|Shares Out. (in M):||37||P/E||21||23|
|Market Cap (in $M):||890||P/FCF||24||23|
|Net Debt (in $M):||94||EBIT||62||57|
|Borrow Cost:||Available 0-15% cost|
For a pdf version of the writeup please go to the following link:
Company: Badger Daylighting
Price: $23.08 as of 12/14/2015
2016 year-end target price: $14
1 year downside: 41%
Investment Thesis Summary
I believe shorting Badger Daylighting Ltd. (“BAD” or “Badger”) offers an attractive risk-reward tradeoff at the current price. I believe Badger is a low quality business with no barriers to entry and deteriorating industry fundamentals. Additionally, I believe Badger provides inconsistent and misleading accounting disclosures and deploys questionable business practices. Historically, Badger experienced a 10 year sales CAGR of 18% from 2004 to 2014. This growth had two stages: 10% sales CAGR from 2004 to 2010 and 32% sales CAGR from 2010 to 2014. Growth in the last 10 years was driven by Badger having a first mover advantage in the use of hydro excavation technology. The stronger than average growth in the last 4 years was driven by exposure to the petroleum sector (roughly 50% exposure) during the shale boom. Going forward, however, Badger’s first mover advantage is rapidly eroding. Badger’s knowhow of hydro excavation technology is no longer proprietary and new competition is popping up all across North America. As a result, I believe both utilization and pricing are under pressure and Badger’s long runway of uncontested growth is quickly dissipating. Additionally, I believe the steep growth trajectory during the shale boom is unlikely to be repeated, even if oil prices rebound, given the large amount of idle hydrovac equipment in the market.
My short thesis is based around the following key issues:
The industry is getting commoditized by new entrants, thus reducing the runway for growth for Badger
The current PE multiple implies market is assuming long term growth rates to be much higher than what will be realized
Badger may be exaggerating the number of local offices it operates, thereby overstating the size of the company
Questionable treatment of franchisees may hurt them sooner rather than later
Inconsistent and misleading accounting disclosures, coupled with management and auditor turnover, raise red flags
The market is assigning a 16x multiple on its 2016 consensus EPS estimate of $1.49. Such a high multiple for a commodity business leads us to believe that investors may be expecting Badger to grow earnings in the low-teens to high teens over the next few years. I believe these expectations are too high and the bulls will be disappointed. I expect Badger to shrink EPS in the high-single digits over the next two years. In my base case, I expect 2016 EPS to be $1.14, 24% lower than consensus at $1.49. Based on a PE multiple of 13 and 2017 EPS of $1.04, I believe Badger is worth $14 a share by the end of 2016, or a downside of 41% on the stock. In my bull case, the stock is worth $28 (using 16x 2017 EPS of $1.75), an upside of 21%. In my bear case, the stock is worth $7 (using 11x 2017 EPS of $0.66), or 68% downside.
Additionally, there is a free option if Badger gets into legal trouble due to questionable business practices, pending and future lawsuits, and inaccurate financial disclosures. However, given the uncertainty around the timing of such events I do not model any of these events in any of my scenarios.
I encourage other investors to conduct their own due-diligence and come to independent conclusions on the issues I have cited in my short thesis on Badger.
Badger Daylighting Ltd. is North America’s leading provider of non-destructive hydrovac excavation services. Badger’s primary revenue-generating asset is its fleet of over 1000 hydrovac trucks, which Badger rents to petroleum, industrial and municipal clients. Contracts are primarily short-term, work-based, and are paid on an hourly basis. The truck rental comes with one to two crew operators that are Badger employees.
23% of Badger’s fleet is operated by franchisee owned locations and 77% by company owned locations. 66% of Badger’s revenue comes from United States and 33% from Canada; and 51% from the petroleum industry (such as pipeline operators, oil/gas drilling, oil refineries) and 49% from utility and construction clients (such as municipalities, utilities and general contractors who operate in areas with a high concentration of underground power, communication, water, gas, and sewer lines, particularly in large urban centers where safety risks are high). Demand from the petroleum industry is driven mainly by the turnaround cycle for refineries, maintenance of pipelines, drilling activity for oil and gas wells, and construction activity for new pipelines. Demand from municipalities is fairly stable while demand from construction contractors is driven by the business cycle.
Hydrovac trucks help dig soil without damaging utility lines, such as gas or water pipelines, which are buried in the ground. Hydrovac trucks have two components that work simultaneously: (1) a pressure washer that uses water and (2) a vacuum system. The pressure washer breaks the soil while excavating and the vacuum system sucks up the slurry and deposits into a storage tank housed on the truck. The truck disposes the slurry at a safe location onsite or offsite. This method of digging has a lower probability of damaging underground utility lines than manual digging or digging using heavy equipment such as backhoes. Therefore, hydrovac excavating is slowly becoming the preferred way of digging in congested areas.
Badger is based in Canada and reports financials in Canadian dollars. Badger maintains a manufacturing facility in Canada, where it assembles its own equipment on truck chassis that it buys from truck manufacturers. The all-in manufacturing cost for Badger is roughly $350,000 per truck. Badger’s competitors buy pre-built hydrovac trucks from manufactures such as Caterpillar, WesTech, Tornado, Smith Industries, AmeriVac, and Foremost. Depending on the specifications, competitors can buy a hydrovac truck for $200,000-$500,000.
The industry for hydrovac services in North America is highly fragmented with hundreds of small companies owning 1-2 trucks, along with a few large companies, namely Badger (1019 trucks), Lone Star West (~100 trucks), Clean Harbors, Big Eagle Services (~100 trucks), and Hydrodig (~60 trucks). Municipal jobs are mainly won on price bids while oil and gas jobs are won on relationships.
Exhibit 1: Picture of Badger Hydrovac trucks in action (Source: Badger’s website)
Thesis Point 1: Industry is getting commoditized by new entrants, thus reducing the runway for growth for Badger
Badger started hydrovac excavation services over 20 years ago in Canada, and was one of the first to offer such services. Over the last 20 years, Badger expanded its business across the United States as well. Being the first mover helped Badger become the most dominant player in the space with over 100 local offices and over 1000 hydrovac trucks as of Sep 30, 2015. Badger grew revenues at 18% CAGR in the last 10 years while maintaining EBITDA margins in the high 20s. During its growth phase, Badger undertook several initiatives that gave it an advantage over its competitors: developing a manufacturing facility to assemble hydrovac equipment on truck chassis; educating potential clients about the advantages of hydrovac services over mechanical digging; and training several hundred employees to use hydrovac trucks and about the safety benefits of hydrovac services.
However, most of the advantages that Badger had over competitors in the past have diminished. Fully assembled, ready to use hydrovac trucks are available from several manufacturers for $200,000 to $500,000 per truck versus Badger’s internal cost of approximately $350,000. Competitors are therefore no longer disadvantaged on cost per truck, and no longer face obstacles obtaining hydrovac trucks. Clients today tend to be more knowledgeable about the advantages of hydrovac services and are looking for the cheapest provider rather than just working with Badger out of lack of options. Several trained hydrovac equipment operating professionals are available for hire by competitors. As a result of the changed market environment, small regional competitors have popped up all over North America. Since hydrovac services are delivered locally to local clients, there is little advantage to being a national player.
In addition to the removal of barriers to entry to the hydrovac market, there is an increasing trend for clients to own their own hydrovac trucks rather than hire external service providers, such as Badger. Municipalities such as the city of Wichita, Kansas and some large construction companies have determined insourcing of hydrovac trucks to be more economical than outsourcing. Over time, I expect this trend to pick up even more.
