Cabot Small-Cap Confidential Issue: October 3, 2024

The Big Idea

For the first time in a long time demand for electricity in the United States is on the rise.

The reasons behind this emerging megatrend include the ongoing electrification of cities, homes, offices and transportation, reshoring of industrial manufacturing facilities and data center electricity consumption.

Exactly how fast electricity demand and load growth will rise is uncertain. But when you look at the estimates from respected sources the trend is clear - it’s up.

As electricity load and demand go up, costs follow. California and New York are just two states that have recently seen double-digit electricity price increases.

Not surprisingly, this is translating to more demand for planning and engineering services so that cities, towns, utilities and businesses can build more energy-efficient infrastructure and buildings.

It’s pretty simple.

If the country’s energy infrastructure doesn’t evolve to meet demand and just lets the electric grid get more and more stressed, communities and businesses won’t have efficient, resilient and reliable power.

And we all know what happens when the power goes out ... and stays out.

It’s not good.

Today we’re jumping into a micro-cap company that provides engineering, consulting, software and program management services that help communities move forward toward a more sustainable, clean energy future.

It’s a North American-focused business that’s been around for over six decades and has continuously evolved to meet the challenges of the day.

Right now, it’s in growth mode, expanding organically to meet rising demand while hunting for acquisition targets to help build on its current competitive advantages.

The Company

Willdan Group (WLDN) is a micro-cap (market cap of $570 million) engineering and energy solutions company that helps communities make the transition to clean energy and a sustainable future.

Typical goals of projects it takes on are to improve energy efficiency, reduce greenhouse gases and make infrastructure more sustainable.

Depending on the scope of work required and depth of customer relationship, Willdan’s services range from advising on policy, providing software and data capabilities, providing engineering and consulting services, and, for larger projects, acting as a program manager.

Most of its business comes from government/public sector and utilities customers (49% and 44%, respectively), while commercial customers make up the remaining 7%.

Management says that since 2013 Willdan’s work has prevented the emission of roughly 5.7 million metric tons (MT) of CO2 equivalent into the atmosphere.

That’s about the same as taking 1.3 million cars off the road, slashing electricity usage of 1.1 million homes, or adding 6.8 million acres of forest.

The company currently has 53 offices and 1,700 employees spread across 25 U.S. states, Canada and Puerto Rico. Most of these folks are scientists, engineers and other technical professionals.

Activity with commercial customers is growing briskly, mainly due to work related to energy usage at data centers. A recent high-profile win with Meta (META) related to a voluntary clean energy procurement program is the latest evidence on this front.

Another recent project win was for the state of Virginia, the largest data center market in the country. Willdan was awarded a program to study the grid impact of energy demand, including analyzing the impact on utility service providers and ratepayers of integrating 10 to 15 gigawatts of new generation load into the Mid-Atlantic regional power grid by 2030.

Portfolio of Services

Willdan has two business segments, Energy and Engineering & Consulting, which work closely together to design and deliver comprehensive and innovative energy efficiency solutions to a variety of businesses, utilities, state agencies, municipalities and non-profit organizations.

Here are high-level overviews of services provided by the two segments.

Energy: Offers audits and surveys, program design, master planning, demand reduction, grid optimization, benchmarking analysis, design engineering, construction management, performance contracting, installation, alternative financing, measurement and verification services, and advances in software and data analytics for long-term planning.

Engineering & Consulting: Provides civil engineering-related construction management, building and safety, city engineering office management, city planning, civil design, geotechnical, material testing and other engineering consulting services related to traffic, bridges, rail, port, water, mining and other civil engineering projects. Willdan also provides economic and financial consulting to public agencies to help them finance their operations and infrastructure, as well as supports mandated reporting for these financings.

Growth Initiatives

M&A: Willdan has a long history of adding growth through acquisitions and is back on the prowl now after taking a few years off to recover from the pandemic. It wouldn’t surprise me if a deal is announced any day now. The image below shows the M&A history, as well as the names of the companies/assets acquired.

Expand Data Center-Related Work: With estimates of power demand from energy-intensive data centers in the U.S. going up, Willdan, who has provided services to the data center market for years, is seeing more opportunities.

Grow Commercial Customer Base: Willdan’s recent contract with Meta (a six-month study project) has boosted the company’s profile (relatively speaking) and is hopefully just another small step in the right direction toward significant growth in the company’s work with commercial customers. Management has said its work for “Cisco (CSCO) and Microsoft (MSFT) and other big tech companies is becoming more important to us.” More to come on this front.

