Earth, Wind, and Fire; Part II (Quanta Services NYSE: PWR)

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We’re entering a new era of electricity, at least one would think. With the recent passing of the IRA and retirement of stinky coal plants, one would presume the energy transition is upon us, or as Jack Sparrow would say, “bring me that horizon.” That said, if you do what Oli Sykes says in one of his songs in Bring Me The Horizon, “if you really believe in the words that you preach, get off your screens and go to the streets.” For those that remember, 2020 was a banner year for raising awareness of renewable energy. There was a lot of hype. There was a lot of money being thrown into these investments by retail investors, and for a while, these stocks went to the moon. As the years progressed, a lot of the hype faded away and empty promises started to show their ugly underbelly. SunRun (RUN) went from sub-$10/share to upwards of $90/share for a market cap of $19b. SolarEdge (SEDG) also shot up to being a nearly $19b company during this euphoric year (and has somewhat retained its value). This was also the year Enphase (ENPH) experienced its first runup to being a $26b company and went onto becoming a $45b company before coming back down to earth for an equity value of $22b. NextEra Energy (NEE), a utility that primarily utilizes renewable energy, saw its equity value run up to $170b at the peak of this period; however, like SolarEdge, NextEra has been bouncing around this heightened valuation for the last few years.

So what about traditional utilities? Much of the same, actually. The Southern Company saw its market cap launch in an upward trajectory and currently sits above the $80b mark, well above its $44b value in 2019. Duke Energy (DUK) has also experienced a lot of good growth, going from a $60b utility to a now $76b utility. The last one I’ll reference, Sempra Energy (SRE) went from a $29b equity value to now being valued at $48b. Xcel Energy’s market cap shot up 75% from the beginning of 2019 during this period and has retained much of that strength.

Though the traditional utilities haven’t experienced such drastic swings as the new guys on the block, their value has held with a slow and steady upward pace. Sexy? No. Provides the ability to sleep at night? Absolutely.

So if we were to be going through this monster energy transition, what are Sempra, Duke, and Southern still running and maintaining their value? Though renewables are a part of these legacy utilities’ books, they’re definitely not the most prominent source of power transmission. The only initiative on the books is the phasing out coal and replacing it with new capacity, primarily natural gas and renewables.

Ultimately, it comes down to one simple factor: cash flow. These companies generate swaths of cash with relatively minimal capital investment requirements. The infrastructure is there, working, and requires minimal maintenance.

Though utilities are a primary component of this note, thematically, this note is a continuation of Earth, Wind, and Fire and will cover the buildout of new capacity.  (1) Earth, Wind, and Fire: Nuclear, Wind/Solar, and Natural-gas Fired Power Plants (AGX) (substack.com) As I had previously discussed, there is a growing demand for renewable power sources at the utility level; however, natural gas and nuclear power will continue to expand throughout the next decade+ for the sake of reliability and energy security.

A lot of interesting headlines have hit my desk in the last few weeks that may change the game, at least for now, unless some government intervention occurs. One of my biggest concerns for renewable energy was the vast amount of real estate necessary for an “effective” solar field or wind farm. One personal example is when I toured Ireland back in 2019. It was an amazing experience to drive city to city in under an hour and tour the countryside. Nothing is more beautiful than rolling hills covered in green with giant carbon fiber windmills visible along the horizon. God certainly blessed this country with green pastures and wind for wind farms. When I think of touring a country that isn’t gridded with skyscrapers, I think of giant steel windmills. Who wants to see a beautiful landscape when you can see spinning fans at every sight.

As you might guess where this is going, as published in the Wall Street Journal on May 8^th, 2023, small-town citizens are standing up to their local governments’ revolutionary renewable energy projects. I suppose not everyone finds windmills sexy. According to the article, five counties in Kansas joined a group of 18 others across the state by placing moratoriums or bans on new wind and solar projects. 16 of 99 counties in Iowa have similar prohibitive rules that place bans on new projects.

