canada`s engineering firms designing impressive shareholder returns

5/26/2018 Canada`s Engineering Firms Designing Impressive Shareholder Returns

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Infrastructure & ConstructionCanadas Engineering Firms: Designing Impressive

Shareholder Returns

Jamil Murji, CFA (Associate)

[email protected]

604.659.8261

Theoni Pilarinos, CFA (Assoc

theoni.pilarinos@raymondjames

604.659.8234

Greg Jackson (Associate)

[email protected]

604.659.8262

Frederic Bastien, CFA

[email protected]

604.659.8232

Ben Cherniavsky

[email protected]

604.659.8244


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RAYMOND JAMES

Canada ResearchPublished by Raymond James Ltd

Please read domestic and foreign disclosure/risk information beginning on page 44 and Analyst Certification on page 45.Raymond James Ltd. | 2200 925 West Georgia Street | Vancouver BC Canada V6C 3L2

Industrial May 3, 2

Industry RepFrederic BastienCFA | 604.659.8232 | [email protected]

Ben Cherniavsky| 604.659.8244 | [email protected]

Jamil MurjiCFA (Associate) | 604.659.8261 | [email protected]

Theoni PilarinosCFA (Associate) | 605.659.8234 | [email protected] Jackson(Associate) | 604.659.8262 | [email protected]

Infrastructure & Construction

Canada`s Engineering Firms: Designing Impressive Shareholder Returns

In this report, we explore the fundamentals of the engineering and design industry and explain why the Canadian firms serv

itGenivar, IBI Group and Stantechave been great stocks to own over time. We also include SNC-Lavalin in our anal

because of the influential position its engineering practice now commands globally, and the similarly impressive returns

100-year old firm has achieved for its shareholders. What we will highlight in the following pages is our thesis that the de

businessor what is often referred to as the professional technical services industryboasts compelling investment attrib

and will continue to be positively influenced by powerful secular trends. We will also demonstrate the four firms comprising

engineering sub-segment of our Infrastructure & Construction (I&C) coverage are best-in-class and suitable for a broad ranginvestors.

A Business Blessed With Attractive (and Enduring) Investment Attributes.Genivar, IBI Group and Stantec boast a numbe

characteristics that differentiate them from the other three I&C groups we cover (contractors, equipment dealers

engineered products). They focus on a fee-for-service consulting model and typically shy away from construction risk (th

where SNC-Lavalins model differs). Design firms also generate healthy margins that reflect their high value-add and tend

have low capex requirements, enabling them to generate strong cash flows from operations. Finally, the nature of their serv

and their positioning in all phases of a project life cycle facilitate the generation of stable and diversified revenue streams.

Strong Fundamentals Underpin this Sector.First there is a growing secular demand for public infrastructure. This was a

premise behind our Nov-28-07 Nation Building reports investment thesis and one that continues to weigh in positively tod

Then there is the highly-fragmented U.S. market, which represents fertile acquisition grounds for the three design firms un

our coverage (especially in light of the strong Canadian currency). Lastly, there is a trend toward larger and more comp

projects, and the impact of tighter environmental regulations, both of which are boosting demand for design services.High-Quality Companies; Near-term Headwinds.We believe the four Outperform-rated companies included herein boast s

management teams, industry-leading positions and very sound business strategies. That said, we remain mindful of certain r

and challenges each firm faces in the short term. Specifically, we expect: (i) the softer market conditions in the U.S. to conti

weighing down on both IBI Group and Stantec; (ii) the government of Trinidad and Tobagos quest to reform procurem

legislation to slow Genivars organic growth for one or two more quarters; and (iii) more headline risk to potentially emerge

SNC-Lavalin in the Middle East and Northern Africa. These headwinds, combined with the lack of any very compelling valua

discount on these stocks, explain why a Strong Buy rating is conspicuously absent from our recommendations for the group.

To Each His Own. None of this, however, should detract from our main message that Canada four engineering firms

designed to deliver impressive shareholder returns over time. Moreover, each boasts unique traits that make it attractive fo

broad range of investors. Genivar, which we selected earlier this year as one Raymond James Best Picks for 2011, stands ou

the stock that offers the best combination of growth and income. What draws us to IBI Group are its proven partnership m

and industry-leading yield. We favour Stantec for its leadership position in P3s and latent leverage to a recovery in U.S. e

market demand, and see SNC-Lavalin as the obvious choice for investors seeking exposure to global infrastructure markets.

Company Ticker Ticker Current Rating Target Price Total Re

Primary Secondary Price (6-12 months) To T

Engineering

Genivar Inc. GNV-TSX C$30.10 2 C$33.00

IBI Group Inc. IBG-TSX C$14.79 2 C$16.50

SNC-Lavalin SNC-TSX C$56.53 2 C$63.00

Stantec Inc STN-TSX STN-NYSE C$29.62 2 C$33.75

Raymond James Ltd.


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Canada Research | Page 2 of 52 Infrastructure & Construc

Raymond James Ltd. | 2200 925 West Georgia Street | Vancouver BC Canada V6

Table of Contents

Overview............................................................................................................................................. 3

Professional Technical Services 101 ................................................................................................... 6The ABCs of Design Firms........................................................................................................ 7How Projects are Administered...............................................................................................8 Defining Features of Design Firms...........................................................................................9

Key Industry Trends ............................................................................................................................12

1. Horizontal Integration: Many Innings Left..........................................................................122. Vertical Integration: More are Embracing the Integrated Approach..................................153. Projects are Growing Larger and More Complex ................................................................16

4. The Environment: A Good Business for Engineers .............................................................16End Market Outlook ...........................................................................................................................17

Buildings.................................................................................................................................. 18Urban and Muncipal Infrastructure ........................................................................................20Transportation......................................................................................................................... 20

Industrial and Power ............................................................................................................... 21

Environmental .........................................................................................................................21

Analyzing the Returns.........................................................................................................................23Return on Invested Capital (ROIC)........................................................................................... 23EBITDA Margin ........................................................................................................................25EBITDA Growth........................................................................................................................ 26Revenue and EBITDA per Employee........................................................................................ 27Working Capital Management (Day Sales Receivable)............................................................ 28

Company Profiles................................................................................................................................30Risks ....................................................................................................................................................41


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Infrastructure & Construction Canada Research | Page 3 o

Overview

This report profiles the engineering and design sub-segment of our Infrastructure &

Construction (I&C) coverage universe in Canada. Namely, the list of public companies

that participate in this market include Genivar, IBI Group, and Stantec. Recognizing

some important distinctions in its fully-integrated business model, we have also

elected to include SNC-Lavalin in this report because of its close parallels to the pure

design firms mentioned above.Our comprehensive analysis begins with a broad, high-level overview of what the

engineering and design business is all aboutor what we label Professional Technical

Services 101. We then identify and discuss what we believe to be the most important

industry trends currently underway before turning to a review of the key end markets

that the sector serves. Next, we introduce a peer group benchmarking exercise that

evaluates the historical performance of select financial ratios for the companies noted

above. We then provide a detailed review of our respective investment theses for

Genivar, IBI Group, SNC-Lavalin and Stantec, and close with a brief overview of some of

the largest independent players domiciled in Canada.

If asked to encapsulate all of the facts and opinions expressed in this comprehensive

report, we would reference Exhibit 1. Therein, it is strikingly evident that investing in

Canadas publicly-traded engineering and design firms has been a very lucrativeexperience over the long-run. For example, since its IPO in 2006 Genivar has generated

a total return (dividends and share price appreciation) of 244%; IBI Groups five-year

return has been 87%; SNC-Lavalins has been 82%; and Stantecs has been 37%. Over a

ten-year period, the total return for the latter two companies has been 819% and 579%

respectively (10-year data are not available for Genivar or IBI Group).

