Q4 Preview – 50% Inc in Backlog & EPS Positive @ 0.30x BV Highest conviction idea right here, earnings out tomorrow, today is your last day to place your bets ahead of Q4. These businesses can be lumpy on a QoQ basis but the bigger picture I want to focus on.
This is a prime example of Balance sheet to Income Statement transition where significant value can be realized just on a rerating of the business on a earnings basis from even a below a blowdown value of the balance sheet. I know it isn’t sexy as a COVID cure but it’s what I do.
You literally can but a dollar of assets that are going to generate a return on that dollar of assets for pennies on the dollar... the general distane for some of these Qubeec based businessses i cant that up. Who the heck is selling a 1.00 of assets of 0.30 on the dollar.
What am I talking about;
Just take the steady state financial position of the business and the balance sheet, Book Value is 94.3M or a value of 2.89/share which would be a 260% upside if they were just to close the business today.
Let’s do it more conservatively, take the blow down value of the balance sheet of A/R and Contract Assets at 75% and Inventory at 50%. I still get to a Book Value per share of 2.30/share or 188% upside.
So with a de-risked balance sheet I still get a base case situation where I am buying 1.00 of assets for 35 cents – are you kidding me. Who is selling this thing right here. Let me just go on a little rant right here, the CDN small/Micro space is so broken, you get to a point on some of these where you are buying below 50 cent of the dollar assets on blow down value and get the underlying business for free even when its producing FCF...there is something fundamentally broken about this…I am just like what the heck at this point take this thing private… why is there not more money looking at these type of opportunities… when capital is free lever this sucker up and take this thing private. Give me a call, I am looking for work. You usually only find these type of values in structurally impaired businesses that are losing significant amounts of money and that are fundamentally broken. I just not the case here and the series of events that have precluded the last couple months has created the best buying opportunity I have seen in the last couple years.
So why is this a structurally sound business and how do you get to that transition from a valuation of discounted balance sheet to some sort of multiple on income state and cashflow generation… keep it simple
Backlog Composition & Growth - Underlying Backlog Growth
- Transition to High Margin Fabrication Hours
- Infrastructure Spending
Underlying Backlog Growth Take the preannounced Backlog figure, January 31, 2020 Backlog stood at 329.2M up 50% YoY. So the future contracted work for the business is up 50% YoY. That is not a situation that presents a structural impairment in the underlying business. If the core underlying business is profitable on each underlying project and in which that business is growing 50% YoY it should trade a premium to book not a discount 200 to Book Value….
Transition to High Margin Fabrication Hours This is the most Bullish part of the story and the crux of my margin improvement thesis. Let’s look back to look forward. Q3 adj Gross Margin was 17.45% w 39% Fab hours vs Q3 Last year of Gross Margin of 10.16% w 24% Fab Hours.
So, if we look at the current backlog of 360.5M the Fabrication hours component of that is 55%. This shift to high margin asset light value add activity associated with much higher margins is in no way priced into the stock. You have a case here, where gross margins could be up 100% on a two-year stack and 50% on a YoY basis which will all flow down to the bottom line it’s a high fixed cost business.
Lets just talk about FCF leverage that comes from this high margin Fabrication Hour Revenue, the incremental capital investment on this revenue is literally immaterial.
It is all incremental FCF…with the stock priced at 0.30x Book Value its priced that the underlying assets cannot generate any incremental profit --- THIS THING IS SO MISPORICED Infrastructure Spending If you think this fiscal bomb of spending is not going to benefit infrastructure spending you got another thing coming to you.
Donald Trump is already talking about a 2.0 TRILLION infrastructure spending bill. Seeing that >90% of their Revenue is US based this is right in their wheelhouse. They have already worked on 4 major US Airport infrastructure projects, bring it on Donald - - If there was ever a time to invest in the dilapidated US infrastructure now is the time. LinkedIn gave me that oh snap moment, they were highlighting US projects they were working on this winter that were associated with CDN dollar cost centers out of Quebec delivering US dollar revenue like the Syracuse University roofing project. There is a massive currency arbitrage there, with a close to a 10% delta that should be all profit.
So, in summary, how do we transition from this heavily discounted balance sheet to income statement investment.
Revenue Growth from backlog being up 50% YoY
Transition to high margin/asset lighter fabrication revenue
Resulting flip in EBITDA margins >10% greater than their cost of capital
Macro Tailwinds from Infrastructure Spending
Currency Arbitrage from CDN dollar cost center and US dollar revenue
Shoot, I said this was a Q4 preview…. Keep it simple.
Q4 Revenue – 31.3M Revenue - Q3 Backlog 360.5M less Q4 backlog as of yearend of 329.5M, business is lumpy, I should stipulate I don’t really care on a QoQ basis it’s lumpy….lol
Q4 EBITDA – 3.3M EBITDA – A lot of it depends on Q4 deliveries relative to costs, but if the CFO was buying stock in the public market in December at 1.23/share he must like what he is seeing.