For the above mentioned reasons, the uncontested, long runway for growth that Badger had enjoyed is fast eroding. As a result, I believe that the future growth rate for Badger is going to be much slower than what it has experienced in the past. Currently, management guides to its US business (~2/3 of total) doubling over the next 3-5 years which would imply a 15%-26% CAGR. I believe such a goal seems unrealistic given increased competition. The Canadian business (1/3 of total) is much more competitive and much more penetrated than the United States, so the runway for growth in Canada is even lower than that in the US. Nevertheless, management guides to 10-15% growth in the Canadian business over the long term, which I believe is unrealistically high.
There is no reliable industry data for market size, market share, and market growth available for hydrovac services in North America. But based on my conversations with hydrovac truck manufacturers, I estimate that the industry’s fleet size for hydrovac trucks in North America is expected to increase by 20%-30% in 2015, leading me to believe that there is a lot of new supply hitting the market.
Because of increasing competition and increasing commoditization of hydrovac services, I believe Badger’s runway for growth is quickly eroding and will continue to further deteriorate over time.
Thesis Point 2: Implied growth expectation is too high to justify valuation
At a stock price of $23 per share and consensus 2016 EPS of $1.49, Badger trades at 16x PE. Such a multiple would imply that the market is expecting low to high teens EPS growth from Badger over the next few years. I believe the probability for Badger to realize such a growth rate in the next 2 years to be low. Instead, I believe EPS will compress in the high-single digits over the next two years.
Below are the key drivers of EPS growth along with my base case expectations:
Growth in revenue per truck per month
Grew at 6% CAGR from 2010-2014. I expect it contract at ~2% annually going forward in my base case
Grew at 25% CAGR from 2010-2014. I expect it grow at 8-9% annually going forward in my base case
USDCAD exchange rate
Currency move was a 10% annual tailwind on 2/3 of the revenue over the last two years. I expect low-single digit headwind annually on ~2/3 of revenue going forward in my base case
EBITDA margin expansion
EBITDA margin expanded from 26.7% in 2012 to 28.5% in 2014 providing a tailwind of 3.5% CAGR to EPS growth over those two years. I believe EBITDA margins will contract going forward in my base case, going down to 24.6%, leading to a mid-single digit headwind to EPS annually
Based on my assumptions of key growth drivers, I believe EPS will contract high-single digits over the next two years. For such a growth rate, a PE multiple of 16 seems very high. I explain my rationale for my base case assumptions below:
Revenue per Truck per Month
Note that this metric captures both pricing and utilization. I don’t believe Badger will be able to increasing pricing going forward. Recent trends suggest that most likely there will be price decreases instead. My industry channel checks suggest that hourly rates for hydrovac services are down 15-20% year-over-year in Texas, down 20-30% down in South Central United States, down 10-15% down in North Dakota, down 5% in the Midwest, and flat in California. I estimate Canadian rates to be down at least 15%. In spite of materially negative overall industry rates, Badger has resisted reducing its rates and is, therefore, losing market share and experiencing decreased utilization. I believe this is an unsustainable strategy and that Badger will eventually have to bring down its rates at the level of its competitors to sustain its business model and keep utilization at a reasonable level. Badger’s trucks and services are no longer differentiated enough to justify premium prices.
If prices start to rise, clients will have an increasing tendency to purchase their own hydrovac trucks rather than outsource to a provider. This phenomenon should keep a lid on pricing, unless the oil and gas industry rebounds aggressively. Even in this scenario, I believe price increases will stay relatively subdued due to a large amount of idle hydrovac equipment in the market.
I believe consolidated revenue per truck per month would decrease ~2% annually in my base case
Badger’s fleet grew at a CAGR of 25% from 2010 to 2014. The growth dramatically slowed to 3% in 2015. I optimistically believe Badger’s fleet will grow in the high-single digits over the next two years, much slower than the historical trend. There are several reasons behind my view.
I expect Badger’s current utilization of its fleet to be below 50%. Although there are trucks sitting idle, management is still building four trucks per month to, in my opinion, artificially prove to the investment community that Badger is a growing company. I feel this growth is unsustainable.
Badger has fired a number of its area managers, which may lead to a lower utilization going forward, as many of the relationships that those area managers built are lost, to some extent.
There is a lower need for trucks going forward, since Badger overbuilt its fleet in the past and forced its local area managers to accept new trucks even though incremental demand for the additional trucks was not there. The head office is therefore able to allocate the cost of a new truck to the P&L of a local office by forcing the local office to accept a new truck to its location regardless of the need for that truck. I have talked to several former Badger employees who have suggested that the head office forces local area managers to accept 1 to 2 new trucks every year at their location even if there is no incremental demand. When a truck is delivered to a local area manager’s location, Badger’s head office charges roughly $110,000 per year to the local office (5 year amortization at a cost base of roughly $550,000) for having that truck. There is an additional incentive for the head office to keep building trucks as it can transfer the cost of those trucks to the local office, which reduces the bonus that the local area manager gets on its location’s profitability. Forcing trucks on local locations has been a reason why many talented area managers leave Badger to start a competing business or to work for a competitor. I believe it will take time for Badger to work through the excess fleet before it builds more new ones.
Beyond the next two years, I estimate fleet growth to be in the low to mid-single digits.
USDCAD Exchange Rate
Badger’s reporting currency is Canadian dollars even though roughly 2/3 of its hydrovac fleet is in the United States. Since the Canadian dollar has weakened by ~20% in the last two years, Badger’s consolidated revenue had an uplift of roughly ~6.5% per year (2/3 times 20% spread over two years) from currency moves. Unless the Canadian dollar further weakens, there would be little tailwinds from such moves in the future. Inversely, if the Canadian dollar strengthens, it will be headwind for Badger.
I estimate the impact of currency moves to be a low single digit headwind in my base case.
Historically, Badger’s EPS growth was accelerated by EBITDA margin expansion, which grew from 26.7% in 2012 to 28.5% in 2014. However, during 2015 Badger has been extremely aggressive in cutting costs and deferring a large chunk of its maintenance expense onto its fleet during the last few quarters. Additionally, the industry is and will continue to suffer from pricing pressure. As a consequence, I believe Badger will experience margin contraction of ~140bp per year going forward.
Thesis Point 3. Badger may be exaggerating the number of local offices it operates, and thereby overstating the size of the company
I think Badger may be exaggerating the number of local offices it operates in order to inflate the size of the company. After reviewing Badger’s website, performing a Google map search, and visiting a small sample of locations, I could not reconcile the total number of Badger’s locations.
Badger has a “contact us” page on its website. On this page there, is conflicting information regarding the total number of local Badger offices. (See Exhibit 2)
At the top of the page, it says Badger has more than 100 local offices across the United States and Canada
If I click on the map view on this page, it gives us a zoom-able map view of all of Badger’s local offices (Exhibit 2 shows this map). Counting the icons on the map, I count 94 local offices in the United States and 57 in Canada, for a total of 151 local offices across North America. This number seemed much higher than 100, but is still consistent with the information in item (a)
From the list view on the same page, I counted 81 unique phone numbers in the United States and 46 unique phone numbers in Canada, implying a total of 127 local offices. This number is still consistent with the information in item (a), but there is clearly a discrepancy with the number shown in item (b)
I also did a Google map search for “Badger Daylighting,” and only got 39 local offices in the US and 30 in Canada, for a total of 69 local offices across North America. This number was much lower than the “more than 100” from item (a), 151 in item (b) and 127 in item (c). In the company’s defense, it is possible that Google map’s information on Badger is incomplete, but nevertheless, there are inconsistencies.