Investing in the engineering an

design sector has been a very l

exercise

Exhibit 1: Five-Year Total Returns for Canadas Engineering and Design Stocks

-50%

0%

50%

100%

150%

200%

250%

300%

Apr-06

Aug-0

6

Dec-0

6

Apr-07

Aug-0

7

Dec-0

7

Apr-08

Aug-0

8

Dec-0

8

Apr-09

Aug-0

9

Dec-0

9

Apr-10

Aug-1

0

Dec-1

0

Apr-11

SNC STN IBG GNV

Source: Capital IQ, Raymond James Ltd.

Raymond James Ltd. | 2200 925 West Georgia Street | Vancouver BC Canada V6C 3L2


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Although the past tells us only very little about the future, our broad recommendation

to stay invested in this sector is significantly influenced by such impressive historical

results. Indeed, we believe it is more than mere coincidence that all four of our

engineering and design stocks have outperformed the index over such a challenging

period of time for the economy. Rather, we view this as indicative of the very strong

fundamentals that underpin this sector. At the macro level these include: (i) a growing

secular demand for public infrastructure; (ii) an increase in the outsourcing of

engineering practices from general industry to specialized firms; (iii) a tightening of

environment regulations and permitting processes; (iv) on-going horizontal and vertical

consolidation; and (v) a trend towards the construction of larger, more complex

projects.

Similarly, we believe that the microeconomics of this business are blessed with some

very attractive (and enduring) investment attributes including: (i) high gross margins

that reflect the value-added intellectual component of engineering and design

services; (ii) limited capital investment requirements that lead to strong free cash

generation; (iii) ample opportunity to cross-sell services and diversify revenue streams

into multiple end-markets and complete life-cycle solutions; (iv) disciplined

competitive dynamics; and (v) a general strategy (with some important exceptions, most

notably for SNC-Lavalin) of focusing on a fee-for-service model that limits exposure to

construction risks.

Favourable secular trends and

business fundamentals

The positive influence that all the variables noted above have had on our universe of

engineering and design companies is visible not only in the long-term shareholder

returns, but also in the financial benchmarking analysis that we have included in this

report (see the section Analyzing the Returns). For example, Genivar, Stantec and SNC-

Lavalin have each consistently averaged an ROIC in the range of 10-13% over many

years, well over their respective cost of capital. Similarly, respectable EBITDA margins

have been maintained in the range of 13-20% for the pure design firms in Canada and

8-9% for SNC-Lavalin going back to 2006 and beyond. Meanwhile, the most recent full

cycle EBITDA growth (i.e. over a trough to peak period in the economy) compounded at

a rate ranging from 23% (Stantec) to 55% (Genivar) for the group.

To the extent that all of the aforementioned macro and micro forces are expected to

remain intact (and in some cases accelerate), we believe that our coverage universe ofengineering and design firms can continue to generate impressive financial results for

the foreseeable future. That is largely why we currently rate all four of these stocks

Outperform. At the same time, we remain mindful of the numerous risks and challenges

that continue to weigh on this industry. As expounded upon in this report, these

include: (i) the governments increasing fiscal restraint; (ii) the depressed state of

private non-industrial construction markets; and (iii) the lofty valuations of independent

target firms that have made acquisitions more expensive. These headwinds, combined

with the lack of any very compelling EV/EBITDA discount on the stocks we cover, have

taken some of the sizzle away from our sector call and investment thesis at this point

in time. As a result, a Strong Buy rating is conspicuously absent from our current

recommendations for the group.

should positively influence

Genivar, IBI Group, Stantec andSNC-Lavalin for years to come

None of this, however, should detract from our main message that the engineering anddesign firms in Canada represent an attractive buy and hold opportunity for investors

seeking healthy long-term returns with relatively low-risk. Accordingly, we expect all

four firms in our coverage universe to perform well over the next 12 months and

beyond, with Genivar standing out as the one stock that was selected for Raymond

James Ltd.s 2011 Best Picks list in the Dec-7-10 report.



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Our investment thesis for each of these companies can be summarized as follows:

Genivar.In the short five years it has operated as a publicly-traded entity, Genivarhas completed 51 acquisitions, grown its employee base from 1,150 to over 4,500,

and generated a total return of 244% for its shareholders. Much of this growth was

facilitated by the firms entrepreneurial and decentralized approach, which

empowers partners to focus on what they do bestwin business and drive revenue

synergies. There is reason to expect more of the same as the firm shifts its focus to

global diversification and aims to add new fields of expertise, including architecturaldesign, energy and mining. At the same, we expect the firms outsized position in

Canada to help drive organic growth at an annual rate of 5-10% for many years to

come (notwithstanding some recent short-term headwinds from the Trinidad &

Tobago operations). This, combined with Genivars healthy dividend, leads us to

believe the stock offers one of the Canadian I&C sectors most enticing combination

of growth and income.

IBI Group.Income-oriented investors will be well-served buying shares of IBI Group,in our opinion. We feel the firm is well positioned to capitalize on: (i) an impending

recovery in private sector spending; (ii) the continued growth in private financing

initiatives; and (iii) an increasing concentration of ownership and management of

real estate portfolios. But what draws us to IBI Group is its proven partnership

model; today the firms leadership team comprises approximately 80 Directors andAssociate Directors who collectively own 46% of the firms common shares. We

believe this is one of the most powerful ways to align the interests of all IBI

stakeholders. Other considerations supporting our constructive stance on the stock

include the firms world-class architectural practice and its strengthened position in

social infrastructure.

SNC-Lavalin. We find it difficult to poke holes in SNC-Lavalins integrated businessmodel. The Montreal-based firm has over the past ten years developed into a global

engineering and construction (E&C) juggernaut as well as an active participant in

the ownership, operation and maintenance of infrastructure assets. Simply put, no

other firm comes even close to matching the breadth and scope of SNC-Lavalins

operations in Canada, where the company is developing massive power and civil

construction projects a mari usque ad mare. Globally, the company is a go-to namefor mining and metallurgy projectsas recent services contract wins from Vale, Rio

Tinto and BHP Billiton can attestand also boasts one of the leading foreign E&C

presences in emerging countries. Recent events in Libya show that investing in SNC-

Lavalin is not without risks, but we know from experience (and the firms 10-year

average ROE of 19%) that management will adapt, innovate and continue to drive

shareholder value higher.

Stantec. Over the past decade, Stantec has evolved from a small, regional playerinto one of North Americas largest design firms. Its ability to generate this type of

self-funded growth (mainly through acquisitions) while maintaining healthy levels of

profitability, respectable ROIC, and conservative financial leverage has earned

management a laudable reputation among investors. Stantecs growing scale has

also provided it with an increasingly diversified revenue stream, lucrative cross-selling opportunities, and an expanding expertise in the P3 market. The depressed

state of the U.S. construction markets, the related depreciation of the U.S. dollar, a

deceleration of acquisition activity, and simply the law of large numbers have all

conspired to slow the companys growth rate more recently. Nevertheless, we

remain positive on the stock because of its reasonable valuation along with the

firms formidable position in the more robust Canadian market (especially in the

West), its strong economic fundamentals, its opportunity to continue consolidating

the market, and its latent leverage to an eventual recovery in end market demand.


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Professional Technical Services 101

Genivar, IBI Group and Stantec compete in the broadly defined professional technical

services field. Participants in this industry offer comprehensive consulting services

(which range from conceptual planning and design to engineering and project

management) to customers in the infrastructure and facilities market. Because these

entities have traditionally centered their activities on the front-end of projects, they are

commonly referred to as design firms. That description isnt stopping a growing numberof companies from adopting a holistic, long-term view to meeting client needs by

rounding out their offering with services such and maintenance and decommissioning

(see Exhibit 2).

