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Mastec: Margin Expansion Back in Focus as 2022 Acquisitions Provide 2023+ Opportunity

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Ahead of the Q2/2023 earnings release (August 2, 2023), we re-visit our take on Mastec (MTZ), one of our preferred picks for the energy transition theme. With direct exposure to stable yet high growth businesses such as Communications (5G network rollout), Transmission Grid modernization and Environmental Infrastructure, we feel that the tailwinds are many as the recurring revenue (Master Service Agreement) model continues to expand. Despite record FY/2022 revenues, pressure on EBITDA margins has been in focus given an acquisition heavy year. Specifically, last year was cumbersome given the integration of Henkels & McCoy (acquired for $600M) and Infrastructure and Energy Alternatives, IEA (acquired for $1.10B) into the Environmental and Infrastructure segment.

Our thesis however remains unchanged based on broad tailwinds in all the business segments coupled with record backlog of nearly $13.9B, as reported last quarter. As a reminder from the Q1/2023 release, recall that the Communications segment posted revenues of $807M representing +21%y/y growth underpinned by increased support for 5G network rollout and fiber expansion opportunities. From the Power Delivery segment, Q1 revenues of $709M were up +9% y/y. In the midst of an energy transition in the US, strong customer demand continues to be seen for connectivity and grid modernization. Additionally, from the Environmental segment (Clean Energy & Infrastructure) revenues totaled $825M however EBITDA margins were weak at ~1.0%. Recall that the acquisition of IEA last year doubled Mastec’s market presence however finalizing the integration along with a delay in panel deliveries and project starts led to the margin pressure. That said, FY/2023 revenue potential is expected to be $5.0B from this segment alone. With integration of the newly acquired assets mostly complete as of Q1, the focus has finally shifted back to driving margin improvement throughout the organization. Consolidated margins are expected to improve from 8.2% in FY/2022 to a midpoint of 8.6% in FY/2023, followed by an expected low double digit range over the next year or two.

The eventual corporate pivot placing less emphasis on the Oil & Gas pipeline segment remains paramount to our longer term investment thesis. As MasTec shifts further to a more favorable business mix trending towards markets with longer term secular growth (renewable generation, electric utilities, grid modernization and 5G telecommunications) a more favorable contracting mix trending towards Master Service Agreements (MSAs) has and will continue to drive decreased cyclicality, increased recurring revenue and with it, eventually higher margins. That said, our thesis is playing out as MasTec continues to gain market share as it transitions to the increasingly recurring and higher margin MSA type contracts found in the Power Transmission and Environmental segments (both accounting for 59.3% of consolidated revenues in Q1/2023).

The 2021 strategic re-focus to higher margin businesses (with MSAs) has resulted in a reduction of exposure to O&G, going from 52.8% in 2017, to 12.5% in FY/2022 and 9.9% as of Q1/2023. As a result of this strategy, for the years ended December 31, 2022, 2021 and 2020, revenue derived from projects performed under MSA and other service agreements totaled 51%, 38% and 36%, respectively, of consolidated revenue. This is important because MSA contracts are not only more stable and recurring, but coming from divisions such as the Electrical Transmission (Power) segment along with the Clean Energy & Infrastructure segment, they offer higher margins as well. We continue to believe that those two segments will continue to benefit from longer term secular tailwinds highlighted by the prevalence of renewable energy and with it, the necessary infrastructure work needed to modernize an ancient North American electrical grid network. Margins from those two particular segments are expected to eventually increase to the low to mid double digits.

In terms of backlog, $13.9B was announced as of Q1/2023. This figure represents a 6th consecutive quarterly record. This latest figure represents a sequential increase of $913M and growth of 31% y/y. New contracting highs were established in both the Communications segment and in the Environmental segment.

We continue to highlight our power focused investment thesis which revolves around the theme of energy transformation related to both to both power generation and delivery, as the country transitions to a carbon neutral economy. We feel that MasTec has both the stable customer base to provide recurring cash flow while also angling to become a leader in much higher growth verticals related to clean energy infrastructure and grid modernization.

Our power related investment focus remains three-pronged: 1) ESG power generation (zero carbon, renewable and ideally unregulated), 2) the needed fuel to power nuclear reactors (uranium miners), and finally 3) the badly needed infrastructure and electrical transmission investments needed to upgrade an extremely old grid network. This is prescient given the strains of variable renewable energy intake coupled with increased charging demand from EVs. Our favored picks over the entire value chain include the following:

Constellation Energy (CEG) ticks just about every check mark we look for in terms of ESG compliance, a dominant, low carbon generating profile and recurring cashflows given LT forward contracts extending to 2027 for fuel, coupled with LT PPAs. Having split from Exelon Corporation (EXC), CEG had its initial NASDAQ listing on January 19, 2022 and has to date gained +140%.

Simply put - Constellation Energy is the largest producer of zero emission (zero carbon) electricity in the U.S. As of 2021, 89% of electricity produced came from carbon free sources, including some smaller amounts from wind generation and solar. That said, CEG is by far the largest nuclear power operator in the U.S. Out of the 93 existing nuclear power plants, CEG operates 21 of those units (Duke Energy (DUK) is in second place with 10 units). In MW capacity terms, approximately 73% of Constellation’s fleet mix consists of carbon-free nuclear and renewables. To put things further into context, the company is responsible for producing approximately 10% of all carbon-free electricity in the country. Annually, the company supplies 215 TWh electricity and 1.6 Tcf natural gas to nearly 2.0M customers spread across 48 states. Note that these figures exclude the recent acquisition of NRG Energy’s (NRG) 44% stake in the South Texas Project Electric Generating Station (STP). More on that acquisition can be found from our most recent Constellation Energy highlight found here. Constellation is expected to report earnings in early August.



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