Exhibit 2: Webpage on Badger’s website showing its local offices across North America
To get more color on Badger’s local offices, I decided to visit some of the local offices shown around the New York City area on the map view on Badger’s “contact us” page (Exhibit 3 shows these locations). There are four local offices that show up on Badger’s website near the New York City area. These locations are labeled as “Central New Jersey,” “Northern New Jersey,” “US North East Regional Office,” and “Seymour, CT”. There were no addresses shown on the map for these local offices, so I zoomed in on the map icon to find the exact location of the local office and visited each of those four locations. Here is what I found out for each:
Exhibit 3: Webpage on Badger’s website showing its local offices near New York City
Central New Jersey Location
I drove to the location that showed up on the map (See Exhibit 4). The google map icon was near a creek with empty land, adjacent to residential property. There was nothing around the area that looked like a business that would rent hydrovac trucks.
Exhibit 4: Map location of the Central New Jersey local office and a picture of the site
Northern New Jersey Location
I drove through the exact point on the map icon location (See Exhibit 5), but the site was undeveloped land. Again, there was nothing around the area that looked like a business that would rent hydrovac trucks.
Exhibit 5: Map location of the North New Jersey local office and a picture of the site
US Northeast Regional Office
I drove through the exact point on the map icon location (See Exhibit 6). I found only abandoned property. I even inquired in several local businesses for the location of Badger Daylighting’s office, but had no success.
Exhibit 6: Map location of the US North East Regional Office and a picture of the site
Seymour CT location
I drove to the exact point on the map icon location (See Exhibit 7), which turned out to be a ramp of a freeway next to a river. I couldn’t even stop my car to take a picture of this location. There was no commercial or building structure, or any business for that matter, around that map icon.
Exhibit 7: Map location of the Seymour CT local office
After going through Badger’s website, Google maps, and visiting Badger’s local office locations around the New York City area as shown on its website, I are unsure of the total number of legitimate local offices Badger has.
Could Badger be overstating the size of its operations in order to inflate its enterprise value? I encourage other investors to conduct their own due diligence on this issue and come to their own conclusion as I have only explored a small sample of Badger’s locations rather than all of Badger’s locations.
Thesis Point 4: Questionable treatment of franchisees may hurt them sooner rather than later
About a decade ago, Badger’s preferred growth strategy was to expand through franchisees, rather than by owning corporate locations. In 2005, roughly 90% of the fleet was under such agreements (called “franchise agreements” in the US and “marketing agreements” in Canada). Franchisees developed relationships with and solicited business from local utilities, construction contractors, and petroleum clients by educating them about the advantage of excavation using Badger hydrovac trucks over other mechanical means.
The economics of such agreements were usually structured as follows:
The franchisee paid 20% of the upfront capex of a truck, and in return kept 60% of the revenue from each truck
The franchisee paid 100% of the operating expenses
The franchisee also paid a recurring admin fee per month to Badger for managing accounting, invoicing, and collections.
Badger retained ownership of the truck.
Certain maintenance capital expenditures related to the trucks were to be covered by Badger.
The initial term of each Franchise Agreement or Marketing Agreement was 5 or 10 years, subject to renewal by the operator for an additional 5 year term.
The contract had minimum performance requirements for the franchisees.
Badger’s growth strategy through the franchisee model worked well, as franchisees performed all of the business development work and incurred all related expenses. Franchisees marketed Badger’s brand name, educated clients about Badger’s hydrovac trucks, passed on their clients’ contact information to Badger for billing purposes. Once a local office has been established and a client list has been developed, Badger didn’t need the franchisee as much as the franchisee needed Badger. Badger began acquiring those franchisees and converting those locations to company-owned. In fact, Badger went from 89% of its trucks under the franchisee model in 2005 to about 23% of its trucks under the franchisee model by 2014 (see Exhibit 8).
My research suggests that Badger may have been overly aggressive in acquiring back its franchisees, to the extent that it used questionable business practices in certain cases. A large number of the franchisees were taken back using non-performance clauses in the franchise agreements. I believe some of those contract violations were un-enforceable or were unfair. Recently, Badger lost a lawsuit (Case number B-CJ 2011-301 in the district court of Creek County in the State of Oklahoma) with a franchisee in Oklahoma called “Hewitt’s Badger Daylighting” (the “Plaintiff”). In June 2015, the jury entered a verdict of approximately USD$13.7 million in favor of the Plaintiff against Badger for breach of contract and other causes of action. This franchisee had 8 hydrovac trucks, so the damages came out to be $1.7 million per truck. Badger is appealing this ruling in the Supreme Court of the State of Oklahoma, but I believe the probability of the ruling getting overturned is low.
My current understanding is that, if Badger loses its appeal, Badger will have to pay additional cash for lost interest to the Plaintiff as well. That’s not the worst news for Badger, though. From my research, I believe that if the Supreme Court doesn’t overturn the district court’s ruling, there are several more disgruntled former franchisees working behind the scenes to file additional lawsuits against Badger using this case as a reference. I estimate Badger took back roughly 65 franchises in the United States over the life of the company. My guess is that the total number of trucks acquired through such methods would most likely be significantly above 100. If all of those former disgruntled franchisees file additional lawsuits, the total damages claimed in such lawsuits can easily exceed $170 million, assuming a judgment of $1.7 million per truck and only a total of 100 trucks under dispute. I agree that the range of outcomes is wide, given the lack of reliable publicly available data, but the fact remains that the above scenarios are materially negative for Badger.
Based on my conversations with former employees, I also think there is a possibility that some franchisees who agreed to sell their franchise back to Badger for a lump sum could also file a lawsuit against Badger on the grounds that Badger made it difficult for those franchisees to operate successfully, in effect, forcing them to sell their business back to Badger. There are several ways Badger can coerce a franchisee to sell. One way would be to not perform maintenance capital expenditures on the franchisee’s trucks even though, according to the franchise agreement, it is Badger’s responsibility. If a franchisee doesn’t have well maintained trucks, then it can’t conduct its business for safety reasons. Badger could also take its trucks back, citing non-performance. If there are no trucks at the franchisee’s location, it is impossible for them to conduct business. In such situations, a franchisee would rather sell its business to Badger and get some money in return, than fight with a deep-pocketed opponent on a lawsuit in which the outcome is unpredictable.
Encouraged by the success of American franchisees in lawsuits against Badger, it’s possible that some former Canadian franchisees may also file lawsuits against Badger.
Given the large amounts of potential damages involved if more cases are filed, Badger’s questionable business practices will be severely tested in the courts. Badger was already in default of its credit agreements after the judgement of the Oklahoma lawsuit came out, and had to get a waiver from its creditors to cure the default. The creditors agreed to the waiver, perhaps thinking this judgement was an isolated event rather than a regular occurrence. However, if multiple lawsuits are filed, Badger may not have the support of its creditors and may have to raise equity to pay off its debt and legal damages.
I highly encourage other investors to conduct their own due diligence on the treatment of former franchisees, as this issue could have a significant impact on Badger’s valuation and business model sustainability.
Exhibit 8: Table showing trucks under franchise or marketing agreements (Source: Sedar filings & my estimates)
Thesis Point 5: Inconsistent and misleading accounting items, along with management and auditor turnover, raise red flags
Several of Badger’s disclosures seem misleading and inconsistent. Additionally, several key employees resigned over the last two years. In May 2014, CFO Greg Kelly (who held the position since 1999) left the company, and in November 2014, Chairman of the Board, George Watson, departed. In March 2015, Director and Audit Committee member Richard Couillard decided to not stand for re-election. In April 2015, Ernst and Young stepped down as Badger’s auditor.
On the disclosure side, there are a few items I would like to highlight:
Dramatic growth in non-hydrovac revenue in 2014 is inconsistent with Badger’s business plan
The number of trucks retired seems understated
The revenue recognition policy excludes collectability criteria
Below I provide more color on each of the above mentioned items.
