January 2025 Vol. 80 No. 1
Features
Utility & communications construction update, 2025 outlook
Daniel Shumate, Managing Director, FMI Capital Advisors Inc.
A cold October morning, looking down-range through the lenses of my pristine binoculars resulted in an image that could be described as mud. My grandfather leaned over and turned the focusing knob and told me to just keep looking through the lenses and the image became increasingly clearer. I then pointed the binoculars toward the ATV closer to our location and the same muddy image came back into view.
The same dynamic presents itself in the utility and communication construction industry today. After gaining the clarity that came with the re-election of President Trump, pieces of the 2025 picture came into focus. Conversely, the uncertainty around select policies and programs has created areas where our view is murky and will shift during Trump’s first 100 days in office.
The United States utility construction market consists of a combination of new construction that we capture in FMI’s Construction Outlook and is estimated in Figure 1. The consistent and growing grey line represents the non-building structures construction put-in-place, and this segment expects sustained continued growth above inflation in the coming years. Additionally, much of the utility construction occurring in power, gas and water and wastewater pipeline is repair and replacement work that is excluded from new construction captured in the figure below. The combination of new construction and repair work required for utility infrastructure creates a picture of a strong and growing market going into 2025.
If there is a clear picture of growth and expansion in our forecast, where does the muddy picture post-election come into play? The first policy that could potentially create challenges in the short term is the tariff program. Most of the equipment and products used in utility construction have origins in global supply chains. This was felt acutely by most of the industry in 2020 and 2021 as the pandemic set in and the global supply crisis impacted availability of both equipment and pipe.
As Elon Musk affirmed when discussing tariffs that impact U.S. manufacturing, they can cause short-term pain for consumers to create incentive to onshore manufacturing of important products. Companies like John Deere, Ford, Belden, Corning, etc. could all experience challenges when operating under new federal policies.
The DOGE (Department of Governmental Efficiency) program could also have an impact on the utility and communication spending, if programs that have been inefficient in their rollout (such as BEAD) have their money curtailed or directed into other technologies. While this is unlikely, given the industry’s support of Trump and his loyalty to his base, there is some concern that sources of significant spending to the utility and communications segment could be curtailed [WIFIA, PHMSA replacement requirements, EPA mandates for water and wastewater, etc.]. This will likely remain unclear until we see what recommendations come from the group and whether they are implemented by the Trump administration.
Lastly, labor remains a challenge for the utility and communication industry and one of the bottlenecks to improving the nation’s infrastructure more quickly. Companies developed programs and have become adept at H-1B visa programs and working to ensure that labor has the required paperwork and sponsorship to be part of the workforce. Companies embraced those willing to “dig” and are largely better for it. Significant changes to immigration policy could have an impact on labor supply and slow the ability of utility contractors to do the work.
Despite the areas of uncertainty, clear pictures in other areas of the economy have boosted morale among contractors nationwide. Certainty of tax policy encourages investment in people and equipment. The excitement around energy independence encourages investment and lowers the cost of fuel and oil-related products. Easing of permitting and environmental requirements could create energy connectivity that lowers cost and increases energy security with both power and gas transmission projects coming online. I remain excited about the effort to improve our nation’s infrastructure going into 2025.
Power transmission, distribution
The power transmission and distribution segment will experience continued growth and investment in 2025. There are two megatrends expected to define the power segment in 2025. The first is the continued march toward net-zero at the state level that will influence power and transmission distribution decisions for new spending in the segment. Required spending to accomplish the goals throughout the United States remains in the trillions and will play out over the course of my career.
The second is the spike in power demand driven by data centers fueling artificial intelligence and quantum computing. The power demand is a surge unanticipated by investor-owned utilities and is fundamentally changing the generation and transmission environment in real-time. The transmission, substation, sub-transmission and distribution requirements necessary to power the technology is an unexpected boon to the companies with the capability to provide creative solutions to new customers in the power generation and delivery space.
In addition to the megatrends, we expect increasing power distribution spending connected to system modernization and resiliency. This includes undergrounding, capacity additions and expansions, connectivity (fiber placement) for monitoring and communication, and grid redundancy programs. Power distribution spending has meaningfully outpaced inflation and we expect the trend to continue in 2025.
Natural gas transmission, distribution
The outlook for the natural gas transmission segment is markedly different under the Trump administration. Some of the most robust years for gas transmission miles constructed occurred during President Trump’s first term. The willingness of his team to foster energy independent policies, build pipelines to improve the flow of oil and gas in the U.S., and reduce the challenges to construction all fare well for the gas transmission segment. The excitement around this segment going into 2025 is palpable and we expect significant construction opportunities as the year progresses.
For the gas distribution contractor, installation, repair and replacement will remain a priority for gas LDCs. The low-hanging fruit in the gas distribution segment has been captured and now the LDCs turn to the dense urban environment improvements and the difficult, congested areas that come with significant repair cost but less total mileage. The other policy being monitored is PHMSA’s ongoing assessment of consequence areas that could meaningfully impact the gas distribution segment. Any adjustments to the population density requirements would change the total mileage of gas transmission and distribution pipes that would require replacement.
Communications infrastructure
The communication construction segment hopes to see the construction spending of the BEAD program begin to roll out during 2025. Delays and administrative hurdles with the legislation that was a part of the IIJA have been a frustration for contractors in the segment, but we expect that the engineering and administrative reviews will transition to construction.