Another article in the Journal, dated 5/10/23, discerned the challenges faced by smaller renewable-energy companies in acquiring loans to develop and implement their technology due to poor credit quality. According to the article, “43% of the 21 European renewable-project developers surveyed this year by operator of clean-energy marketplaces LevelTen Energy said they wouldn’t work with a buyer with a credit rating below investment grade.” This means the company must have a BBB- or above credit rating in order to do business. This can be exceptionally challenging given the profitability, or lack thereof, many of these firms face. This treatment may only add to the pressure towards profitability.

As discussed in part I of this series, the IRA does a fantastic job at creating opportunities for companies that require capital to expand into new grounds. The downside to this is that these loans must be originated by banks, not the US government. The US government only guarantees these loans at the expense of the US taxpayers. Upon reviewing previous projects from the Obama-era regulation, many of the loan defaults were a result of failed utility-scale renewable projects. I’m not saying history will repeat itself; however, I believe financiers are becoming more stringent on requirements for new loans, especially after coming out of an era of easy money into tighter credit. To quote once more from my favorite energy analysts G&R and their use of EROEI, or energy return on energy invested, “as much as 25-60% of the energy generated in a renewable system is consumed internally, compared to 3% for a modern gas plant.” In layman’s terms, it costs a hell of a lot more to produce renewable energy than it does to produce energy using fossil fuels. The energy in/out model indicates a 1-to-5 energy input/output for renewables, 1-to-20 for fossil fuels, and 1-to-100 for nuclear energy, meaning it takes one unit of energy to produce xxx amount of energy.

A few points worth mentioning that I neglected in my last article on Enphase (1) It's Not Enphase, It's a Lifecycle (NASDAQ: ENPH) (substack.com) are their partnerships in developing utility-scale power systems. Enphase announced a partnership with PG&E in December of 2022 to develop a fixed power solutions pilot program for residential storage in which PG&E will provide Enphase’s IQ Battery storage systems to approximately 100 low-income residential customers that are affected by outages as a result of PG&E’s Enhanced Powerline Safety Settings. Enphase is also participating in the Connected Solutions program, a program implemented by two utilities in the Northeast region of the US to reduce electrical demand during high-use periods. Though there are a few residential-/utility-driven initiatives out there, these beta programs must be looked at as use cases for future renewables programs.

How do we determine the future for renewable energy? We go to the source. Who’s building out these utility-scale projects? As discussed in Part I of this series, we look at the contract construction firm Argan (NYSE: AGX). This week we’re reviewing Quanta Services (NYSE: PWR). Quanta Services is an EPC firm based in Houston, TX, that carries an enterprise value of $29b, well above Argan’s $229mm. Quanta Services primarily focuses their business in North America and Australia whereas Argan’s exposure is in the Northeast region of the US, the UK, and Ireland. Their projects span all areas of power transmission and communications, from O&G pipelines, refineries and plants, renewables, transmission lines, communications lines, and emergency services (think hurricane season). Using the same period as at the beginning of the article, Quanta’s market cap grew from just under $10b to $25b (2021 to today, May 2023). Though they sport a firm valuation of 20x EBITDA, their premium commands a lot of value from the future of energy transmission. In that period alone, Quanta has grown their top line from $11.2b to generating $17b in revenue for FY22 and this growth doesn’t appear to be ending anytime soon. Their recent acquisition of Blattner secured their seat at the table for renewable energy, generating roughly $3.7b in revenue from renewables alone.

Getting into some of their upcoming projects, Quanta Services recently announced a multi-year project with Pattern Energy Group to provide comprehensive infrastructure solutions for the SunZia Transmission and SunZia Wind projects, the largest clean infrastructure project in the US to date.

The project will span across Arizona and New Mexico and provide power for 3,000,000 consumers. The SunZia Transmission project is designed to transmit approximately 3,000MW of electricity generated by SunZia Wind on a 550-mile bidirectional +/-525kV high-voltage direct current transmission line from Central New Mexico to South-Central Arizona. The SunZia Wind project is projected to produce 3,500-MW wind generation from 900 turbines, 10 substations, 7 operations and maintenance facilities, and a switchyard. This is one mother of a project.