Dramatic growth in non hydrovac revenue in 2014 is inconsistent with Badger’s business plan
Most of Badger’s revenue comes from hydrovac services. This is the segment where management deploys almost all of its capital. However, Badger also generates revenue from four other activities, namely sewer inspection (called “Benko”), tank cleaning (called “Fieldtek”), shoring rentals (“Shoring”), and truck placement fees. The truck placement fee is a one-time payment Badger gets when it delivers a truck to a franchisee. Badger discloses truck placement fees in its earnings releases. Exhibit 9 shows the description of the other three business lines. As per the disclosure, none of those business lines are a major component of Badger’s consolidated assets or revenues. Before 2015, Badger didn’t provide any financial information on non-hydrovac revenue performance. Therefore, non-hydrovac revenue contribution needs to be estimated by piecing together information from various other line items.
Exhibit 9: Snapshot from Page 7 of 2014 AIF describing Badger’s other revenue sources
As per the company disclosures, Benko was acquired on April 1, 2007 for $4.1 million and had a revenue of $4 million in 2006. Benko came with 3 hydrovac units, 4 sewer maintenance vehicles, and 3 camera units, for a total of 10 pieces of equipment. The key point here is that Benko is a very small component of Badger’s business.
As per company disclosures, Fieldtek was acquired on November 1, 2013 for $19.2 million. Fieldtek came with 50 pieces of equipment, including semi-vacuum trucks and trailers, pressure trucks and steamer combo units. The price paid was 4 times trailing EBITDA, so trailing EBITDA was roughly $4.8 million. The key point here is that it’s a small component of Badger’s business, but is much larger than Benko. Also, just one quarter after the acquisition, management hinted in its earnings release that Fieldtek was not a good acquisition, as the company does not believe it will be able to increase Fieldtek’s margins.
There is little information about the shoring rental business in any of the company disclosures in the last several years, so my guess is that this business contributes very little in revenues. I would estimate revenues to be $1-$4 million per year.
I used all of the above disclosures, along with commentary from quarterly results made by Badger, to calculate the implied individual contribution from (1) Hydrovac services, (2) Fieldtek, and (3) Benko + Shoring combined. I estimated these three components using the following method:
Assume all US revenues are from hydrovac services only. Convert US revenues into USD from CAD using average exchange rate over the relevant period, and divide that converted revenue by the average US fleet size to find the implied revenue per truck per month for the US business in USD
Using revenue per truck per month for the US business derived from step (a), consolidated revenue per truck per month reported by the company, average fleet size in Canada, and average fleet size in the US, calculate revenue per truck per month for the Canadian hydrovac business only, using a weighted average formula
Multiply the Canadian revenue per truck per month from step (b) by the Canadian Average fleet to calculate Canadian hydrovac revenue contribution
Take the total Canadian revenue reported by the company and deduct the Canadian hydrovac revenue derived in step (c) and the “Truck Placement Revenue” reported by the company. The resulting number is the total contribution from Fieldtek and Benko+Shoring combined
Calculate revenue generated by Fieldtek using management commentary in the quarterly earnings releases
Calculate the combined revenue generated by the Benko+Shoring business lines by deducting the estimated revenues generated by Fieldtek from step (e) from the result of step (d)
I show the results of my quarterly estimates in Exhibit 10a, and yearly estimates in 10b, using the above process. There are a few interesting observations which I would like to highlight from this analysis:
In the first year of Benko’s purchase in 2007, Benko+Shoring combined contributed roughly $4.5 million in revenue. From company disclosures at the time of Benko’s purchase on April 1, 2007, I also know that it had generated $4.1 million in revenue in the previous year under the previous owner. So Benko’s contribution in 2007 for nine months must be close to $3.1 million, leaving Shoring to have generated ~$1.4 million. This implies Shoring is a very small component of Badger’s business.
The yearly growth rate of the Benko + Shoring business is very volatile from 2008 to 2014. It more than doubled in 2008, just one year after Benko’s acquisition in 2007, then shrunk by more than half in 2009, and then more than doubled again in 2010. One would expect the growth rate over the last 7 years to be relatively smooth, given such businesses have fairly steady end market demand.
Combined total revenue from Fieldtek, Benko and Shoring was 7% of total revenues in 2013 and 13% in 2014. This seems high given that management discloses these business as a non-significant component of Badger’s revenue or assets.
In 2014, revenue from Benko+Shoring of $29.7 million was larger than that of Fieldtek’s $26.1 million, even though disclosures suggests that Fieldtek is a much larger business than Benko+Shoring combined. After all, Fieldtek had 50 pieces of equipment in 2013 and generated $19.2 million in revenue whereas Benko only had 10 pieces of equipment in 2007 and generated $4.1 million in revenue, and Shoring is an insignificant contributor. None of the disclosures suggest that Badger was aggressively investing in the Benko subsidiary throughout those years. Plus, business lines such as sewer inspection and shoring rental in Canada have little to no organic growth.
Revenue from Benko+Shoring combined grew an astonishing 63% in 2014. From the various earnings release in 2013 and 2014, it never appeared that Badger was investing significant capital in growing these businesses. This begs the question: how did the revenues grow at a 63% rate in 2014? If the 63% growth was legitimately realized, then a prudent management would allocate a significant amount of its capital resources to further grow such business lines. But Badger didn’t.
Could Badger be using Benko/Shoring revenues as a cookie jar account to manage the market’s growth expectation in order to manipulate its stock price?
Exhibit 10a: Estimated quarterly revenues from Hydrovac Services, FieldTek, & Benko+Shoring Rental
(Source: Sedar filings and my estimates)
Exhibit 10b: Estimated yearly revenue contribution from Hydrovac Services, FieldTek, and Benko+Shoring Rental
(Source: Sedar filings and my internal estimates)
Retirements seem understated
In its Annual Information Form (AIF), Badger discloses that it amortizes its hydrovac trucks over 10 years for depreciation purposes. (See Exhibit 11). According to management knowledge and past experience, the economic life of hydrovac truck is 10 years. An implied conclusion would be that Badger’s fleet should turnover 100% every 10 years if Badger were to start with a brand new fleet.
Exhibit 11: Excerpt from page 12 of Badger’s 2014 AIF disclosing its amortization assumptions for its hydrovac trucks
In Exhibit 12, I show Badger’s fleet size, additions and retirement for the last 10 years. In deriving 2015 estimates, I have made some assumptions as Badger hasn’t yet reported its Q4’15 earnings. If I take Badger’s fleet size in 2005 year-end and assume that the whole fleet at the end of 2005 was brand new, I should expect all of those 2005 trucks to be retired by 2015. The fleet size at the end of 2005 was 241 trucks, but the total number of retirements between 2005 and 2015 was 154, far short of the 241 that I predicted. This is just 64% of the predicted number, even when I made the simplifying assumption that all of the trucks at the end of 2005 were brand new. This would imply an average life of a truck to be ~16 years (i.e. 10 divided by 0.64).
Now, let’s compare the above results using no simplifying assumption that Badger’s fleet at the end of 2005 was brand new. In its 2005 annual report, Badger disclosed that the average age of its fleet was 4.5 years and that the economic life of its trucks were 10 years (See exhibit 13). So the fleet at the end of 2005 would have had an average remaining life of 5.5 years (10 minus 4.5), and therefore would have all been completely retired by mid-2011. But Badger only retired 84 trucks between 2005 and mid 2011 compared to my expectation of 241. This is only 35% of the expected number. This would imply an average life of a truck to be ~29 years (10 divided by 0.35) versus management’s estimates of 10 years based on past experience.
Exhibit 12: Table showing Badger’s hydrovac fleet size, additions, and retirement
(Source: Sedar filings and my estimates)
Exhibit 13: Excerpt from page 11 of Badger’s 2005 annual report shows its fleet’s average age
Is Badger overstating the size of its fleet to inflate the size of the company in order to get a higher enterprise value from the market? An explanation in Badger’s defense could be that the company is keeping its old trucks in its parking lot and not retiring those old trucks. In that case, the true usable fleet size could be a lot lower than its Q3’15 ending fleet size of 1020 trucks; maybe just 35% of its size, which would imply only 357 usable trucks! Whatever the case may be, the most likely conclusion is that the truck retirement numbers disclosed by Badger don’t seem realistic and are inconsistent with other disclosures.
