RBC Top Pick January 15, 2023
Industrial Products: 2023 Outlook
Anticipating choppy waters ahead, but there are opportunities
Our view: While the macro backdrop has become increasingly uncertain in recent months, we believe unique tailwinds/catalysts across some of our sub-sectors provide attractive opportunities for 2023. For our E&C firms, the outlook for infrastructure has (arguably) never been better, with our coverage well positioned to benefit from upcoming infrastructure spend. For our Dealers, we expect FTT/TIH to continue to execute well as they navigate a tight equipment supply environment amidst a strong demand backdrop. For our Automotive Aftermarket coverage, we expect BYD's margin profile to continue to trend toward historical levels and the pace of M&A activity to pick up. Lastly, we believe ATS will continue to successfully execute on its organic/M&A strategies despite macro headwinds and believe that the company is less cyclical today. In this report, we update our estimates/price targets for ACM (pg. 74), SNC (pg. 96), and ATS (pg. 127), and roll forward our valuation to 2023 figures for ARE (pg. 82). Among our Outperform rated names, our top picks for 2023 include WSP, SNC, BYD, and ATS.
Key themes for E&C firms:
Well positioned amidst key tailwinds in 2023 and beyond — Overall, the E&C space is well positioned with many companies sitting on record/near-record backlogs as Infrastructure Investment & Jobs Act ("IIJA"; ~US$550B of incremental/new spend) and CHIPS bill (US$53B) spending continue to ramp up (a number of global firms expect awards to become more meaningful in Q2/Q3 2023), while the Inflation Reduction Act (US$369B) is expected to be a late-2023/early-2024 event. We also believe the commitment to infrastructure investment across other major markets (e.g., the U.K., Canada, Australia) could offset the uncertain macro backdrop. In our view, the favorable outlook for infrastructure spending, the elevated focus on energy security/transition, tailwinds from re-shoring efforts, and the diversified exposure of the larger Engineering firms positions them well through the cycle.
M&A activity could accelerate — M&A is a core focus for most of our covered Design/Consulting firms as these global businesses continue to roll up the fragmented industry and add capabilities/headcount through acquisitions (particularly as balance sheets remain in good shape across the industry). While the industry has evolved over the recent years, the focus for M&A still appears to be on Environmental Services, Water, and now increasingly Energy Transition services. With the uncertain macro outlook and moderation in valuations over the past year, we believe that M&A activity could pick up over the coming year, particularly among the more well-capitalized companies.
Key themes for Dealers:
Tight equipment supply environment persists amidst supportive demand backdrop — Companies across the Dealer space have noted that prime equipment supply conditions remain tight amidst the supportive demand environment (despite the uncertain macro outlook, demand has remained resilient thus far given the strong commodity price and regional funding backdrops). Amidst this set-up, Finning/ Toromont have been successfully directing customers toward used equipment, rentals, or rebuilds in situations where new equipment has not been available. If supply chain pressures ease in 2023, we expect Toromont/Finning to be able to capitalize on their record/near-record backlogs.
Key themes for Diversified Industrials:
A number of moving pieces — For our Automotive Aftermarket coverage, the outlook for future insurance rate increases should benefit collision repairers (and by extension, Boyd) as the industry looks to get back to historical profitability, while we also expect supply chain conditions to continue to stabilize/improve and traffic patterns to continue to trend toward/beyond pre-pandemic levels (both of which we view as positive for Boyd and Uni-Select). For ATS, we believe the company will prove resilient through the cycle (given its end-market exposure has increasingly shifted to less cyclical industries).
ATS Corporation | Outperform | Price target: $55 (+$1)
Outlook
1. A well positioned business heading in the right direction
Since his appointment as CEO in February 2017, Andrew Hider has implemented notable operational and strategic changes at ATS, which have contributed to strong results in recent years. This has included robust organic top-line growth (average of ~8.5% annually from F2018-F2022) and meaningful margin improvement (EBIT margin of 13.4% in F2022 vs. 9.6% in F2017). ATS has also been reinvesting capital at attractive rates of return (primarily via M&A), which has led to a directional improvement in its ROIC profile in recent years (14.6% in F2022 vs. 10.0% in F2016).
2. Supportive long-term industry backdrop
Bain expects the +US$250B global Automation market to grow at a ~6% CAGR through 2030, while ATS has historically expected ~mid- single digit long-term growth rates in its core end-markets. Market growth is being driven by the increased adoption of automation across various manufacturing end-markets, which in turn is being driven by factors such as aging/retiring populations, wage growth, and near-shoring, in our view. As such, we believe there is meaningful runway for further adoption of automation technology, particularly as automation offerings continue to improve and the value proposition becomes more compelling to end-users over time.
3. ATS should fare relatively well in a macro slowdown
Given the focus on macro headwinds that have arisen in recent months, we would also highlight that ATS' end-market exposure has increasingly shifted to less cyclical industries that are likely to be relatively resilient through the economic cycle compared to the company's historical exposure. To this point, the company's two largest end-markets are Life Sciences and Food & Beverage (which have historically been two of the most stable end-markets), which combined account for ~70% of ATS' annualized revenue.
4. Executing on a sound M&A strategy
We believe that M&A is essential for growth in the Automation Industry (driven in large part by customer stickiness) which makes it difficult to displace incumbents and win new work. Under Mr. Hider’s leadership, ATS has deployed ~$1 billion of capital on M&A to- date, including ~$745 million in F2022 alone. The evolution of ATS' underlying business mix (driven in a large part by M&A activity over the last 3-4 years) leads us to believe that the company will focus on regulated and defensive/less cyclical markets going forward. In terms of potential targets, we estimate there are tens of thousands of automation companies globally, which in turn implies a long tail of potential acquisition candidates for ATS. For context, the global Industrial Automation market is a fragmented +US$250 billion market, and ATS (one of the larger System Integrators globally) generated F2022 revenue of $2.2 billion.