New Analyst Coverage: WLDN has very limited analyst coverage. If the business does as well as I expect, this will change, and more investors will buy in (after us). Just recently, Wedbush picked up coverage with an “outperform” rating and 51 price target (stock trading near 41).

Business Model

Willdan’s business model and growth strategy revolve around three phases of work. Customer engagements typically begin with policy work, then expand to include some mix of data analytics and software. Over time, as Willdan learns the client’s unique needs, the company can create more effective program management solutions. While revenue is skewed toward program management, all three phases of work deliver roughly equal profit to the business.

Willdan reports both contract revenue and net revenue. The difference between the two is “subcontractor services and other direct costs,” which are passthrough costs. Depending on what platform/data feed one looks at, these measures of revenue might not be entirely clear.

The slide below should be helpful. It shows both contract and net revenue, while also showing the revenue breakdown and trends between the energy segment and engineering & consulting segment revenue (84% and 16%, respectively).

The Bottom Line

With the exception of the two pandemic years of 2020 and 2021, when revenue shrank by about 10% each year, Willdan is typically a double-digit growth company.

Revenue grew by 21% in 2022 and by 19% in 2023.

Over the last twelve months (through June 2024), revenue has grown by 21%. This includes 17% growth in Q2, which was better than expected. Given strong performance, management increased full-year guidance for net revenue (not contract revenue!) by $10 million, to a range of $280 - $290 million.

That implies adjusted EPS of $2.00 to $2.10 this year, the high end of which represents 20% growth.

Another plus is that Willdan added $28 million in net cash from operations through the first half of the year, which helped to bring its net debt down to $50 million at the end of June from $75 million at the end of 2023. This puts the company in a strong position to pursue strategic acquisitions.

Risk

• Data center work may not materialize as expected.
• Willdan’s revenue mix is skewed toward its top 10 clients, which accounted for 53% of revenue in 2023. The two biggest clients are the State of New York (10.7%) and the LA Dept. of Water and Power (10.3%).
• Some of Willdan’s businesses may have lumpy revenue due to the timing of contracts.
• Micro-cap stock, not well-known, limited analyst coverage.

Competition

Competition is fragmented and depends on region, type of client and services needed. Publicly traded peers include NV5 Global (NVEE), Bowman Consulting (BWMN), Resources Connection (RGP) and Montrose Environmental (MEG). Privately held competitors often include local electrical and mechanical contractors, engineering firms, and lighting and lighting fixture manufacturers.

The Stock

Trading Volume: WLDN trades an average of 133,000 shares daily ($5.5 million). We might move this stock, so best to average in.

Historical Price: WLDN came public in 2006 so has been through a wide variety of markets. The stock hit an all-time high of 55 in February 2021, during the pandemic bull market. But as the impacts of lockdowns became more apparent in the company’s financials, WLDN stock suffered. By the end of October 2022, shares had sunk as low as 11. The stock has been recovering since then. The most recent consolidation phase began in August 2023, had a trading range of 33% (17 to 25.5) and lasted for roughly 150 days. The breakout above 25.5 came after the Q4 2023 earnings report on March 7, 2024. WLDN rallied 24% and walked up to 30.5 before calming down. After a couple more consolidation phases (spring and early summer) WLDN approached its Q2 earnings date (August 1) trading near its 2024 high of 34.8. Shares rallied 11.5% afterward and have made a series of higher highs and higher lows on their walk up to multi-year highs above 40, finding consistent support at the stock’s 25-day moving average line.

Valuation: WLDN trades with a forward PE of 17.9. That’s a premium to the undervalued S&P 600 Small Cap Index (forward PE of 15.6) and a discount to the S&P 500 Index (forward PE of 21.5).

Short-Term Buy Range: Expect to buy in the 39 to 44 range in the short term.

The Next Event: Expected Q3 earnings release date is October 31.

Current Recommendations

Please email me at tyler@cabotwealth.com with any questions or comments about any of our stocks, or anything else on your mind.

Glossary

Buy means accumulate shares at or around the current price.
Hold means just that; hold what you have. Don’t buy, or sell, shares.
Sell means the original reasons for buying the stock no longer apply, and I recommend exiting the position.
Sell a Half means it’s time to take partial profits. Sell half (or whatever portion feels right to you) to lock in a gain, and hold on to the rest until another ratings change is issued.

Disclosure: Tyler Laundon owns shares in one or more of the stocks mentioned. He will only buy shares after he has shared his recommendation with Cabot Small-Cap Confidential members and will follow his rating guidelines.

The next Cabot Small-Cap Confidential issue is scheduled for

November 7, 2024.

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