One point that I tend to lean on that isn’t as readily available in the public domain is the required acreage for a windfarm as compared to more traditional power sources. I’ve found some sources which suggest that 1.5 acres are required for a single 2MW wind turbine. When stacking multiple wind turbines for a utility-scale windfarm, a 2MW wind turbine may require between 40 to 70 acres of land to avoid interference from other turbines. According to an article published through the Harvard School of Engineering suggests that wind and solar would require 5x-20x more land area than previously thought for large-scale wind farms. With this assumption, a 900-wind turbine farm would require at minimum 36,000 acres of land to avoid wind shadowing, or the wind resistance that results from the first wind turbine. This doesn’t include substations, transmission lines, roads, and facilities, among other requirements for operations.

 What really struck my interest that doesn’t seem to be talked about is that the surface temperatures as a result of utility-scale wind farms would increase by 0.24 degrees Celsius with the greatest temperature change at night, an increase of 1.5 degrees Celsius. The article concluded that the immediate climate impact when comparing wind to coal and natural gas over the next decade would be negligible and wouldn’t be experienced for thousands of years.

Regardless, the SunZia Wind and the SunZia Transmission projects will drive some major revenue generation for Quanta Services with an estimated total investment $8b by Pattern Energy. Despite the information I provided on land requirements above, neither Pattern nor Quanta disclose the acreage of this project. This projection is discerned from other sources on land requirements and information available on the project.

Another major project announcement is a partnership with Xcel Energy as prime constructor for Colorado’s Power Pathway high-voltage electric transmission project in Colorado. This project includes the construction of approximately 610 miles of 345kV transmission infrastructure, four new substations and the expansion of four existing substations to improve the reliability of the state’s power grid and enable future development of renewable energy. This project may be followed up by a future development of 5,500MW of new wind and solar capacity that Xcel Energy plans to develop within the state.

Reviewing Xcel Energy's recent investor presentation, the company projects to invest $1.5-3b in renewable energy capacity and $0.5-1b in transmission between 2023-2027. They project 4,000MW of new renewable capacity in Colorado between 2025-2030, which could potentially be awarded to Quanta Services as the transmission project continues. Bids for this project were received in March 2023, portfolio recommendation will occur in the summer, and the CPUC decision will occur in Fall 2023.

These two projects aside, Quanta Services has a huge outlay of future projects in energy transmission. One area that is more or less neglected that may take form is in their communications segment. Only accounting for 6% of total revenue, it will require some materially large projects to move the needle; however, given the requirements for 5G technology, the buildout may improve this mix. Despite telecom companies selling 5G services, the required infrastructure for true 5G communications isn’t quite built out yet to see any material differences from 4G. To save some space in this note, 5G communications systems must be built above power lines in order to reduce signal interference, and special certifications are required to execute this work. Typical telco engineers do not hold these certs, opening an opportunity for Quanta’s services.

My final thought before talking numbers is Quanta Services’ continuous drive to expand operations through acquisition. Though this is pure speculation, Argan would be a prime target for Quanta to expand operations in the UK and across the Northeast region of the US. With an enterprise value of $229mm, Argan’s firm value is priced at a mere 5.25x EBITDA, providing a great opportunity to scoop up a smaller competitor at a great price. With Argan’s already proven expertise in building out renewable capacity and natural gas plants, this expansion would only benefit the greater goal of Quanta Services in building out the next generation of energy capacity.

Looking at the numbers, Quanta Services trades at a significant premium compared to their perspective market. The firm is valued at 20x trailing EBITDA; however, given their growth trajectory, this premium may be justified. Quanta has been trading at a heightened premium for the last two years and it may be more optimal to value the company as a growth company as opposed to a value company. Given that revenue grew by 31% for FY22 to $17b, this valuation methodology would only make sense. The real question we must ask is whether the energy modernization megatrend continues and for how long. Considering the research I’ve provided in this and previous articles, I’d say it may be choppy as the US enters into a recession, but will continue with strength throughout the next few decades.

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