Exhibit 2: Project Lifecycle

Project Lifecycle Phase Role of Professional Technical Services Firms

- Explore project concept

- Decide type of project (fixed price, cost plus)

- Determine delivery method (design-bid-build, design-build, PPP, etc.)- Feasibility study

- Schematic design and specifications

- Draft contract

- Project management

- Surveying

- Resident engineering services

- Facilities and infrastructure management

- Facilities operations

- Performance engineering

- Solutions and recommendations for taking facilities out of active serviceDecommissioning

Maintenance

Design

Pre-project Planning

Construction

Source: Stantec Inc., Raymond James Ltd.

Within the design industry, there is considerable diversity among companies. Some

choose to specialize in one or two specific disciplines while others (generally the larger

ones) strive to offer complete life-cycle solutions. The one common thread is that all

design firms focus on a fee-for-service consulting model and typically shy away from

construction risk. This low-risk strategy used by Genivar, IBI Group and Stantec differsfrom the integrated approach SNC-Lavalin has employed successfully for years and that

many global construction firms are moving towards. There are pros and cons to each

business approach, all of which will be expounded upon below. But first we wish to

delineate the professions that this report includes in its definition of design firms.

Professional technical services

focus on a fee-based model an

typically shy away from constr

risk



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The ABCs of Design Firms

We have structured this report to include the following practices: architecture, design,

urban planning, engineering and surveying. Architecture can be loosely defined as the

art and science of designing buildings and other physical structures. The discipline

employs licensed professionals who spend hours blending functional, technical, social

and aesthetic considerations into their drawings. On many projects, architects are also

called upon to prepare detailed bid documents, hire the engineers and general

contractors, and administer the construction contract on behalf of the project owner. In

contrast, designers are non-designated (no pun intended), less technical and generally

handle only a subset of an architects responsibilities.

Architects blend functional, soc

aesthetic considerations into th

drawings

Interior designers, for example, apply their skills to achieve built environments that are

functional and aesthetically attractive, support user safety and enhance the quality of

life of the occupants. Urban planning extends beyond the architectural practice (and

physical buildings) to include activities supporting the continued welfare of people

land use management, the design of transportation and communication networks, and

the protection and enhancement of the natural environment. To the extent

architectural, planning and design activities often overlap, it is common to see

companies offer these related services under one roof. IBI Group and Stantec are two

such firms.

While architects, designers and planners are generally viewed as the artists responsible

for the functionality, look and ambience of a building, engineers use math and science

to make it all work. Civil engineers ensure buildings are strong and stable enough to

resist all appropriate structural loads; mechanical engineers handle the ever so critical

HVAC and plumbing systems; and electrical engineers are responsible for all

communications, lighting, wiring, power and control systems. It is worth highlighting,

however, that these building engineers represent only a portion of all practicing

engineers today. Countless others specialize in other fields of the infrastructure and

construction sector (such as transportation, power and utilities, water treatment and

distribution, mining and energy) and in unrelated industries.

while engineers use math an

science to make it all work

We have opted to include geophysical surveying and mapping in this report for obvious

reasons. Because the profession focuses on locating and measuring the extent ofsubsurface resources, it exerts significant influence on sectors that are of strategic

importance to SNC-Lavalin, Genivar and Stantecoil, gas, mining and metallurgy

especially at this point in the cycle. However, for the sake of keeping the scope of this

report manageable, we exclude any other technical services professions from our

discussion.

Combined, these five consulting industries form a vital and growing part of the Canadian

economy, accounting for roughly two percent of GDP. According to Statistics Canadas

most recent survey, design firm operating revenues rose at an impressive compound

annual growth rate (CAGR) of 11.7% to $27 billion between 2004 and 2009, with

engineers making up the lions share of this market (see Exhibit 3). We attribute much of

the industry growth in Canada to three secular trends. Firstly, competitive and cost

pressures have compelled entities ranging from large oil and gas companies to realestate developers and crown corporations to focus operations on their core

competencies. As a result, such organizations began outsourcing their engineering

needs, the implementation of their capital expenditure programs and other non-core

projects to consulting firms. Secondly, all levels of government took decisive steps in the

mid 2000s to bridge the countrys infrastructure gap by significantly boosting

investments. This was the fundamental premise behind our Nov-28-07 Nation Building

reports investment thesis and one that continues to weigh in positively on the I&C

sector and all design firms (even despite our governments recent belt-tightening).

Lastly, professional technical services firms are seeing increased business from

With annual revenues of $27 b

design firms form a vital part o

Canadian economy



9/54


environmental compliance and permitting as regulations continue to dictate the

progression of an infrastructure project be it a greenfield job or a brownfield

redevelopment.

Exhibit 3: Canadian Design Firm Operating Revenues

75%

12%

13%

2004 Market Size = $16 billion

80%

8%

12%

2009 Market Size = $27 billion

Engineering Architecture, design and landscaping Surveying and mapping

Source: Statistics Canada, Raymond James Ltd.

In the United States, the economy may be softer, but the demand for design services is

still outpacing overall GDP growth. Over the five-year period ending 2009, we estimate

that the industry expanded at a CAGR of 8.0% to US$252 billion, compared to an

average of 2.9% for the U.S. economy. We believe the decentralization of government

engineering arms and stricter environmental regulations have similarly influenced the

sectors growth, as have technological advances and the increased complexity of

projects undertaken nowadays. To the extent the American Society of Civil Engineers

gives Americas infrastructure a grade of D and estimates a five-year investment need

of $2.2 trillion, there is the potential for many more years of above-GDP growth rates

for design firms south of the border (www.infrastructurereportcard.org). However, we

believe this will depend largely on the countrys willingness to adopt innovative ways to

finance infrastructure projects (including public-private partnerships, or P3s) as well as

its ability to raise taxes as a means of tackling the federal and state deficits that loom

over the economy.

The U.S. design industry witnes

CAGR of 8.0% between 2004 an

versus 11.7% for the Canadian

How Projects are Administered

On a typical Design-Bid-Build project, which many in the construction industry refer to

as conventional delivery, the architect and its design team are the owners agents (and

represent its interests). While this relationship still holds true for much public and

private sector work performed today, the advent of the P3 and design-build (DB) models

over the past decade has altered the traditional pecking order for large-scale

infrastructure projects. Under these alternative delivery methods, the owner awards the

design-build mandate to a general contractor or a construction joint venture, which in

turn hires consulting firms to carry out the design and engineering. Because P3s are



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structured over terms that generally last between 25 and 30 years, they also force said

firms to place greater consideration on the assets operation and maintenance phases.

Although DB projects are diminishing the influence design firms have traditionally held

on the tendering process, they often bring additional opportunities for such firms. Thats

because a public owner sometimes chooses to engage a team of professionals, often

referred to as the owners engineer, to advise and represent its interest over the length

of the DB contract.

Defining Features of Design Firms

Professional technical services firms sell knowledge and solutions. As such, their most

valuable assets are the employees on their payroll. To attract and keep these

individuals, design firms must develop a healthy corporate culture that fosters a strong

entrepreneurial, can-do spirit, and offer opportunities to work on challenging projects

with some of the most talented people in the industry. They must also take the

necessary steps to groom the next generation of professionals through various training

and leadership programs, and incentivize all employees to row in the same direction. To

this end, all three design firms under our research coverage require their senior

management to own an equity position in their firm and offer up-and-comers long-term

stock-based compensation. These incentives, we believe, go a long way in building asignificant accumulated knowledge base, continuity in the firms relationships with their

clients and business stability.

Human capital is the largest an

important asset of a design firm

Design firms boast a number of characteristics that differentiate them from the other

three I&C groups we cover (see Exhibit 4). Broadly speaking, they tend to boast

relatively healthy margins that not only reflect their high value-add, but also their

critical role in the industry value chain. They are well-diversified and have low capex

requirements, but generally lack scalability. Equipment distributors similarly have

limited fixed capital investments, but do operate with considerable working capital

requirements. This group is exposed to attractive parts and service opportunities and

tends to perform best during the later stages of the cycle. Engineered product

manufacturers have comparatively high fixed capital requirements, which in turn

provide significant operating leverage. The defining characteristics of the contractorsegment are lower margins and a rather high degree of cyclicality (and scalability). The

amount of fixed capital investments for these companies depends on the degree to

which they chose to 'self-perform' construction activities.