Revenue recognition policy excludes collectability criteria
In Exhibit 14, I can observe that Badger’s revenue recognition policy doesn’t have any collectability assurance criteria, which seems strange. This would imply that Badger can book revenues even if Badger is not sure about the counterparty paying its bills.
Exhibit 14: Excerpt from page 10 of Badger’s Q4’14 financial statements regarding its revenue recognition criteria
As expected, other Canadian peers have collectability clause in their revenue recognition policy. Exhibit 15 shows the revenue recognition policy of LoneStar West, who is Badger’s closest peer. Exhibit 16 and Exhibit 17, shows the revenue recognition policy of two other Canadian oilfield services companies, Secure Energy Services and Ensign Energy Services. All three companies clearly have a collectability clause in their revenue recognition policy.
Exhibit 15: Excerpt from page 6 of LoneStar West’s Q4’14 financial statements regarding its revenue recognition criteria
Exhibit 16: Excerpt from page 7 of Secure Energy’s Q4’14 financial statements regarding its revenue recognition criteria
Exhibit 17: Excerpt from page 58 of Ensign Energy’s 2014 annual report regarding its revenue recognition criteria
In Exhibit 18, I provide the details of Badger’s trade receivables using disclosures in its annual reports. I noticed that in 2014, the percentage of receivables that have been due for more than 90 days jumped from 13% to 23% of the total trade receivables.
Could these trade receivables never be paid? If these receivables are never paid, the reported revenue in 2014 might be inflated and therefore, the adjusted revenue could go down from $422 million to $398 million, which would imply Badger grew revenue at a 22% rate in 2014, instead of the reported 30%.
Since Badger reports trade receivables details only annually and not quarterly, I don’t know the receivable performance over 2015. However, given the economic slowdown in 2015 among Badger’s end markets, I would anticipate the receivable quality to have further deteriorated in 2015.
Based on the above, it seems that the bulls are taking unknown risk regarding the quality of Badger’s revenues, as Badger has no collectability criteria in its revenue recognition policy.
Exhibit 18: Ageing analysis of Badger’s trade receivables (Source: Sedar filings and my estimates)
Valuation and Sensitivity
In Exhibit 19 I show my estimates and assumptions for my base, bull and bear scenarios.
I believe there is a high probability that some of Badger’s accounting disclosures may be inaccurate and maybe restated in the future. However, given the uncertainty around the timing of such events, I do not model any such event in any of my scenarios. In other words, I assume all accounting disclosures to be fair and accurate as presented. Any restatements of prior financial statements would be an additional downside to the stock and is a free option for the short seller.
I expect 2016 and 2017 Rev/EBITDA/EPS growth rate to be 5%/-1%/-9% and 2%/-3%/-8%, respectively
I expect 2016/2017 EPS to be $1.14 / $1.04. My 2016 EPS estimate is 24% below consensus estimate at $1.49
I optimistically believe that such a growth rate profile for a commodity business could justify a 13x PE valuation, On my 2017 EPS of $1.04 this would imply a target price of $14 by the end of 2016, giving a downside of 41%.
From a replacement value standpoint, the current stock price looks expensive in my base case. The stock trades at $711,000 on EV/truck in 2017 even though it takes Badger ~$350,000 and competitors $200,000-$500,000 to build a truck. This implies that a competitor could possibly replicate the business for roughly half of the value. In my target base case price scenario, using 13x PE, the implied EV/truck is $418,000, which seems more reasonable in a rational market environment.
I expect 2016 and 2017 Rev/EBITDA/EPS growth rate to be 13%/17%/19% and 11%/13%/14%, respectively
I expect 2016/2017 EPS to be $1.53/$1.75
I believe such a growth rate for a commodity business would justify a 16x PE multiple on my 2017 EPS of $1.75. This gives us a price target of $28, or an upside of 21%
Implied EV/truck is $817,000, well above the replacement cost of $200,000-$500,000 for competitors
I expect 2016 and 2017 Rev/EBITDA/EPS growth rate to be -2%/-13%/-25% and -8%/-17%/-29%, respectively
I expect 2016/2017 EPS to be $0.94/$0.66
I believe such a growth rate for a commodity business would justify an 11x PE multiple on my 2017 EPS of $0.66. This gives us a target price of $7, or a downside of 68%
Implied EV/truck is $223,000, near the lower end of the replacement cost of $200,000-$500,000 for competitors
Asymmetric Risk Reward profile
My scenario analysis suggests that shorting Badger stock provides an attractive asymmetric risk-reward profile skewed towards the downside. (Base Case: 41% downside, Bull Case 21% upside, Bear Case 68% downside). Additionally, I believe that the probability of the bull case playing out is low. Plus, there is a free option if Badger gets into legal trouble due to questionable business practices, pending and future lawsuits, and inaccurate financial disclosures.
Exhibit 19: Model summary for my base, bull and bear case estimates (Source: Sedar filings and my estimates)
Key Risks (in order of priority from high to low)
Clean Harbors approached Badger with an offer in 2011 for $20.50 per share that was rejected by Badger’s shareholders. Given that the shale boom has busted and the industry has been commoditized over the last few years, I am not sure if Clean Harbors would still be interested in paying up for Badger.
Plus, it is cheaper to build Badger than buy Badger. One could replicate Badger’s fleet of 1020 trucks assuming $400k per truck, by paying a total of $408 million versus Badger’s current enterprise value at $950 million.
Company stays under the radar and investors don’t do detailed work on the company
Coverage on the name is thin. There are only 3 small sellside brokers who cover Badger: CIBC, Canaccord, and Cormark Securities.
Strong recovery in oil price
Given current oil prices, and given that both United States and Canada are just coming off of one of the biggest investment cycles in oil and gas industry history, I feel this risk is manageable, as any recovery in hydrovac truck utilization will be slow
Additionally, there is enough excess idle hydrovac equipment in the market that even in an oil price recovery environment, price growth for hydrovac services may not be strong
The content of this document represents the views of the individual user only, does not purport to be complete, and has been provided to Value Investors Club as a means to exchange investment ideas amongst a community of professional investors. Investors are encouraged to perform their own diligence when formulating an investment view.
New lawsuit filings or settlements
|Subject||The other side of the coin - an opposite view|
|Entry||01/04/2016 05:34 PM|
Thank you, ILoveStocks, for the detailed analysis of Badger Daylighting (BAD). You clearly have dedicated a lot of time on this name but I think you have not included a few important points in your analysis.
I will start with some large themes that you omitted from your analysis and then I will address the individual points.
First, you do not discuss one of the key competitive advantages the company has related to its size and national footprint. That is - the ability to move around its fleet from locations with limited activity to locations with high activity. In 2015 the size of the Canadian fleet has been shrinking and the size of the US fleet has been growing as the company is quickly repositioning trucks to areas where they can be more profitably deployed in the US. To the extent of my knowledge, no other peers have the ability to do that this as efficiently as BAD. That is the advantage of having assets on wheels and large national presence. This affords them ability to maintain pricing and utilization at a decent level even during these very depressed times.
