Beacon Initiated at Buy Target $4.25 Foraco International SA Resources Corp.FAR Drilling Down on This Under Loved Story
We are initiating coverage of Foraco International SA (FAR-T, “Foraco” or Company) with a BUY rating and a target price of C$4.25. In summary, our recommendation is based on the following:
Third Largest Driller with Great Opportunity Down South. Foraco is the world’s third largest drilling services provider for the mining industry by rig count with a current rig fleet of 302 and a revenue base of $358 MM (TTM as of Q3/FY23E end). The company has a strong presence in key mining markets including Canada (33% of revenues) and South America (35% of revenues).
Foraco currently doesn’t have presence in the US market but has operated in the country before. The US is the world’s 4th largest market for exploration drilling, valued at >$1.6 Billion (13% share), and has witnessed the strongest growth rate over the last 10 years. We believe this represents the most immediate growth opportunity and could provide a 5-10 pps lift to topline growth with just a low single digit market penetration rate. Diversified Into Higher-Margin Water Drilling.
Foraco built a solid reputation in water-related drilling services which it successfully leveraged to establish a foothold into that segment within the mining industry. The company’s water drilling segment is currently focused on environmentally-responsible water management within mining operations. Foraco derives ~12% of its revenue from this segment, which also provides higher margins (to the tone ~400 bps). Financial Flexibility Following Debt Refinancing Transactions. Over the last 3 years, the company concluded two debt refinancing transactions that helped improve its financial flexibility. Most recently, the company refinanced its $85 MM senior secured bond facility which resulted in 1) 50% reduction in interest costs, or about $7 MM annually and 2) Spreading out principal repayments from ~$85 MM to be paid over FY24E-FY25E to just $22 MM to be paid over that period and pushing out a big lump sum payment (from $75 MM due on FY25E to $47 MM due on FY27E, with option to spread it over 5 years). Free Cash Flow Generation Should Unlock Value and M&A.
Looking ahead, we expect Foraco’s free cash flow to nearly double, to ~$40 MM annually. This is driven by the aforementioned debt refinancing as well as stabilizing the business following a successful run of improving fundamentals where 3-year CAGRs for revenue and EBITDA were 21.5% and 36.3%, respectively. Thus, we believe Foraco is well positioned to pay down debt at a faster rate, return capital to shareholders in the form of more substantial buybacks and conclude M&A to accelerate its growth in the USA and/or water business. Attractive Valuation and 51% Upside.
Foraco currently trades at EV/EBITDA (FY24E) of 3.1x, a 0.5x turns discount to its historical average and a 0.8x discount to the industry leader Major Drilling (MDI-T, Buy, C$12.25/sh PT). We believe Foraco shares should trade towards the higher-end of their historical range (3.5x-4.0x) given our expectations for it to continue to report strong single digit/low double digit topline growth and to continue to deliver margin expansion. Consequently, we apply 3.75x EV/EBITDA to arrive at our 12-month target price of C$4.25. With expected return of 51%, we initiate coverage with a BUY rating.