Relative to other I&C segments

firms generate higher margins

have lower capex requirement

generally lack scalability



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Exhibit 4: Infrastructure and Construction Value Chain

DesignSurveying and mapping

Preliminary plans

Detailed engineering

Value engineering

Process engineering

Equipment selection

Equipment design

Programming

Construction

Site preparation

Site construction

Site supervision

Site inspection

Procurement

Scheduling

Quality control

Cost control

PlanningMaster plans

Feasibility studies

Strategic planning

Project development

Financial analysis

Functional programming

Technical programming

Operation &

MaintenanceCommissioning

Training

Start-up

Maintenance programs

Materials and

Engineered Products

ADF Group, Canam Group,

Armtec Infrastructure

GLV, ZCL Composites

Russel Metals

Equipment

Finning

Cervus Equipment

Rocky Mountain

Ritchie Brothers

Strongco, Toromont

Wajax

Engineering

Genivar

IBI Group

Stantec

SNC-Lavalin

Contractors

Aecon Group

Bird Construction

Churchill Corp.

North American Energy Partners

SNC-Lavalin

Source: Raymond James Ltd.

If we focus our analysis on the technical consulting firms specifically, we find that the

nature of their services facilitates the generation of stable and diversified revenue

streams. This level of diversification stems from their positioning in all phases of theinfrastructure and facilities project life cycle, and can be often enhanced further through

geographical expansion and/or the pursuit of complementary practice areas. To drive

this point home, we note that the seven engineering consulting firms included in our

I&C comparable valuations table were able to grow EBITDA at an average annual rate of

12% over the two-year period ending Dec-31-10, compared to respective declines of 6%

and 15% for two groups comprised of global integrated firms and North American

contractors (we provide more detail in theAnalyzing the Returns section). Additionally,

while we track and document the large jobs our engineering and architectural names

secure, this analysis merely captures the tip of the iceberg; the bread and butter for

these firms actually comes from a myriad of projects each performs for its clients every

single working day, and which are typically small in both size and scope (e.g., feasibility

studies, conceptual drawings and environmental impact assessments). For proof

consider that IBI Group, Genivar and Stantec handled roughly 10,000, 15,000 and 25,000active projects, respectively, in 2010 with none deriving more than 3% of their top-line

from any single project. This steady flow of work, in our view, also helps explain the

relative resilience of design firms in recessionary timeswhen clients prefer to plan

projects in anticipation of better times ahead.

Professional services firms wor

large number of small projects

various sectors, which helps extheir resilience in recessionary

Architects and engineers, like other consultants and professionals, charge a fee for their

service. The fees are structured depending on the type of project undertaken, the scope

of work to be performed, and whether the contract was competitively tendered or sole-

sourced (read: negotiated). In situations when the scope of services and schedule can be



12/54


clearly defined, a lump-sum or fixed-fee arrangement is generally favoured. Examples of

this are an architectural firm executing a contract for a percentage of a buildings

construction cost, or a municipality hiring a civil engineering firm to perform a

transportation study for a set amount. However, in instances when either the scope or

the schedule of services cannot be reasonably defined, as is often the case on industrial

projects, a time-and-materials or hourly agreement is recommended.

Design firms agree to fixed-fee arrangements based on an estimate of the costs a

specific project will entail. They will tend to favour such contracts over those based onhourly rates to the extent they generally result in higher-margin, more profitable jobs.

But every so often some unforeseen difficulties can force staff to work additional hours

on a particular assignment, rendering it less profitable than anticipated. It is worth

stressing, however, that these cost overruns are usually immaterial to the consultants

bottom-line (especially when considering the multitude of projects over which they are

spread), and pale in comparison to the losses contractors and even integrated firms can

suffer on large hard-bid jobs. This latter point was most clearly driven home two months

ago when Aecon Group warned about a $55 million loss suffered on Suncors Firebag 3

Central Plant Facilities (CPF) project. Even best-in-class SNC-Lavalin was inadvertently

caught by surprise in 2007 when the bankruptcy of a key supplier derailed its Goreway

thermal power project for several quarters. From these examples, it is clear one key

advantage to the design firms fee-based strategy is that it limits their liability; the

flipside is that it prevents them from offering fully packaged, in-house solutions.

Cost overruns are rare and usu

immaterial to a design firms bline

...but can wreck a contractors

fortunes

Each consulting firm employs a unique mix of professional, technical and administrative

support staff with differing levels of experience, expertise and responsibility. As a rule of

thumb, when preparing their budgets, most firms typically commit 70-80% of available

staff time to billable projects, with the remaining 20-30% made available for business

development efforts, R&D projects, training and professional development. Also, since

there is a limit to how much revenue they can extract from the average professional,

design firms are best served to expand headcount when reporting over nine months

worth of backlog (conversely they should downsize when the backlog falls below six

months). To provide the basis for continued organic growth, and to offset the lack of

scalability inherent in their fee-for-service business model, Genviar, IBI Group and

Stantec have all been active acquirers; in the section that follows we explain why we

expect they will remain so.



13/54


Key Industry Trends

Demand for the services design firms offer is innately linked to the business cycle. It

rises during economic upswings as the ability of private and public sector clients to

make investments improves, and typically declines when the outlook for corporate

profits becomes less certain. The degree to which fee volumes soften will invariably

depend on the governments ability to continue funding infrastructure projects or,

failing this, their willingness to embrace Keynesian economics. Recent history shows thefederal and provincial governments in Canada did just that following the 2008 credit

crisis, whereas their U.S. counterparts were largely ineffective with their pump priming

efforts. We believe this helps explain in part why Canadian-centric Genivar has been

able to expand its business while other technical consulting firms with U.S. exposure

struggled to grow organically (though there were also other factors at play behind

Genivars healthy performance). But over and beyond these macro forces, we see four

underlying themes combining to drive continued growth for the professional technical

services firms under our coverage. These include:

1. Horizontal Integration: Many Innings Left

The consolidation of engineering and design firms is much like the consolidation that

occurred in the accounting industry. In the 1950s most public accountants operatedlocally as sole-proprietorships or single-office partnerships. But as travel and

telecommunication improvements in the 1960s and 1970s made it easier to expand

business beyond local confines, accounting firms started following their clients abroad.

Many established satellite offices from the ground up, but soon found it simpler and

more efficient to partner with established companies sharing complementary client lists

and similar values of service quality and professionalism. From this emerged a multitude

of national firms and ultimately, through cross-border consolidation, the Big 4 (Deloitte,

PricewaterhouseCoopers, Ernst & Young and KPMG). Today these accounting firms: (i)

audit 98% of the more than 1,500 largest U.S. public companies on recordaccording

to United States Government Accountability Office; (ii) boast an expanded offering of

management consulting, corporate finance, risk and tax services, and (iii) are major

developers of talent within the financial services industry. While the Big 4 dominate theaudit market and are orders of magnitude larger than their next largest competitors,

they still leave some room for smaller entrepreneurial firms to thrive in specific niches

or regions.

Although no other profession has experienced to date a structural evolution emulating

that of the accounting industry, we believe design firms appear to be following a similar

path. In 2010, Stantec continued to march toward its goal of becoming a top 10 global

design firm with ten acquisitions, Genivar outlined plans to double in size over three

years, IBI Group snapped up the United Kingdoms largest architectural practice

specializing in social infrastructure (Nightingale Associates) and SNC-Lavalin added

Colombias biggest oil and gas engineering firm to its services offering. Notably, all of

this was unfolding as industry giants Aecom Technology Corp. and Tetra Tech were

gobbling up medium-sized firms across Canada including EBA, RSW and BPR.With all this consolidation activity, investors may be justified in asking: How long can

this possibly last?For quite some time, we believe. The ten largest U.S. design firms

generated combined revenues of US$34 billion in 2010, giving them a mere 13% share

of the professional technical services market (see Exhibit 5). Of these participants even

the largest, Aecom, had just 2% market share. This leaves the U.S. industry with nearly

400 firms generating annual fees ranging from US$25-500 million, and thousands of

smaller ones focusing on specialized sectors (see Exhibit 6). The design and consulting

world may not be as fragmented as it used to, but we believe there are many innings

left in the consolidation theme.

