5 Top Picks for 2023 – A Levered Turnaround Story...Forgot to hit post on a couple of these so I will just fly through this one.
This is a personal favourite set-up I love to find. You got a highly levered business with a secular growth business that has been under-earning for a period of time that the market has just thrown it hands up and puked out the stock right as the earnings power of the business is improving.
Going to follow the same set-up as I did with Premier Health Group of America $PHA.V – go check that one out because that stock still hasn’t moved and we have just seen more buybacks and insider buying
https://stockhouse.com/companies/bullboard?symbol=v.pha&postid=35188947 We are going to looking for 5 criteria;
1) Accelerating Revenue Growth 2) Expanding Gross Margins
3) Expanding EBITDA Margins
4) Manageable Net Debt/EBITDA
5) Trough Valuation on Recovering 1) 2) 3) 1) Accelerating Revenue Growth – It’s all about mix shift here into 2023. 2022 was about right sizing the business and focusing on projects that could deliver profitable growth.
The growth engine of the business is the US renewables business. Especially after Joe Biden passed that 369B over 10 years Clean Energy/Inflation Reduction Act to accelerate the buildout of the green energy infrastructure footprint in the US.
Since I have been following the story the Renewables business has grown to almost 35-40% of total Revenues. This is clearly the more growthy side of the business and as it grows as a percentage of revenue so should the blended growth rate into 2023. Where you have a steady growing GDP+ growth rate on the more recurring Technical Services side of the business.
I would just highlight the US Solar business in particular, which these projects can be lumpy at times but the US Solar business is up nearly 250% YoY in the first 9 months vs 2021. Not too bad…
Have to talk about the divesture here, they sold off BullFrog Power for up to $35M which was doing call it $10-11M in revenue – They got a great price!!!
We are early here as more of the story is on the other side of the balance sheet but the secular story here on the US green buildout I think has unequivocally been accelerated with US policy decision which in the long run will benefit not only growth rate but the multiple expansion potential as well. 2) Expanding Gross Margins – This is where the rubber meets the road which is key to the story, they got smoked by raw commodity costs without question in 2021.
Since, commodity costs have come back in, and project bidding has had a chance to catch up. You Can see it in the trailing 7 Q gross margin profile of the business. FY22 Q3 – 25.0%
FY22 Q2 – 23.1%
FY22 Q1 – 19.4%
FY21 Q4 – 14.5%
FY21 Q3 – 18.4%
FY21 Q2 – 24.2%
FY21 Q1 – 25.3%
We went down into the abyss there and in a matter of 4Qs you have seen the pig go through the python and come out the other side on a lot of commodity pricing.
You put in the discipline during the tough times and now you have a chance over the next 4Qs to overshoot on gross margins to push even higher. As you costed out projects with higher commodity prices as price come in.
Should note that the divesture was higher margin revenue which will hurt the blended gross margin possibly down a couple hundred basis point but on a total gross profit dollar basis these gains are not going anywhere.
3) Expanding EBITDA Margins – You can copy paste a lot of the story on gross margins right again here on the profitability side
They have been able to carry the cost discipline right down the income statement and see that same trend in margins over the past 4Qs and the dramatic recovery.
FY22 Q3 – 20.3%
FY22 Q2 – 14.3%
FY22 Q1 – 4.0%
FY21 Q4 – 3.8%
FY21 Q3 – 14.9%
FY21 Q2 – 11.2%
FY21 Q1 – 13.0%
Once again, I do think they are over-earning here as there are a couple of non-cash adjustments in the BullFrog Power business that are not repeatable and once it gets divested the blended margin could come in a touch.
But over the long-run the ability in a matter of 4Qs to bring that EBITDA margin back up into that mid teen rate is so impressive.
A lot of it I think is just simply cost discipline post-COVID after the government foot the bill with CEWS you were essentially paid to keep on slack labour and once all these business units that were brought in to form Spark power fully got integrated under one roof and the management structure got streamlined. 4) Manageable Net Debt to EBITDA ratio – This is where a good business becomes an amazing equity investment in a levered turnaround. You got the operational improvement listed above so as more of the value of the business improvement accrues to the equity holders as it is still such a small part of the capital stack with a lot debt on this thing relative to the equity value.
The Divesture was critical, they sold aprox. 5% of the revenue base for $35M which gives them balance sheet flexibility to what was getting to a stretched balance sheet on at breach of covenants. Not only did they bring in the overall debt outstanding by a third they also got the remaining debt refi’d so they will be able to reclassify it to long term.
Pre-Sale they has aprox. $89M in net Debt which they refi’d at year end using the proceeds of the sale of BullFrog to pay down debt. Leaving them $55M in debt at year at my estimate as they said cash collections will be strong in Q4.
As a result, just on a LTM EBITDA basis of $30.5M they are comfortably trading <2x Net Debt/EBITDA and closer to 1x on a go forward basis if you look at the margin recovery of the continuing business that did >$10M in EBITDA in Q4 alone.
How they did it, I don’t know; but they were able to pull that balance sheet out of a debt spiral. Very impressive.
5) On Valuation – This is where things just gets silly on these levered turnarounds. As there is still hardly any value being assigned to the equity as they right sized the balance sheet and were able to take the liquidity fears off the table.
Let’s say for FY23 I get to an estimate of $280-300M in revenue with the recovery in the margin structure we laid out above to a mid-teen EBITDA margin recovery of 14-16% gets me to $39.2 – 48M in EBITDA or $43.6M EBITDA at the midpoint.
So current Valuation is 1x EBITDA. Yes, you read that right. 1x EBITDA…
I say the tongue in cheek because this is a levered business and we have to factor in the debt, Let’s say we get a recovery in the multiple to a 6-8x EV/EBITDA multiple which gets me to a stock price range of 2.05 – 2.95/share or 2.50/share at the midpoint or a casual 437% upside.
Keep in mind… the stock got as 2.70/share in 2021 so my midpoint would not even take it back to the highs yet the business is in a better position today than it was back then… Crazy thing I think that could be conservative on the valuation if the stock gets going because of the green infrastructure narrative they could sell to the street to get people excited and push that multiple higher to other more green infrastructure plays to a 10-12x EV/EBITDA multiple. So there it is, the secular tailwind story accelerated by US policy decision on US green infrastructure spending to the total of 369B over the next decade leads to a multi-year glide path of growth for the business. A bombed-out stock price trading at a trough valuation where the stock price is still at the lows even though the business has already bottomed and recovering from both a margin structure and a balance sheet perspective with an equity value that hasn’t reflected the shift in not only business climate South of the boarder or the operational and balance sheet recovery. LONG