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NAPEC Inc. (NPC-T) currently provides an "excellent" entry point for investors, said Raymond James analyst Frederic Bastien.
He initiated coverage of the Drummondville, Que.-based company with an "outperform" rating.
"In our years following Canada's publicly-traded contractors, we were presented with many opportunities to add to our coverage list," said Mr. Bastien. "We passed on several of them as we couldn't get comfortable with these firms' managements, strategies, service offerings or geographic footprints. It proved the right decision, in hindsight, as the stocks we contemplated failed to create meaningful value for investors. While the same can be said of NAPEC up to now, we argue the proverbial stars are beginning to align for this specialized utility contractor. Our analysis shows that NAPEC carries little downside risk at current levels and solid upside potential as the company capitalizes on the growing and consolidating market for electric and gas utility construction."
Mr. Bastien sees visibility for double-digit organic growth for NAPEC, which provides construction and maintenance services to the public utility and heavy industrial markets, through 2018.
"NAPEC derives over 80 per cent of its revenues from the Northeast U.S., where factors are converging to form an exceptionally supportive operating environment," the analyst said. "Sitting atop the list are reliability and safety. U.S. regulators won't allow the electric grid to reach the breaking point again after Hurricane Sandy left 8.5 million people without power and paralyzed Manhattan. As a result they are now granting operators rate base increases to reinvest in aging infrastructure. In addition, publicly-listed utilities are playing catch-up after years of underinvestment in the wake of the global financial crisis. With a stronger American economy and continued access to low-cost capital, they are more open to invest for the long-run. Lastly, a rapidly changing energy mix in favour of natural gas and renewables is driving major investments in the infrastructure to bring this new power to market. All of this is effecting record capital spending plans for some of NAPEC's major customers"”including Exelon and Con Edison."
"More and more utilities are turning to acquisitions to combat the adverse effect of reduced consumer demand, steeper regulatory costs and increased competitive options for power. As they get bigger and oversee larger capex programs, we believe utilities will expect increasingly more from their suppliers. Therein lies the opportunity for NAPEC, which has ambitions and the wherewithal to grow with them. With CEO Pierre Gauthier's industry know-how and sound forward thinking, support from Quebec's two largest pension funds (Caisse de depot et placement du Quebec (la Caisse), the Fonds de solidarite des travailleurs du Quebec (FTQ)) and access to capital markets, we see NAPEC particularly well positioned to consolidate small electrical and gas utility contractors across the U.S. Northeast. Longer-term, we believe the stock represents an ideal takeover target for a large utility contractor with subscale presence in the region, or a diversified firm lacking capacity in NAPEC's service areas."
Mr. Bastien touted Mr. Gauthier's three-year strategic plan, which includes a repositioning of its operations on both sides of the border as well as the sale of non-core businesses and an emphasizes on "more profitable" activities. He called the impact, thus far, on margins "impressive" and expects further profitability from the recent acquisition of PCT Contracting, which he said "commands a leading position in New York's lucrative natural gas market.'
"There is potential for further improvements next year, as NAPEC's restructuring efforts yield additional savings and scale drives operating leverage," he said. This, at least, is what is implicit in our sector-leading EBITDA margin target of 8.7 per cent for 2018."
Mr. Bastien set a target price for the stock of $1.40, which is the consensus price target.
"The stock notably trades at an EV/EBITDA [enterprise value to earnings before interest, taxes, depreciation and amortization] multiple of 5.0 times our 2017 estimates, versus average multiples of 6.2 times for the three Canadian contractors we cover and 8.2 times for a better representative group of U.S. specialty contractors," he said. "Assuming NAPEC delivers on its well-laid out strategic plan and the market rewards the company appropriately, we believe investors could be staring at a $2.00 stock price in two years' time.”