Sterling Infrastructure may be a unique way to invest in your data center, but it doesn't come with a return.
Number of small cap stocks sterling infrastructure (STRL 3.61%) Investors are in tears as they devour anything that seems to have anything to do with artificial intelligence (AI). This appears to include the specialist infrastructure contractor. The British pound stock price has increased about 180% in the last year (as of April 24, 2024, as of this writing).
Starling is certainly a unique way to play AI. The company's largest and most profitable division is called “Electronic Infrastructure Solutions,” which provides construction services for large enterprises (think Big Tech) that need things like data centers, e-commerce warehouses, and power generation facilities. We are handling it. In fact, with data centers being a high priority these days, Starling seems to be leaning towards this important segment. Is the stock still a good buy?
A secret bet on data center development?
Since 2017 (when current CEO Joseph Cutillo took over the reins of the business), Starling has embarked on a growth mission. We started by strengthening our traditional highways and private businesses (the “Transportation Solutions” sector) by making bidding for jobs more stringent. The goal is to increase profit margins, and this is a successful strategy (more on this later).
Since then, Starling has made multiple acquisitions to enter large-scale residential projects in Texas and Arizona (a division now called “Building Solutions”) and several acquisitions to form its “E-Infrastructure” division. We have made acquisitions.
It's this last part that Wall Street is interested in. Electronic infrastructure revenue in 2023 was $937 million, accounting for 48% of Starling's total revenue last year. However, E-Infrastructure operating income was $141 million, accounting for 62% of the total. Therefore, this fast-growing segment is also the most profitable part of this construction business.growth and As profit margins improve over time, stock prices can rise significantly.
However, Starling is not only working on electronic infrastructure through data centers. Last year, the company saw a significant 66% increase in RPO (remaining performance obligations, current and future amounts billed to customers) in its transportation division. Large private projects such as highways and freeways take years to complete, so new projects entering the pipeline can take years to turn into revenue and accumulate in proportion as RPO. .
However, short-term RPOs for e-infrastructure also increased by 35% in 2023, reaching $814 million. This could be a sign that construction of data centers and related projects is heating up for Starling.
Cheap small-cap stocks or an AI-fueled cyclical peak?
Starling Infrastructure was a great topic in 2023. However, the construction industry, even specialty construction, is a highly competitive industry. That is reflected in Sterling's historic single-digit percentage operating margin profile. Thanks to bidding discipline and significant additions to electronic infrastructure in the transportation sector, profit margins have improved dramatically in recent years, bringing the overall business margin to more than 11% at the end of 2023. I did.
Clearly, the contractor is on a strong growth trend, with further growth planned as data center and AI builds heat up. The stock trades at about 20 times Wall Street analysts' expectations for 2024. This is by no means a bargain, but compared to the AI ​​and data center hype that is occurring elsewhere in the stock market, the pound looks like a relative value.
I'm hesitant to buy because construction is an inherently cyclical business. Starling could lose its position as a high-level construction stock in another year as it relies on big tech companies that continue to ramp up development of data centers and other specialty real estate. This is the life of a highly cyclical company.
As an alternative for investors willing to invest in infrastructure development, Invesco Building & Construction ETF (PKB 1.69%) It might be worth considering. Its portfolio of holdings includes Starling Infrastructure.
For now, it's interesting to see Starling's electronic infrastructure acquisition efforts starting to bear fruit. However, the sharp rise in the stock price over the last year is not a reason to buy. Investing in small-cap stocks requires discipline, so invest with caution.
Nicolas Rossolillo and his clients have no position in any stocks mentioned. The Motley Fool has no position in any stocks mentioned. The Motley Fool has a disclosure policy.