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  | | This turnaround bet with solid fundamentals is bucking the stock market dip
BENJ GALLANDER, BEN STADELMANN, and PHILIP MACKELLAR
Tuesday Sept 6, 2022 Do you have any winning investments so far in 2022? This has been a common question for investors given the grinding market weakness. Inflation is running hot, central bankers are hawkish and many of the pandemic-era favourites, from the likes of Peloton Interactive and Zoom Video Communications to special purpose acquisition companies and crypto, have plummeted. Even bonds have been whacked with rising yields. Shawcor Ltd. (SCL-T) is one of the stocks that has bucked the trend and is up about 50 per cent year-to-date. This Toronto-based company is in the energy and transportation infrastructure business, operates in more than 20 countries with roughly 5,000 employees and generated $1.1-billion in sales last year.
Here at Contra the Heard, we purchased shares twice in 2021, for an average purchase price of $4.96. The thesis for owning the name was straightforward. The company looked like a respectable contrarian candidate with a strong underlying business and sensible management team. The upside appeared solid, the valuations were good and the organization had a history of consistent cash flows. The balance sheet was decent, too. The current ratio (current assets divided by current liabilities) was regularly well over 2.0, debt was stable and the share count had been flat for a decade. Insiders owned roughly 1.5 per cent of the stock at the time, and the big brains at Turtle Creek, a successful (but quiet) independent asset manager based in Toronto, owned 17.9 per cent.
Shawcor also interested us because it straddles the new and old energy economies. It got its start in the oil and gas sector, but its share of non-petroleum revenues had grown from 9 per cent in 2013 to 33 per cent in 2020. It was in turnaround mode, too. In 2019, it had purchased ZCL Composites, a manufacturer of plastic storage tanks. The purchase was poorly timed, given COVID-19 was right around the corner, and the ensuing pandemic-era writedowns hammered the income statement in 2020 and 2021. Nevertheless, the executive team was proactively addressing the integration issues and navigating the COVID-19 crisis. When the stock was purchased, we were also worried about inflation and were looking to invest in energy, mining and materials to insulate the portfolio. All in all, during 2021, an investment in the enterprise appeared to tick many boxes.
Fast forward to the present day, and the pillars underlying our thesis remain intact or have strengthened. The non-petroleum share of sales has grown to about half of revenue. Though it now has profitability issues in its pipeline segment, the composites division has turned the corner and margins have recovered. Behind the scenes, insiders are holding onto their stake, and the investors at Turtle Creek have increased their ownership to 19 per cent. Inflation is much worse now than it was in 2021, too. As expected, the pricing pressures have propelled energy names higher while most other sectors have fallen.
Though these features explain why the stock did well through the first half of 2022, in August, the shares really took off after Shawcor won a contract worth $500-million. To put this deal into perspective, SCL’s market capitalization was around $530-million on Friday. The deal will see it provide TC Energy Corp.’s Mexican subsidiary with pipeline coating services. Shawcor expects to begin work in early 2023, and forecasts the project will take a year to complete. It is unlikely the company will score a similarly large deal soon, but it highlights its value proposition to customers. Moreover, while this contract is a big one and grabbed a lot of attention, the organization has successfully rebuilt its revenue and backlog since early 2020 when COVID-19 rocked the global economy.
We think there is more upside. The valuations remain low, the economic trends appear strong and the big backlog and recent contract win will buoy Shawcor’s income statement in the quarters ahead. The stock is trading much higher than our average purchase price of $4.96, but there is likely plenty of room to grow. Though there is no guarantee it will get there, our sell range stands between $20 and $25. | | |