This is a very important point because this is how the company manages to maintain its profitability and positive FCF throughout the cycle. This brings us to the second point. The quite substantial free cashflow generation. The Company generated $2.45 of Distributable Cash (which is defined as Cash From Operations less Maintenance Capex). This is a 10%+ FCF yield on current prices. In the first nine months of this year the company has generated $1.51 of FCF which should become around $2-2.25 by the end of 2015. In other words, despite its 51% exposure to Energy, its FCF is virtually unchanged from last year. I have not found been able to find other energy services companies that can boast similarly stable results in this oil price environment. Yes the weak CAD helps but even accounting for this, this company is significantly outperforming peers. The Strong FCF generation is another very important point that you did not bring up. I should point here that during 2008/2009 - the company saw its sales go down 9%, while its EPS remained unchanged and its FCF was positive. This is a company that is very quick to control cost (reduce labor and other costs) and redeploy assets or manage the feet by reducing supply/increasing retirements and adjust very quickly to a new environment. As a point in case, in the first nine months of 2014, the company generated $314mm of revenues (when oil was $80-$100), while in the first nine months of 2015, the company generated $304mm (when oil was $40-60), similarly adjusted EBITDA declined only slightly from $35.9 to $33.7. Again the CAD helped but nevertheless it is much better when compared to other global energy services companies that saw their revenues decline by 50%+.
Another major point is the strong profitability. The Company has generated ROEs in the range of 20% to 30% in each of the last ten years. Here is the math as you point out, the price of the truck is c. $350,000. The average revenue per truck in the last three years was in excess of $30K per month or $360,000+ per year. It dipped to $28K/month/truck in the last quarter. Historically, the average (EBITDA - Maintainance Capex) per truck has been in the $90K range per annum. This is a pre-tax figure. Therefore the Average pre-tax ROIC is around 26% or the payback is less than 4 years on a truck. Not too bad for a truck with accounting life of 10 years and a much longer actual useful life. Even accounting for taxes, the ROIC is in the mid-to-high teens. This is a profitable business and indicates that the company does have a moat.
Now here are some of my comments on the other points that you make. I address them in order of appearance.
1) Cost of Equipment. You have stated that the price of equipment ranges between $200K and $500K. However you did not mention that the types of equipment range too (Some are smaller, some are just VAC and not HVAC etc). There are some companies that operate smaller equipment (Hydrodig is an example) that are suitable for limited applications. Those cost less but this is not BAD’s business. They manufacture varying types but generally larger size trucks. You also did not mention in your analysis that BAD is the only provider that manufactures its own equipment and therefore has a 20-30% cost advantage. No one else in the business makes their own equipment and they have to order it from third parties. BAD has engineers on staff whose job is to collect feedback from clients and reflect that into the design of the truck and thus serve customers more efficiently. Third party manufacturers of HVACs make many different types of equipment and as such are less dedicated to in-time design improvements. You correctly stated that Lonestar West is the closest and largest competitor with less than 100 HVAC trucks. However, you did not point out that that on page 6 of their latest investor presentation they state that the cost of a new truck is $475K. This is the second largest industry player (after BAD), whose management claims they are the best in the business, yet they pay 26% more for their equipment than BAD.
2) In your assumptions upfront you state that the CAD will be a headwind going forward. The CAD is driven by oil. If CAD gets strong that means that oil prices are recovering and therefore activity, or the CAD economy, are getting stronger. Both factors bode quite well for BAD, and should offset the stronger CAD impact.
3) You correctly point that the market is very fragmented and localized and equate that to increased competition. However, no other company has managed to grow its fleet as fast as BAD. There are so many small players that have stayed small because of capital or labor constraints. Oaktree acquired T-Rex Services over a year ago but despite Oaktree’s deep pockets their fleet has stayed constant while BAD has grown. T-Rex was founded 15 years ago and is still at 40 trucks. Lonestar has been around for 13 years but has yet to cross the 100 HVAC trucks mark. While T-Rex and LoneStar have not managed to expand beyond a 100 over the last decade, BAD has quadrupled its HVAC fleet to over 1,000. They are 10+x larger than the next player.
4) You say that supply is going to grow and that will hurt BAD. Here is a fact from Gas & Oil Mining Contractor magazine 2/2014. Granted this is an old data-point but still gives an indication of the market. According to the magazine, there were 600-700 hydrovac units in Alberta with a population of 4mm in 2014. There were 150 units in Texas with a population of 27mm at the same time. Assuming the same adoption rate per person, one gets to nearly 4,400 hydrovacs in Texas alone. BAD is the absolute leader in the US with 550+ trucks here, so there is clearly a huge market opportunity for HydroVacs in the US. The biggest driver for HVAC expansion is the demand for increased safety in excavation. According to the U.S. Bureau of Labor Statistics, 271 workers died in trenching or excavation incidents from 2000 through 2006 (reference http://www.cdc.gov/niosh/topics/trenching/). The costs of spills from ruptured pipes due to using manual excavations are in the tens of billions (Burnaby is a prime example). Municipalities are now increasingly demanding the use of HVACs to be deployed in excavation work. That is a strong tailwind to the industry.
5) On a related point one should also point that other factors that drive the use of HVAC is much greater efficiency and flexibility (ability to excavate frozen soil, narrow spaces etc). The BAD company presentation has many case studies showing the advantages of using HVAC over manual excavation. HVAC is a much more advanced method of doing excavations than backhoe and contractors are increasingly being educated on that, thanks to BAD.
6) You talk about how the Company has not reduced its pricing during the downturn. This is true. The company manages proactively its fleet to maintain pricing and utilization at an acceptable rate. BAD has stated that they don’t reduce pricing in bad times but don’t increase it in good times. Pricing per hour has been flattish over a number of years. This is a somewhat unique characteristic for BAD and its clients now that and appreciate the stability for their planning budgets. Although BAD’s management will admit that they are above the average on a price per hour, when it comes to safety, efficiency and speed they are among the best which brings the total cost of the project. Here is a statement from a HVAC veteran Mike Clark, the CEO of one of the leading Texas-based hydro-excavation operator, H2X LLC, with 15 years of industry experience. Here are some quotes from his website which are useful.
“…The price has always been high compared to a backhoe. The reason is that when you hire a hydro excavation company you aren’t just buying a hole in the ground. You are buying a safe hole in the ground, and one created by a machine that may cost nearly half a million dollars, so it comes with a price tag…”
“….[However,] contrary to what you may have been told, it’s not about the hourly rate. It’s actually about the cost of the specific amount of soil that was moved on your job. This should be calculated, or estimated, in dollars per cubic yard. If hydrovac Company A charges $300 per hour and removes two yards of soil in that hour, their actual cost is $150 per yard. If Company B only charges a “bargain” $200 per hour but moves only a yard of soil in that time, they seem drastically cheaper by the hour, but their actual cost is $200 per yard…”
“…All hydrovac trucks and crews are not the same. Even among trucks designed to be hydro excavators, there are differences. Does the truck have water pressure and water flow that can be dialed up or down depending on the soil conditions? This can be critical in excavating older and deteriorating underground lines. Does the truck have enough water and debris capacity to dig at least half a day without having to leave the jobsite to dump? Too much drive time off the job can cost you more than you think. If you are working on a street or highway, is the truck within the legal weight limit in your state when it shows up on the jobsite loaded with water and ready to work? You may be incurring liability for an overweight truck when you don’t even know it. In the winter, does the truck have a boiler on board to heat the water to a temperature that will melt frozen ground? If not, you will pay more than you need to for the excavation, guaranteed.…”
“…Even more important than the truck is the crew running that truck. Those two people (and don’t hire a hydro excavation company that sends a truck out with less than two people) are 75% of the secret to efficient, safe and productive hydro excavation services…”
7) A quick note on the franchises. The company bought them back because the operators were not performing or growing their respective markets. Given the high profitability of the business they got to a size that earned them a nice living and had no incentive to expand. BAD is certainly a very performance based company. They are focused on both growth and costs. They are very quick to cut costs or make changes if the returns are not justified and this is what happened with the franchises. As a point of how cost-conscious the company is, one should read employee comments on Glassdoor – most complain that the company is very quick to cut costs if necessary. Anecdotally, the CFO is also the IR person (the CFO answers his own calls, no assistant picks up).
