National Bank Free cash flow generation is likely to be the focus of attention during AtkinsRalis’ Investor Day event on June 13, according to National Bank Financial analyst Maxim Sytchev, who warned “hopes of a stronger and more consistent FCF trajectory are still just that, hopes, for now.”
“Until recently, ATRL earnings have been extremely volatile which, among other factors, understandably restrained the multiple investors were willing to pay for the shares,” he said in a report released Friday. “Since 2021, however, core earnings (adjusted EPS ex. Capital contributions) have remained in positive territory and have grown steadily to an expected $2.28 over the next four quarters and stepping up to $2.54 in 2025. Shares have continued to rally, advancing an additional 27 per cent year-to-date, which has helped narrow ATRL’s valuation gap to peers. That said, there is still a significant chasm to both global and Canadian peers, and further multiple expansion will be contingent on the full runoff of legacy LSTK work, a monetization of the low-margin Linxon business, continued capitalization on opportunities in the nuclear space, and a broad-based improvement in margins (especially in Canada, which lags other regions by several hundred bps due to a mix of smaller and less profitable projects).”
Mr. Sytchev thinks a noticeable improvement in both free cash flow and generation is “key” to calming investor concern about the Montreal-based company, formerly known as SNC-Lavalin.
“On a forward basis (and we sound like a broken record here), FCF needs to be commensurate with core EBITDA of $859-million for 2025 (our anchor for valuation is on blended 2024/2025 numbers),” he said. “Still some working capital drag from LSTK, underperformance of Linxon (hopefully sold or wound down soon), and lesser FCF conversion from O&M still lead us to believe that $350-$400-million should be doable over the coming two to three years. With most engineering companies trading at a 3-3.5-per-cent FCF yield, that points to an $11.5-billlion market cap or somewhere in the $65.00 per share range, inclusive of 407 (and in line with our NAV). The operative word, here, again, is FCF realization.”
The analyst expects management to emphasized Engineering margins and its Nuclear growth prospects are important levers to increased free cash flow.
“In 2021, we calculated the EBITDA margin delta vs. WSP/STN [WSP Global and Stantec] stood in the 200 basis points range (when properly allocating corporate costs); now it’s closer to 500 bps as both Canadian peers have seen significant margin expansion,” he said. “While relative margin is of course one part of the story, so far we have not witnessed operating leverage from superior organic momentum at Atkins. This needs to change. Nuclear (20 per cent of NAV) is seeing a sentiment renaissance now and more studies around SMR and new builds are being contemplated. Approval processes can, however, be arduous and will likely take more time to come to fruition than some are hoping for (backlog in this division, however, now stands at $1.8-billion, the highest since 2017 at $1.4-billion); that being said, we don’t expect this business to grow by a factor of 4 times.
“All in, one could say that the ‘easy’ recovery is behind us as the LSTK run-down and portfolio slimming were the obvious choices. The reality, of course, is more complex as there is nothing “easy” when it comes to winding down a construction business that has been a core of an ‘A to Z’ market approach to project securement (hence we suspect a different go-to-market strategy for the engineering business in Canada for Atkins now vs. history).”
Mr. Sytchev reiterated his “outperform” recommendation and $61 target for shares of AtkinsRalis. The average on the Street is $62.45.