The ten biggest U.S. design firm

up only 13% of the market



14/54


Exhibit 5: Top U.S. Design Firms in 2010

Ranking Company Type of Firm 2010 Revenue (million) Market Share

1 Aecom Technology Corp. Engineer-Architect $5,920 2.3%

2 URS Corp Engineer, Architect, Contractor $5,039 2.0%

3 Jacobs Engineer, Architect, Contractor $4,748 1.9%

4 CH2M Hill Engineer-Contractor $3,603 1.4%

5 Flour Corp. Engineer-Contractor $3,128 1.2%

6 Amec Engineer-Contractor $2,456 1.0%

7 Tetra Tech Inc. Engineer $2,456 1.0%

8 Bechtel Engineer $2,210 0.9%9 KBR Engineer-Contractor $2,170 0.9%

10 Parsons Brinckerhoff Inc. Engineer-Contractor $2,010 0.8%

$33,740 13.4%

25 Stantec Inc. Engineer, Architect, Planner $578 0.2%

Source: ENR Sourcebook, Raymond James Ltd.

Exhibit 6: Top U.S. Design Firms, 2002 & 2010

..but the total number

of firms in the industry is

very large.

0

50

100

150

200

250

300

350

More than $1

billion

$500 million to

$1 billion

$250 million to

$500 million

$100 million to

$250 million

$50 million to

$100 million

$25 million to

$50 million

Less than $25

million

2002 2010

In 2002, there were just 17 U.S.

Design firms with revenue greater

than US$500 million. in 2010 there

were 27.

..but the total number of

firms in the industry is very

large.

1000's

Source: ENR Sourcebook, Raymond James Ltd.

Genivar, IBI Group, Stantec and SNC-Lavalin consider acquisitions to be an integral part

of their long-term strategy. There are several reasons for this. Acquisitions provide

design firms with an increasingly comprehensive range of engineering services to

promote and cross-sell. They help address the scalability issues engineers and

consultants face when targeting new opportunities and can unlock significant revenue

synergies (as the customer lists of the design practices are combined). Moreover, if

done right, they allow employees to enjoy greater career opportunitieseffecting a

powerful and attractive virtuous circle for these firms (see Exhibit 7).

Acquisitions offer engineering f

an increasingly comprehensive

of engineering services to prom

and cross-sell



15/54


Exhibit 7: Engineering Services Virtual Circle at Work

The firm adds capabilities across all three

parameters of the enterprise geography,

discipline and end marketmost predominantly

through acquisition

Satisfied clients in turn outsource more and more

engineering services to the firm, increasing demand

for new types of services

The firm gains a new client base to which it

can cross-sell services

The firm provides a full range of

professional consulting services to its

private and public sector clients

Potential

Partners

and

Targets

Private

and

Public

Clients

ProfessionalTechnical

Services

Firms

1

3

4

2


No matter how attractive an avenue for growth it represents, it is our view that a firms

roll-up strategy will ultimately be influenced by its cash flow generating capacity as well

as its ability to tap external funds. Specifically, we estimatebased on the industrys

historical operating profit margin of 10%that design firms can afford to grow

strategically at an annual rate of 5-10%. Beyond this range, growth can only be

reasonably achieved with sufficient access to capital (either from the public markets or

through strategic partners). This puts private firms at a significant disadvantage to the

extent their internal funds are typically paid out to employees-owners or retained to

buy-out retiring shareholders. The silver lining for the smaller firms it that the industrys

ongoing consolidation is giving them a practical alternative to succession. As the old

adage goes, if you cant beat them, join them.

Another driving force behind the growth-through-acquisition model is that it can be a

highly accretive exercise. Private companies, depending on their size and focus, have

historically been acquired for multiples ranging from 3.0x to 7.0x trailing EBITDA. For the

larger design firms, this compares very favourably to the average EV/EBITDA multiple of

8.5x they have commanded from the Street over the past 15 years (see Exhibit 8).

and can be highly accretive



16/54


Exhibit 8: Engineering Services Historical EV/EBITDA Valuation

2x

3x

4x

5x

6x

7x

8x

9x

10x

11x

12x

1Q

96

1Q

97

1Q

98

1Q

99

1Q

00

1Q

01

1Q

02

1Q

03

1Q

04

1Q

05

1Q

06

1Q

07

1Q

08

1Q

09

1Q

10

1Q

11

TTM EV/EBITDA Average

Average: 8.5x

11.7x

5.1x

The engineering services industry has traded at an average

EV/EBITDA multiple of 8.5x over the past 15 years

1 standard

deviation

Private companies in the industry are

typically acquired for 3-7x EV/EBITDA

Source: Capital IQ, Raymond James Ltd.

2. Vertical Integration: More are Embracing the Integrated Approach

SNC-Lavalin was one of the very first engineering firms to package the professional

services that Genivar, IBI Group and Stantec deliver efficiently today with full-blown

construction services. In the late 1990s the company went a few steps further by

layering on investment financing and operations and maintenance (O&M) capabilities to

its engineering and construction offering. This was in keeping with the objective of

major infrastructure owners to integrate all key phases of the value chain to drive

efficiencies and reduce costs. To wit, SNC-Lavalins one-stop approach can take pressure

off the design, engineering and procurement activities, cut the risks of supply chain

conflicts and avoid the inefficiencies of managing too many supplier interfaces. It also

allows for more flexibility, as construction projects can be handled with varying risk

profiles and better coordinated with the work of designers. The integrated approach has

certainly pushed SNC-Lavalin to assume more risk, but it also has rewarded the firm with

a first-mover advantage over its industry peers and a significantly larger share of client

budgets.

There are advantages to integr

all key phases of the I&C value

chain

and large contractors have ca

on to these

Big construction firms have caught on to the benefits of the integrated model, and are

now positioning themselves earlier in the project life-cycle. This is precisely what U.K.-

based Balfour Beatty did in 2009 when it acquired U.S. engineering stalwart Parsons

Brinckerhoff (PB) for US$626 million. The deal combined PBs well-established globaldesign practice with Balfour Beatty's large construction and investment businesses to

create a group with significantly enhanced capabilities. Based on this example, we

would be remiss to ignore some of the appeal IBI Groups global architectural practice

may have for players situated further down the I&C supply chain.



17/54


3. Projects are Growing Larger and More Complex

On a recent magazine cover, ReNew Canada coined the expression Infranormous to

describe the 100 largest infrastructure projects currently underway in Canada. We felt

this was appropriate since the average project on the list had ballooned in size from

$680 million in 2010 to $960 million in 2011. Due to their sheer size and the increased

complexity that tougher regulations and stricter standards have placed on owners, the

planning of such projects has been taken to a whole new level. Nowhere is this more

obvious than in the oil sands where a host of recently sanctioned projects are slowlyprogressing through the planning and engineering phases. Producers reason its better

to spend more time planning things right in the very early stages of development, than

to cut corners and end up paying for it dearly at the end. These delays may drive the

contractors we follow up the wall, but they are music to the ears of engineers.