8) Here are some comments on the acquisitions that your analysis suggests are being used for cookie jars. The company made those acquisitions not for the equipment but for the client base. They absolutely do not need to acquire equipment (they make the HVAC trucks at lower prices and better than anyone). In fact they are likely to dispose of these non-core businesses at some point now that they have access to the client base. With such a fragmented market if they wanted to make acquisitions they would have made many so far – they have done none for equipment alone. Therefore the increase in revenue post the acquisition of Fieldteck is most likely the realization of those revenue synergies related to the new client base. If the company was using this as a growth cookie jar (as you claim) why would they point to how weak these non-core businesses performed in 2015. Fieldteck/Benko and Shoring did well in 2014 and poorly in 2015. The management has made that point clearly. Not sure how that fits the “cookie jar” theory. Also you question how come the revenues of the non-core business went from 7% of total in 2013 to 13% of total in 2014. The answer is due the fact that Fieldteck was bought in November 2013, so it only contributed a month of revenues in 2013 and a full year in 2014.
9) Your analysis suggests that the company is making some accounting misstatements with respect to economic life of the trucks. They are depreciated over 10 years but the company has stated that there are trucks in its fleet that are much older than that. There is obviously a big difference between economic and useful life. The company retires trucks faster when the market is slow and slower when it is hot. It was pretty hot in the last few years so the retirements were slower. The pace has picked up quite a bit in the last three quarters in 2015. Most importantly, the company expenses all the maintenance and repairs for its trucks on its income statement (this is not capex i.e. these are expenses). The Maintenance CapEx, which is also disclosed, is the amount of capital needed to maintain the fleet at the same size as at the beginning of the period – this may even be considered by some as growth capital. This is a rather conservative definition of maintenance capex. If anything this Company is being very conservative in the way it accounts for repairs and maintenance (i.e. it is being expensed and capitalized). Lastly, you make the claim that the company is artificially inflating the size of its fleet. There is absolutely no incentive for that. The Management is being compensated on multiple targets – one of them is achieving Revenue per Truck per Month of $30,000+. If they inflate the size of the fleet it will be much harder for them to achieve their profit targets. By the way, management compensation is closely tied to doubling the size of the business in the US over the next 3-5 years – something that you question. The market is currently slow, for sure, but the management has the incentive to achieve their goal. Lastly, I should point out that I have not seen anyone valuing the company based on the size of its fleet so there is no valuation incentive for that either.
10) Your comparison of the revenue recognition methods is a question of semantics. BAD measures revenue on the FAIR VALUE OF CONSIDERATION RECEIVED OR RECEIVABLE. Presumably if the auditors added the word FAIR VALUE, it means that they intended to account for the probability of collecting the receivable. If the consideration is already received then the probability that it will be received is 100%, so the fair value relates to the receivable and not the received. Again it is a matter of semantic if collectability is a stronger word than fair value of receivable. I could argue that if the peers view the revenue as likely collectible they would account it as revenues at 100% probability, which is less conservative than BAD, which will adjust for the probability of collection based on its fair estimates.
11) My impression of reading through the company’s press releases and financial statements is that they provide a lot of data and metrics and are not sugarcoating underperformance if there is one. They made a strong point in the last few calls how Eastern Canada has been weak and how they are making changes to management there. They blame that entirely on themselves and not the market. They do blame the market for weakness in Western Canada.
12) As it relates to accounts receivable, the company A/R days has stayed in the range of 90-100 days in the last few years, in fact in 2014 that metric was down from 2013 so there are no aberrations from trend as your estimates suggests. It looks like your estimated that only 15-25% of the A/R days are above 90 days. This does not reconcile with the fact that the total A/R days were 97 in 2014.
13) Your analysis uses EPS as a valuation metric. EPS is kind of irrelevant due to D&A being lower than CapEx. The Company generates FCF that is higher than EPS. Currently the stock trades at c. 10% FCF. This is not expensive at all, considering that 2015 is one of the worst year for the business in the last decade. Both FCF and the multiples are depressed. The company is trading at a fraction of its EBITDA multiples it garnered a year or two ago.
14) I am not sure why anyone would want to value the business at the cost of constructing the trucks. As pointed out this company has generated 20-30% ROEs and its pre-tax ROIC is 25%. This business has generated very strong returns and should not be valued at cost.
15) Lastly, you mentioned that this company is not followed by the buy side or sell side. It has a pretty strong following in Canada and some great initiation reports by local brokers.
|Subject||Lone Star vs Badger 3Q results|
|Entry||01/04/2016 06:12 PM|
LoneStar - the second largest industry player posted pretty disappointing results for Q3 - declining margins, rising bad debt, negative earnings and increased marketing spend on getting new business. Stock was down 35% since announcement.
Badger reported 3Q results that were very strong, as described in my prior post, as a results Badger is up 40% since announcement.
This is a 75% delta in stock market performance post 3Q results between the #1 player and the #2 player. Perhaps the industry is not as commoditized as it appears at first sight.
|Subject||Offices and Covenants Clarifications|
|Entry||01/05/2016 04:07 PM|
1) The company has confirmed that as per their financials disclosure the number of their offices in North America is over 100.
2) The covenant breach discussed in the analysis related to the recent franchise litigation was not triggered by the debt incurrence / coverage ratios being tripped but by a clause which states that if there is a negative judgement against the company of certain material size it needs to be rectified within 30 days. As highlighted in the presented analysis the creditor banks granted a waiver.
|Subject||Re: Offices and Covenants Clarifications|
|Entry||01/12/2016 10:20 PM|
It would really help investors if mgmt provides the exact addresses of each of its "over 100" locations.
Since customers have to visit or call-in a Badger's local office to do business with the company, the exact addresses of Badger's local offices should be in the public domain anyways for business reasons. Imagine Walmart trying to conduct its business without diclosing the addresses of its stores!
In my writeup I had mentioned that I visited four locations in the NYC area, and all of them didn't exist. Its possible that this is just the tip of the iceberg. There could be many more locations that may not be legitimate.
Here are some additional data points that support my hypothesis. I went through 5 more local office locations shown on Badger's website and overlaid those sites with Google Earth and Google Street View to crosscheck if a local office exists. None of those 5 locations seem legitimate. Here is the link to the PDF that provides Google Earth and Google Street View images to support my hypothesis: https://www.dropbox.com/s/89xs05gsvk6v6dm/Badger_Locations.pdf?dl=0
Below is the summary of my analysis of those five locations shown in the pdf link:
The five locations analyzed in the pdf link seems to be just the tip of the iceberg. There are many other locations that don't look legitimate when I overlay those locations with Google Earth and Google Streetview.
If all of Badger's 100+ locations are legitimate, what's preventing managment from provding the actual addresses of each of those locations so investors can analyze the company with confidence?
|Subject||Re: The other side of the coin - an opposite view|
|Entry||01/13/2016 03:15 AM|
Thanks Varna10 for providing opposing views on the writeup. Below I provide my thoughts on several of the relevant issues you bring up:
· Verna10’s view: Badger has the ability to move its fleet around
o Varna10 brings up a good point. Historically, Badger has been able to move fleet around from weak areas to strong areas. In almost all cases, strong areas are characterized by lower competition vis-à-vis end-market demand. Therefore, as competition increases over time, Badger’s advantage in relocating fleet in tough times will diminish over time as well. Therefore, Badger’s ability to use this lever will slowly erode. My chat with industry professionals suggests that competition is increasing rapidly all across the country.
