopted the name of a British acquisition target, and now makes 83 per cent of its revenue outside Canada. And rather than deploy the classic “roll-up” strategy that chases new revenue at any cost, they’ve been quite disciplined with their ambition.

“Growth hasn’t been for the sake of growth,” said Ian Gillies, a research analyst at Stifel Canada who covers both companies.

Because Stantec and WSP aren’t traditional roll-up plays where management provides very little colour on what the deals will do for profit, their investors aren’t going to wake up one day and realize the companies have run out things to buy – or worse, that they’ve overpaid for previous deals and are now saddled with debt.

“The key is, they’re doing this profitably,” said Shah Khan, a portfolio manager at Mackenzie Investments, which is one of Stantec’s largest investors.

Companies that grow through acquisitions sometimes get addicted to doing deals, because investors start to blindly reward them for getting bigger. When Stantec was worth $3-billion, it wasn’t large enough to attract many institutional investors, but now that it’s worth $12-billion, and WSP is valued at roughly double that, more people learn about their stories and want to buy in, which can fuel the desire to do more deals.

But the two companies are being disciplined. Last week Stantec acquired Morrison Hershfield, a Markham, Ont.-based firm that specializes in transportation projects and has 1,150 Canadian employees, and in an interview chief executive officer Gord Johnston was asked about the number of available takeover targets.

“The pipeline of potential firms has never been this full,” he said. Yet he stressed something: “We turn away 95 per cent of the opportunities that are presented to us.”

Both companies are also cautious when it comes to debt, which has historically put roll-up strategies in trouble. Eventually the economy turns, and acquirers struggle to keep up the interest payments.

WSP tends to take bigger swings on deals than Stantec, because it’s got more financial heft, but to date it hasn’t used too much debt to write huge takeover cheques. “Leverage remains somewhat elevated but completely manageable following recent acquisitions,” Veritas Investment Research analyst Dimitry Khmelnitsky wrote in a recent note to clients.

Both Stantec and WSP have also proven their deals can boost productivity across their work forces. “In this business, utilization is single-handedly the most important driver of margins,” said Mr. Khan, the portfolio manager.

Often, standalone engineering firms focus on a specific geography or type of business. Yet every region or project type will face an economic downturn at some point, and during these quieter periods revenue tends to drop. As part of a larger organization, engineers can be staffed on projects in other cities, or perhaps even in other countries.

In other words, the work-from-home movement has been another boon for the acquirers.

The key for management is making sure they never start thinking too highly of themselves, or overestimating what they’re capable of biting off. Mackenzie has owned Stantec shares for years, but briefly sold its stake when the company got overzealous with its construction acquisition and returns suffered. “All it takes is one bad deal,” Mr. Khan said.