The trend toward larger and m

complex projects

Many Canadian public owners have embraced the use of the P3 model to undertake

large-scale infrastructure projects. But we note that the resulting growth has had mixed

implications on the design industry. For one, high barriers to entry effectively render the

P3 market impenetrable to smaller firms. They also require the designer to work for a

reduced fee early in the proposal and qualification stages of a project, with the promise

of much improved economics if the bid proves successful. Accordingly, firms must

efficiently manage staff utilization and carefully asses the proponents they team up with

to ensure the rewards for chasing P3 work more than justify all efforts put in and risksassumed. There is obviously more upside for firms that maintain high securement ratios,

to the extent they can spread their costs across a greater number of successful bids. IBI

Group and Stantec appear to be doing a good job of it, judging from their recent

successes. Notably, the former company is lead architect on SNC-Lavalins Glen Campus

project in Montreal as well as the Womens College Hospital in Toronto; the latter is

handling all design services for two Carillion-led projects in Ontario, the new Forensic

Services and Coroner Complex and the Centre for Addiction and Mental Health.

has had mixed implications o

engineering and design industr

We invite readers interested in learning more about P3s to refer to our comprehensive

Jun-11-08 report titled Under the Microscope; How P3s Change Industry Dynamics and

our Sep-30-10 update The P3 Model: An Enduring Feature of Canadas I&C Marketfor

more detail.

4. The Environment: A Good Business for Engineers

Long gone are the days when environmental matters were plainly ignored in the

execution phases of a project. Increased regulation and public awareness have,

together, propelled environmental considerations and permitting to the forefront of a

projects planning phase. In turn, demand for related consulting services and expert

advice has balloonedarguably making environmental engineering the hottest

subsector of the design and consulting industry. Since all new projects under

consideration now invariably have a greenangle to them, most engineering firms see

the benefits of developing or acquiring expertise in this field. Stantec significantly

bolstered its expertise in the field in early 2009 when 1,700-employee strong Jacques

Whitford, an internationally recognized leader in environmental and earth sciences

solutions, joined the company. Largely as a result of this deal and the many tuck-ins it

has performed since, the firm today ranks as a top-tier firm in the North American water

sector.

but the impact of tighter

environmental regulations has

universally favourable



18/54


End Market Outlook

Before turning our focus to the key market segments that professional technical services

firms target, we believe a brief analysis of the industrys macro drivers is warranted.

There are stark differences in t

fiscal state of Canadas ten

provinces, which biases our

research towards companies wstrong foothold in the west

Activity in the design industry is dictated at least partially by the economic cycle. This

certainly rings true for private sector spending, which relies heavily on corporate profits,

the labour market, property vacancy rates and commodity prices. When private sector

activity dried up at the onset of the global credit crisis, the Canadian governments keptthe lights on in the construction sector by not only committing $21 billion in stimulus

money, but also accelerating the roll-out of large-scale projects earmarked under the

$33 billion Building Canada Plan. However, as mounting fiscal realities force certain

provinces to scale back their funding, we believe that a sustained economic recovery is

necessary to propel the I&C sector higher. We maintain the western Canadian provinces

will provide more ample and lucrative business opportunities than their counterparts to

the east and the south, ceteris paribus, thanks to their healthier fiscal position (see

Exhibit 9) and wealth of natural resources.

Exhibit 9: Projected Provincial Debt-to GDP Ratios (F2011)

17%

-6%

7%

26%

36%

48%

34%

40%

35% 35%

-10%

0%

10%

20%

30%

40%

50%

B.C. Alba Sask Man Ont Que NB NS PEI NFLD

Source: Conference Board of Canada, Globe and Mail

Canadian design firms serve a smorgasbord of industries (see Exhibit 10). This makes an

analysis of numerous end markets an important part of any outlook for the sector, and

we follow a wide range of macro indicators accordingly. In some cases, such as mining

and oil and gas, where our firm has established respected sector research, we largely

defer to our internal sources of expertise for our analysis. In other areas, such as

buildings, transportation or municipal infrastructure, we have established our own

practice of evaluating trends and monitoring key demand drivers. Either way, a

thorough review of all the end markets that the design and consulting universe serves

could constitute a separate report on its own. Therefore, in order to maintain a

manageable scope, we limit ourselves to providing a summary of the current demand

conditions in and future outlook for the five markets that are most relevant to design

and consulting firms we cover.



19/54


Exhibit 10: Sector Exposure of Canadian Designers and Engineers

BuidingsUrban and Municipal

InfrastructureTransportation Industrial and Power Enivironmental

Dessau < 5%

exp Global 5-20%

Genivar 20-50%

Golder 50-75%

Hatch 75% +

IBI

Stantec

SNC-Lavalin

Source: ENR, Company Reports, Raymond James Ltd.

Buildings

Projects in this segment are carried out for both public and private sector clients and

run the gamut from courthouses, hospitals and universities to condos, office towers andentertainment complexes. To gauge the prospects of the related components of this

industry in North Americaresidential, commercial, institutional and industrialwe

continuously monitor the monthly buildings permits data made available by both

Statistics Canada and the U.S. Census Bureau, the American Institute of Architects (AIA)

and the websites of all major P3 agencies.

Most large-scale social infrastructure projects north of the border have recently been

tendered under various P3 forms, and we expect this to continue for some time. In

healthcare alone, the list of projects includes the Oakville Hospital and the third phase

of the London Health Sciences Centre in Ontario, the Interior Heart and Surgical Centre

Project in British Columbia, and the Montreal University Hospital Centre (CHUM) in

Quebec. In Alberta, the government is expected to stick to the traditional procurement

approach to fund health facility projects in several medium-sized cities and rurallocations, including a massive hospital for Grande Prairie. However, if we look at the

general trend for institutional buildings intentions (see Exhibit 11), the data suggests a

drop in activity over the coming months and quarters, which is consistent with the more

cautious outlook we communicated in our Jan-14-10 report dubbed Life After Stimulus.

The outlook for privately-funded construction activity in Canada has brightened

considerably from 18-24 months ago, especially in the industrial sector, where key

commodity prices generally remain above investment threshold levels (despite the

recent volatility). According to many industry sources, the commercial building segment

in western Canada is also rebounding from trough levels as the surplus in office and

retail space is being worked off, but the last few months of data suggest the recovery

may be lumpy.

The outlook for privately-funde

construction activity has bright

considerably in Canada...

Also key to the publicly-traded design firms we cover are the construction intentions for

multi-residential buildings and the related influence these have on urban land

development. We would be remiss to ignore their impact on IBI Group, in particular, to

the extent the firm has been instrumental in the planning and design of Toronto and

Vancouvers waterfronts. In this regard, the outlook for private condo developments

also appears to be on the mend.



20/54


Exhibit 11: Canadian Non-Residential and Residential Building Permits

Canadian Non-Residential Building Permits

0.0

0.5

1.0

1.5

2.0

Fe

b-0

6

May-0

6

Aug-0

6

Nov-0

6

Fe

b-0

7

May-0

7

Aug-0

7

Nov-0

7

Fe

b-0

8

May-0

8

Aug-0

8

Nov-0

8

Fe

b-0

9

May-0

9

Aug-0

9

Nov-0

9

Fe

b-1

0

May-1

0

Aug-1

0

Nov-1

0

Fe

b-1

1

PermitVa

lues(

$bil

lion

)

Industrial Commercial Institutional

Canadian Building Permits

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

5.0

Fe

b-0

2

Jun-0

2

Oct-02

Fe

b-0

3

Jun-0

3

Oct-03

Fe

b-0

4

Jun-0

4

Oct-04

Fe

b-0

5

Jun-0

5

Oct-05

Fe

b-0

6

Jun-0

6

Oct-06

Fe

b-0

7

Jun-0

7

Oct-07

Fe

b-0

8

Jun-0

8

Oct-08

Fe

b-0

9

Jun-0

9

Oct-09

Fe

b-1

0

Jun-1

0

Oct-10

PermitVa

lues

($bil

lion

)

Non-Residential Residential

Source: Statistics Canada, Raymond James Ltd.