This is one segment where significant questions about other technologies have begun to creep into the conversation. The most common technology discussed is Tesla’s Starlink. Starlink may be a great solution for hard-to-reach segments of the country that are sparsely populated. The challenge that Starlink will begin to encounter, if deployed on a grand scale comparable to what is being asked of current federal programs, is one of bandwidth and reliability.
For those less familiar with the technology, Starlink is a low-orbit satellite constellation that transmits high-speed internet from thousands of satellites. Starlink will encounter challenges with a growing user base that could impact speed and reliability. Weather events (i.e., thunderstorms) also impact Starlink reliability. Compared to existing wireless and fiber-based networks, there are significant challenges to being a replacement.
Creativity and action defined the contractors most successful in the communication segment over the past 12 months. Working hand-in-glove with power cooperatives, or coordinating with local officials to install high-speed internet at low cost, has had a profound impact on communities that do not get the same attention from Google, AT&T or Verizon. As discussed earlier this year, capex from the major players was impacted by other priorities within these organizations and as the peak demand areas for 5G reached a tipping point, spending slowed. Based upon investor reports by Verizon and AT&T, an increase is expected for capital expenditures on communication networks in 2025 that exceeds the levels last seen in 2022.
Municipal water/wastewater
New construction in both the water and wastewater segments is expected to grow significantly in 2025. Spending on water supply is expected to increase 14 percent year-over-year due to continued federal funding, population shifts and industrial production. The EPA estimated that the U.S. needs investment of over $650 billion over the next 20 years to ensure a safe drinking water supply and most of the spending is in the clean water transmission and distribution networks.
Spending on sewage and waste disposal is projected to increase 9 percent in 2025 due to water treatment improvements and residential construction growth. The population migration trends have also created challenges for clean infrastructure reliability and necessitate pipeline improvement to keep waste out of clean water including oceans, lakes and rivers. The needs gap studied by the EPA has only expanded and sits at $630 billion dollars in the latest Clean Watershed Needs Survey.
In addition to the new construction discussed, pipeline repair and replacement remains a significant area of spending for the water segment. The Biden administration set forth an executive ruling that requires all lead-based pipes be identified and replaced within a decade. The EPA is investing $2.6 billion for drinking water upgrades and lead pipe replacements funded by the IIJA and other loan-based federal programs. Assuming the program and its effort continues in the Trump administration, this represents a significant investment relative to prior efforts to improve clean water infrastructure.
UCCI performance & updates
The Utility & Communications Construction Index (“UCCI”) shown below presents the stock performance of the sector’s publicly traded stocks over the past year (Figure 2), the past three years (Figure 3), and the past five years (Figure 4). The UCC Index has been adjusted to reflect companies with increasing focus on underground infrastructure and removed those who are no longer participants or were declining in their influence.
Specifically, we have included APi Group that houses significant infrastructure capability alongside their fire prevention and security businesses. We exchanged MDU for Everus Construction Group, the spin-off from MDU that focuses on power utility infrastructure. We also added Sterling Infrastructure, given its capabilities around site development, pipeline construction and utility relocation connected to their transportation solutions.
The last 12-month performance of the UCCI is up 69.4 percent on the year because of the expectation for sustained growth and spending on utility and communications infrastructure. Additionally, this occurs while the stock market has surpassed its all-time highs throughout the year. The UCC Index outpaced the S&P 500, which increased by 30.9 percent over the past 12 months. Market expectations for revenue and earnings growth will continue to rise and while there are numerous strong fundamental elements of the utility infrastructure market, continued growth at these rates will be challenging.
Source: FMI Research, S&P Capital IQ; as of December 13, 2024
The three-year UCC Index fairly closely aligns with the “rebound” as the market loosened following COVID and the inflationary environment improved. The companies in the UCCI performed quite well relative to the S&P 500 due to federal legislation (for example the IIJA) and consistent increases in utility spending over the period. Multiple expansion (the amount profit is multiplied to create the value of a company) also grew during this period to reflect the expected increases in profitability, cashflow and growth of the industry.
Source: FMI Research, S&P Capital IQ; as of December 13, 2024
The five-year UCC Index in Figure 4 is nothing short of extraordinary. The relative growth of the UCC Index companies compared to the S&P 500 is impressive (and rare). The growth reflects the expectations that investors have for the UCC index companies and sets a very high bar for the industry, as we move into 2025.
Source: FMI Research, S&P Capital IQ; as of December 13, 2024
Source: S&P Capital IQ, data as of December 13, 2024; all data is TTM
Mergers & acquisitions
The final quarter of activity in 2024 was quite busy in the M&A markets. While this article is submitted before year-end closings, the activity leading up to December was robust and diverse. Azuria, backed by the private equity team from New Mountain Capital, continues to invest in the consolidation of the water and wastewater pipeline rehabilitation and repair markets.
Additionally, Quanta Services continues to invest in construction industry adjacent companies to reduce the supply chain risk. The investment in both eSmart systems and Niagara Power Transformers increases the addressable wallet share that Quanta can target moving forward. Certainty around capital markets, tax rates and a strong public market create an interesting market for sellers going into 2025.
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