Appulse is a small, $4M market company that trades in Canada. It trades at around 5x earnings and should be able to grow revenues at mid-single digits moving forward through new customer wins and growth in OEM relationships. The company trades at a cheap valuation and there is potential for upside if management eventually sells the business.
In August 2003, Appulse purchased Centrifuges Unlimited, a provider of remanufactured/reconditioned centrifuges and centrifuge parts. Centrifuges Unlimited mainly sells to the food & beverage industry and represents a large majority of Appulse’s current sales.
While Appulse also has exposure to the oil & gas industry (through Centrifuges Unlimited and another subsidiary, Rolyn Oilfield Services), sales to these customers represent <10% of revenues. In addition, over the last number of years, the company has focused on increasing their share of the food & beverage market in Ontario and Quebec, while moving away from oil & gas applications. The move was to reduce revenue cyclicality.
The company generates revenue through three main ways:
Refurbished Centrifuge Equipment: Sales in this segment vary significantly from quarter to quarter but represented 21% of Fiscal 2021 revenues. The machines are used by dairies to separate cream from milk, while meat packing plants use them to separate blood from other contaminants. Appulse offers their refurbished centrifuges at a fraction of the price of new ones, which can cost hundreds of thousands of dollars. The company also offers centrifuge rentals, which represents 5% of company sales.
Example of a Refurbished Machine
The company’s committed machine sales has grown slowly over time. Historically, committed sales have accurately forecasted sales for the fiscal year. Despite only selling ~$500K of machines in the first half of this year, management forecasts that they will sell $1.5M in the remainder of the year.
2) Service Revenues: Service revenues represented 16% of total revenues for Fiscal 2021. The company provides 24/7 servicing across North America, although they are still looking for more reliable service support in the United States. If a reliable service options are found, this could provide some lift to revenues.
3) Parts Revenues: Part sales represent the majority of revenues at Appulse at 58% of Fiscal 2021 revenues. The company both distributes OEM parts and manufactures aftermarket parts at their own manufacturing facilities. Management’s goal is to slowly move towards manufacturing more of their own parts to avoid being dependent on OEM relationships.
An underappreciated part of Appulse is the lack of cyclicality in the business. During the Great Financial Crisis, revenues increased by 10% in the parts segment, 29% in the services segment, but declined by 60% in the machine segment. The variability in the machine segment was due to exposure to the oil & gas industry, where Appulse had “virtually no oil & gas involvement”. As Appulse has diversified away from this segment and reduced exposure to volatile machine sales in favor of more consistent service & parts revenues, this should represent a smaller source of risk to revenues. However, the shift towards food & beverage sales also means that supplying equipment to oil & gas will not represent a significant tailwind to revenues in the current climate.
Appulse currently has a number of issues that it is working on solving.
Contribution margins have hovered around 30% for the past few years. Margins have fallen in recent quarters, as the company began to see the effect of inflation on costs. In response, the company has implemented a number of price increases, which should help margins reach 30% again.
The company should also be a net beneficiary of the widespread inflation, as customers look to purchase cheaper refurbished centrifuges, rather than new ones.
Revised agreement with a major international OEM
The company revised their agreement with a major international OEM. As a part of that agreement, the company’s geographical coverage for parts distribution was limited to western Canada. The prior agreement allowed Appulse to distribute their parts across all of Canada. The revised agreement had a significant impact on sales as Appulse’s exposure to Ontario/Quebec is over 50% of revenues.
Parts sales fell 5% after the agreement was put in place. However, if you exclude the impact of parts revenue from this specific OEM, parts sales at Appulse had increased by 10% over the last year. As Appulse laps the effect of the revised agreement, the company should be able to show strong growth in the parts segment.
In addition, Appulse is also pursuing a number of new opportunities to mitigate the impact of the new agreement. They are increasing capital expenditures to increase the production of internally manufactured parts & products for their customers. In addition, they are in the process of securing a relationship with another international OEM supplier to supplement parts & service revenues across Canada.
Supply Chain Issues
The business only reported $500k worth of machine sales this year, compared to ~$1m in the same period last year. The business has been hampered by supply chain issues resulting in difficulties in securing the parts and materials to refurbish equipment. Despite these challenges, management has confirmed machine sales of $1.5m for the remainder of 2022, which should bring machine revenues more in line with prior years.
Management at Appulse is aligned with shareholders through their ownership of the stock. The prior owners of Centrifuges Unlimited own a significant share of Appulse, roughly ~40% of the shares outstanding. As management grows older, they will likely look at selling the business to monetize their substantial investment in the company.
In Fiscal 2021, Appulse recorded $9.2m in revenues and $742k in net income, which is an EPS of $0.053. At the current share price of $0.28, the company trades at just over five times earnings in a period where they faced a number of challenges which resulted in declining revenues. The earnings multiple suggests that the business will continue to see significant challenges, which is unlikely given the actions that management has taken.
There is some downside to earnings. The largest impact is an increase in the effective tax rate from 0% to 15-20%, as the company has finished utilizing their net operating losses. A return to $10M in sales which represents just under 10% revenue growth to a level seen in 2020, should enable them to earn $0.045/share, while a return to 2019 revenues should allow them to earn $0.05-$0.06 a share, in line with 2021 levels. At the low end, the company would still trade at 8x earnings.
FCF at the business has been challenged as well due to increases in working capital. This is the result of an increase in WIP due to supply chain challenges. WIP has increased by $700k since December 31st, 2021 and by over $1m since June of last year. As supply chain issues ease, WIP and working capital challenges should normalize.
Due to the low valuation, an investor is paid reasonably well to wait for a take-out of the business at some point in the future. It is difficult to forecast what a small company should trade at, however a take private at ~5x EBITDA would represent a premium of 30% to the current share price, assuming revenues grow by 10%. At a 13-20% earnings yield and a discount to a potential transaction price, we believe the opportunity offers a reasonable return.
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