Any concerns about the fiscal condition of certain Canadian provinces pale in

comparison to the problems that the U.S. federal government and many U.S. statescurrently face. Simply put, we feel public-sector building work south of the 49th parallel

will continue to languish until the current debate in Congress over the deficit and the

budget gets resolved. The outlook for private construction activity is more favourable,

though we believe the restricted lending practices of the banks, excess housing supply

and a general lack of confidence in the economy will continue to present the industry

with near-term headwinds. All of these issues are evident in certain key industry metrics

that we track such as the building permits or the Architectural Billings Index. The latter

reflects a 9-12 month lag time between architecture billings and construction spending,

with any score above 50 indicating an increase in demand for design services (see

Exhibit 12). The corollary to this suboptimal environment, when combined with a strong

Canadian currency, is that the U.S. market should remain fertile acquisition grounds for

the Canadian-based designers for some time to come.

but economic conditions in th

remain suboptimal

This may prove fortuitous for t

companies highlighted herein

Exhibit 12: U.S. Non-Residential and Residential Building Permits, Architectural Billings Index (ABI)

150

200

250

300

350

400

450

500

550

600

650

700

750

Feb-02

Aug-02

Feb-03

Aug-03

Feb-04

Aug-04

Feb-05

Aug-05

Feb-06

Aug-06

Feb-07

Aug-07

Feb-08

Aug-08

Feb-09

Aug-09

Feb-10

Aug-10

Feb-11

(SAAR,US$

billion)

R es id en ti al N on -r es id en ta l

30.0

35.0

40.0

45.0

50.0

55.0

60.0

65.0

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

Architect's Bi llings Index (ABI)

12M Moving Average

Source: U.S. Census, The American Institute of Architects, Raymond James Ltd.



21/54


Urban and Municipal Infrastructure

Professional services provided in this area focus on a citys below- and above-ground

infrastructure. This results in a broadly-defined market that encompasses water

distribution and treatment, wastewater collection and treatment, land planning,

landscape architecture and transportation accessibility. New investments in this field

are generally driven by the cyclical housing market, population growth and urbanization;

in contrast the maintenance, operations and repair of existing infrastructure is generally

managed (unfortunately) on an as-needed basis. This chronic underinvestment has todo with the fact that much of the funding commitment falls in the hands of local

municipalities, which have limited financial flexibility.

A more stable residential sector and fiscally stronger jurisdictions provide for a much

healthier outlook in Canada than in the U.S. Moreover, we view the nations aging water

infrastructure as the next logical candidate for the P3 model, and surmise that a pipeline

of related projects will build over the medium term. Globally, Frost & Sullivan pegs the

water market for design, consulting and construction at $126 billion. We highlight the

global water treatment and re-use segment for its explosive potential, as drinking water

shortages now affect roughly one-third of the worlds population.

Transportation

This segment includes planning, surveying, design and project management services fora variety of transportation projectsincluding highways, bridges, ports, airports, mass

transit facilities and traffic systems. Most clients represent public authorities, weighting

the sectors outlook heavily on spending budgets. However, as we have highlighted in

previous industry reports, larger-scale transportation projects are ideally suited for the

P3 model because: (i) the capital asset provision and the availability payments can be

tied to performance, and (ii) they necessitate significant operation and maintenance

requirements (see Exhibit 13). It is no wonder P3s are being contemplated for many big

ticket projects across Canada including the eastern extension of Torontos Highway 407,

the final leg of the Edmonton Ring Road and the reconstruction of Montreals crumbling

Turcot Interchange and Champlain Bridge.

Exhibit 13: Suitability of P3 Model for Various Infrastructure Project Types

Urban Government Major Water / Government Health Schools Post Facility

Highway owned service Rural Wastewater owned public Facilities Secondary Upgrades

delivery facility Highway buildings Institutions (brownfield

Higher Lower

Suitability Suitability

Proven model Defined and Defined Defined and Specialized Building L imited Partial GoA Latent

Well defined stable funct. performance stable program and complexity economies of funding defects

requirements requirements criteria operating and functional Premature scale Technology Unforeseen

Stable long Defined and Stable long performance requirements obsolescence Premature change risks

term O&M stable program term O&M criteria One-off Technology obsolescence Specialized Limited deal

Innovation & requirements Low financial Utility type buildings change Size/bundling technology flow

economies of Stable long risk function Architectural / Jurisdictional Program Building

scale term O&M Government Jurisdictional design issues inconsistency complexity

Low financial Government payment issues competition Need GoA Jurisdictional Jurisdictional

risk payment stream (municipal) Long term payment issues issues

Government stream Expansion Need GoA performance guarantee Need GoA Need GoA

payment Lessons requirements payment criteria change Severance of payment payment

stream learned Limited guarantee Technology O&M guarantee guarantee

Deal flow innovation & Asset change Limited deal Severance of Limited deal

economies of ownership Severance of flow O&M flow

scale O&M Asset Limited deal Asset

Limited deal ownership flow ownership

flow Asset

ownership

Source: Alberta Infrastructure and Transportation, Raymond James Ltd.



22/54


South of the border, decreasing tax revenues and continued uncertainty about long-

term funding has stifled some planned transportation projects. A case in point is the

recent proposal from the House Budget Committee to reduce the mandatory budget

authority for all federal transportation programs by 30% to $41 billion for F2012. There

might be a silver lining to this, as the shortage of funding and the construction downturn

have many public agencies rethinking their approach to capital asset allocation and

evaluating alternative financing and procurement methods. But before we can count on

P3s to drive the U.S. transportation sector into recovery, lots of political hurdles need to

be cleared.

Industrial and Power

This segment encompasses various sectors including mining and metallurgy, oil and gas,

power generation and transmission, and manufacturing to name a few. The service

offering spans the entire project life-cycle, from planning, functional programming and

engineering to project management, construction support and decommissioning.

The industrial segment of the Canadian economy continues to demonstrate marked

resilience and growth. This is largely a function of strong commodity prices that support

elevated levels of related activity. The prevailing levels of capex in mining and energy

are particularly robust and, notwithstanding some recent volatility, are expected to

remain strong over the foreseeable future. Longer term our Raymond James Ltd. and

Raymond James & Associates energy and mining teams project oil, gold and copper

prices to settle at $125.00/bbl, US$1,100/oz and US$2.50/lb. We note that these

estimates, assuming they materialize, remain well above investment threshold levels

and should create favourable operating dynamics for the engineering firms that support

exploration and production (E&P) activities.

The industrial segment of the

Canadian economy continues t

show marked resilience and gr

In a sure sign that power demand is on the rise, various hydro-electrical power projects

were recently sanctioned across Canada. These include two SNC-led developmentsthe

Lower Churchill Project in Newfoundland and B.C.s Waneta Expansionas well as the

Lower Mattagami Complex in Northern Ontario. Although no material power gen

projects are slated for Alberta in the immediate term, the province is bulking up its

transmission infrastructure with investments totaling $14.5 billion over the next decade

(also a potential boon for SNC-Lavalins AltaLink). And while the demand outlook for

new nuclear reactors looks grim in the wake of the Fukushima Daiichi power plant crisis,

we believe more money will flow toward the refurbishment of older plants. Add to this

burgeoning wind and solar power industries and you have the recipe for many years of

growth for the engineering firms serving the power market, in our view.

while investments in power

generation and transmission as

have been accelerating

Environmental

As discussed in the Key Industry Trends section, a regulatory push from pollution

cleanup to prevention has taken hold amid growing public awareness. This has left

engineering firms to handle ever increasing volumes of work ranging from impact

studies, permitting and compliance audits to hazardous waste remediation and air

pollution monitoring. Engineers are also spending more time on existing assets, as thefear of retroactive environmental liability escalates among infrastructure owners. The

two high-profile industrial disasters in recent historyBPs Deepwater Horizon oils spill

and Fukushimas nuclear reactor leakmay also turn clients focus from solely

complying with regulations to more proactively managing the integrity of their assets.

Based on these, and to the extent environmental matters will increasingly dictate the

development and ongoing operation of infrastructure and facilities projects, it is easy for

us to envision a favourable outlook for the environmental engineering profession.



23/54


Exhibit 14: Sector Summary Table

Market Key Drivers Outlook

- Overall economic activity

- Building permits

- Municipal budgets

- Environmental regulations

- Drinking water shortages

- Overall economic activity

- Government financing for public works

- Global economic activity

- Commodity prices

- Corporate profits

Environmental - Regulation and public awareness Neutral to Positive

Buildings Neutral to Positive

Neutral

PositiveIndustrial and Power

Transportation

Municipal Infrastructure Neutral




24/54


Analyzing the Returns

In this section of the report, we present a comparative analysis of certain financial

metrics we consider key to the design industry. The intent is to provide investors with

some insightful data about how each company we cover stacks up against other

industry bellwethers (Aecom Technology, AMEC, Arcadis and Tetra Tech), along with a

cursory overview of how professional technical services firms compare to other

subsectors of the I&C industry, most notably the integrated firms (please refer toAppendix A for the list of companies comprising this group).

This analysis obviously involves some subjectivity in selecting what to measure and how

to measure it. It is also an imperfect exercise in that some of the companies we examine

have unique reporting segmentssuch as SNC-Lavalins Infrastructure Concession

Investments (ICI) divisionor operated under different capital structures until recently.

Here we specifically refer to Genivar and IBI Group, both of which converted from an

income fund structure to a corporate structure at the beginning of 2011. Our ability to

look back at and compare the historical performance of design firms is further limited by

the length of time they have operated as public entities. This is not a problem for

companies like Stantec and SNC-Lavalin, which have been public for many years. But for

IBI Group and Genivar, which first tapped equity markets in 2004 and 2006, respectively,

it is a consideration that cannot be overlooked.

Notwithstanding these complications, we believe a comparative analysis can still be

useful and telling. In particular, we like to look at it in the context of valuation. That is to

say, perhaps the companies with the best and most consistent financial performance

should command a premium multiple in the market, while those that have

underperformed deserve a discount. But this too becomes a subjective call because the

past can obviously tell us only so much about the future; we also, for reasons noted

above, have to be careful with how we interpret relative performance. With all of these

considerations in mind, we will briefly discuss each of the metrics that we have selected

for this analysis, why we selected them, how we define them, and what the numbers

tell us about the companies thatwe cover.Return on Invested Capital (ROIC)

We believe that ROIC is a useful measure of a companys overall financial performance

and of a management teams ability to create shareholder value. This measure,

however, is open to various definitions and interpretations. For our purposes, we prefer

to measure ROIC using net operating income less adjusted taxes (NOPLAT) divided by

total invested capital. We also like to adjust the capital base for any goodwill

writedowns and ignore the related charge to EBIT. Specifically, in our methodology, we

define ROIC as follows:

We view ROIC as one of the be

measures of a management te

ability to create shareholder va

EBIT less Adjusted Taxes + Changes in Deferred Taxes

Net Debt + Equity Capital

We have tax effected the operating profits of the two former incomes trusts using a

statutory rate of 34.5% over the 2005-2010 period, which helps to adjust for a more

accurate comparison with their corporate peers. We also elected to omit the addition of

changes in deferred taxes as we assume the tax rate adjustment accounts for GAAP and

income tax reporting mismatches. Ultimately, we will leave it up to the investor to

decide how to interpret these distortions and what to make of the whole income trust

debate (i.e. did it starve companies of capital for future growth?). But from our

perspective we offer the following observations about the data presented in Exhibit 15:



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Generally speaking, all of the companies in this benchmarking analysis havegenerated respectable ROIC metrics over both five and ten year periods. This

consistent ability to exceed the cost of capital reflects the attractive economics of

the engineering and design business and underscores our view that all four of the

firms that we profile in this report represent attractive buy-and-hold investment

opportunities.

Stantec has not only averaged the industrys highest ROIC over the medium andlong term, but also shown tremendous consistency over the years. This comes to usas no surprise in light of the firms consistent profitability (to be illustrated next)

and assiduousness in funding growth mainly through internally generated funds.

Having said this, we would be remiss not to acknowledge that its ROIC (after

adjusting for asset write-downs) has tracked lower in recent years (2009 and

especially 2010). This, we believe, is a function of changes in project mix, intensified

competitive pressures, and the timing and pace of acquisitions.

Stantec has generated the indu

highest ROIC over the mediumlong term

Genivars double-digit ROIC performance suggests to us that management has donea good job deploying the $200 million of additional equity it has raised since the

IPO. We also attribute the solid results, in part, to the firms concentrated exposure

to the Canadian I&C markets, which have proven more resilient than many other

jurisdictions in the past three years.

IBI Group, on the other hand, has exhibited the lowest returns among the group.We believe much of this has to do with the fact that as an architecture-heavy firm,

its past performance closely reflected the overall state of the commercial and multi-

residential (read: condominium) markets. Recent acquisitions in the civil and social

infrastructure markets should go a long way in alleviating some of the cyclicality

inherent in these private sector markets, and provide smother returns over time.

There has been a step change in SNC-Lavalins ROIC over the past few yearsanimpressive feat considering the improvement was achieved amid recessionary

times. We link this performance to a number of factorsincluding a maturing

staple of concession investments, the favourable allocation of resources toward

growth producing regions and strengthening project execution.

Exhibit 15: Peer Group Analysis of ROIC for Design Firms

ROIC 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 5-yr AVG 10-yr AV

ENGINEERS

Genivar n.a. n.a. n.a. n.a. n.a. n.a. 8.5% 11.3% 10.0% 8.6% 9.6% 9.6%

IBI Group n.a. n.a. n.a. n.a. 5.2% 9.0% 8.3% 6.4% 4.5% 5.6% 6.8% 6.5%

Stantec 11.5% 13.5% 15.8% 14.0% 17.0% 14.9% 13.6% 14.1% 13.6% 11.5% 13.5% 13.9%

Aecom Technologies n.a. n.a. n.a. n.a. n.a. n.a. 18.6% 6.9% 7.2% 10.0% 10.7% 10.7%

AMEC 8.8% 2.6% 13.2% 6.4% 5.7% 12.5% 5.1% 15.7% 5.4% 18.7% 11.5% 9.4%

ARCADIS NV 11.6% 15.7% 12.1% 10.5% 17.1% 14.7% 12.9% 14.9% 12.9% 10.8% 13.2% 13.3%

Tetra Tech 8.0% 12.0% 12.2% 3.5% 4.1% 8.8% 7.8% 8.3% 15.6% 11.2% 10.3% 9.2%

Engineers - Average 10.0% 10.9% 13.3% 8.6% 9.8% 12.0% 10.7% 11.1% 9.9% 10.9% 10.8% 10.4%

SNC-Lavalin 5.5% 6.9% 7.2% 8.1% 8.6% 7.6% 4.1% 10.9% 13.9% 12.8% 9.9% 8.5%

Integrated Firms - Average 2.9% 12.3% 17.2% 11.1% 12.9% 10.3% 10.9% 10.3% 14.8% 11.2% 11.5% 11.0%

Source: Capital IQ, Company Documents, Raymond James Ltd.



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EBITDA Margin

One notable disadvantage to using ROIC, in our view, is that it fails to reflect the

different policies design firms use for their purchase price allocations and to amortize

intangible assets. In other words, it does not provide a clear account of a firms cash

generating capabilities. For this reason, we feel it is important to look at the EBITDA

margin performance of the professional technical services firms under review (see

Exhibit 16). An analysis of EBITDA margins also provides us with a good read of firm

profitability. Our conclusions are as follows:

The Canadian companies we cover have sustained generally higher margins thanother

canada`s engineering firms designing impressive shareholder returns

Documents

design firms u

impressive returns

engineering practice

canadian firms servitgenivar

design industry

raymond james ltdplease

ibi group

public infrastructure