· Verna10’s view: Badger generates strong free cashflow and trades cheap on fcf yield. Also EPS is not a good metric to value this company
o The free cashflow definition that Badger uses is a flawed way of capturing the true free cash flow (fcf) generation ability of the company over the long run. Badger defines fcf as cash from operations less maintenance capex. To calculate maintenance capex Badger takes the number of trucks retired during a reporting period and multiplies it by the capex per new truck. So in order to reduce its maintenance capex to zero, all Badger needs to do is not retire any trucks. If Badger just leaves those old unusable trucks sitting on its parking lot, it can show to investors increased fcf as per its definition. This doesn’t mean that Badger’s fleet is not depreciating and that there is no replacement cost for that depreciation. Just because the company chooses to keep an old truck sitting on its parking lot rather than retire doesn’t make the company more valuable.
o Instead, I would think about valuation based on fcf per share in the following two ways:
1. Fcf = cash from operations less depreciation; and determine if this fcf multiple is cheap for a non-growing company
· I estimate Badger to generate 92mm in cashflow from operations in 2015 and 42 million in depreciation. So I end up with 50mm in fcf after allocating a replacement for depreciation. This gives me fcf per share of 1.35. At $23 per share stock value this would imply a 5.8% fcf yield versus Varna10’s alternative calculation of 10%+ fcf yield using management’s definition of fcf. A similar calculation for 2016 using my methodology leads me to $1 fcf per share based on my base case assumptions, which implies a 4.3% forward year fcf yield. I would not consider such a yield cheap.
2. Fcf = cash flow from operations minus total capex; and determine if the fcf multiple is cheap for the future growth profile that Badger offers
· For 2016 if I deduct the full capex of 46mm from a cash from operations of 83mm, I get a FCF of 37 million, or 99 cents per share using my base case assumption. This would imply the stock is trading at 23x 2016 FCF for a 6%/-1%/-9% Revenue/ EBITDA/ EPS growth in 2016 and 2%/-3%/-8% Revenue/ EBITDA/ EPS growth in 2017. I would argue that this is an expensive multiple to pay for such growth profile
o Underestimating maintenance capex is a common mistake MLP investors made over the last few years and therefore overestimated the true fcf generation ability of some of those MLP assets in the long run. I think, using management definition of fcf would lead us to make a similar mistake.
o I would disagree that EPS is not a good metric to value this company. EPS is the leftover amount for equity holders after paying for all costs (including replacement for depreciation), and therefore is the most relevant valuation metric to value this company. So D&A is not lower than replacement capex over time unless you make the case that it costs less to build a new truck now than it use to in the past. From my conversations with management, it seems that the cost of building a truck has actually gone up in 2015 due to CAD weakness. Company use to cite 325-350k capex per new truck last year. This year the tone has changed to 350-375k range.
· Verna10’s view: Badger is better than an oil services company
o Agreed. Almost 50% of Badger’s income come from municipalities and utilities, which are inherently less cyclical than oil and gas. So the business mix for Badger is definitely better than a typical oilfield services company. However by no means this makes Badger a non-cyclical company or a high quality business. Competition for municipal jobs is increasing as well and some municipalities are buying their own hydrovac trucks e.g. City of Wichita has 8-10 hydrovac trucks of its own now.
· Verna10’s view: Badger generates strong profitability as evidenced by its high ROE
o As Varna10 correctly pointed out, Badger has generated high ROE and high ROIC historically over the last 10 years. I fully appreciate Badger’s great performance in the last 10 years. What I am saying is that the incremental ROIC and incremental ROE on future investments will be much lower than what it has been in the past.
o The very fact that Badger has historically accomplished 4 years payback on a truck investment is attracting new competition. This situation reminds me of what happened to the pressure pumping companies when the shale boom started. Payback period on those equipment use to be in the low single digit years. Soon everybody caught on to the trend and pricing in that industry collapsed leading to various restructurings during 2011 – 2013 even when oil boom was at its peak. I can foresee a similar story playing out in the hydrovac industry as well.
o Because of the high ROE and ROIC in the past, even large clients of Badger have realized that the economics of owning such trucks is better than renting. Therefore, Kinder Morgan and Atlas Energy have started owning hydrovac trucks rather than renting them.
o Badger doesn’t have a moat and its evident by new mom and pop hydrovac services popping up all over North America. The great returns in the past generated was because Badger had a first mover advantage and not because the business has a moat. Just type on google “Hydrovac Services New York” and see how many results show up besides “Badger Daylighting”. Try and do the same search 3 to 6 months from now and you will get even more results.
· Verna10’s view: Hydrovac trucks come in different flavors therefore all hydrovac trucks are not comparable
o I fully agree with Varna10’s point that all hydrovac trucks are not the same. Some are smaller, some are bigger; some can operate in very harsh weather and some cannot; some breakdown more frequently than others; some are more powerful than others, etc. Therefore, there is a wide range of pricing for such equipment ($200k-$500k)
o My point is that competition is increasing for all different types and scope of work e.g. in some regions where harsh weather trucks are not needed, one can get a cheaper truck to do the job. In some regions the land is softer and therefore you may not need a very powerful truck. Just Because Badger may have a more powerful truck than a competitor does, it doesn’t mean that a client will pay higher prices for Badger’s truck. If a low end truck gets the job done at lower price, a client will choose the lower priced truck. A similar analogy can be made to oil rigs. Just because somebody has a better oil rig doesn’t necessary mean that those rigs will be hired over lower end rigs. The final decision will depend on the need of the client. A client in Permian Basin may very well hire a low priced, low end rig whereas a client in the Bakken shale will go for the high priced, high end rig.
o Lonestar claims that its trucks are even better than Badger’s and therefore it seems the higher price its pays per truck may be justified. Seeing that Lonestar achieved higher revenues per truck in 2014 ($35k/truck/month) vs Badger at $32k/truck/month, Lonestar claim may very well be true.
· Verna10’s view: Canadian dollar and oil prices are correlated
o I agree with Varna10 that CAD and oil prices are correlated to a good extent. So CAD and oil activity in Canada my go up at the same time. However, I take comfort in the fact that a large amount of Canadian oil production is tied to oil sands whose marginal cost of production is one of the highest in the world. So oil will have to recover a lot and for a sustained period of time before we will see strong pick up in oil sands activity. Nevertheless I fully appreciate and acknowledge Varna10’s point on this issue that there is somewhat of a natural FX hedge in Badger’s business.
· Verna10’s view: Badger has done a better job than its major competitors in the past
o Point fully taken. Badger has executed well in the past compared to its major competitors.
o However, competition has intensified much more than what was in the past. There are several mom and pop owners of hydrovac trucks all across North America competing for business. Plus municipalities and large clients are starting to do hydrovac excavation in-house by owning their own equipment.
o I fully acknowledge that there is a risk to the short thesis if Badger continues to execute at the same growth and return levels as in the past in spite of the incremental competition.
· Verna10’s view: Addressable market is large
o I agree with Varna10 that the addressable market could be large. I am only questioning Badger’s ability to capture a large chunk of that addressable market while maintaining high returns even in light of heightened competition. With mom and pop competitors are emerging all over North America, every market is getting more competitive and therefore future revenue growth for Badger will be lot slower than that in the past. Plus larger clients are beginning to in-sourcing hydrovac services. I am modelling fleet growth in all my scenarios: base, bull and bear to acknowledge the large addressable market but I am modelling incremental returns to be lower.
· Verna10’s view: Hydrovac excavation is safer and more efficient way to dig
o I fully acknowledge this point. This is a tailwind for both Badger and its competitors. What I am arguing for is that hydrovac excavation is getting commoditized and therefore, future growth and returns will note be as favorable as in the past.
· Verna10’s view: Crew provides a competitive advantage for Badger
o I would push back Varna10 on this one. Access to a superior crew is no longer an advantage for Badger. Training a new person to operate a hydrovac truck is not a very challenging task. I have talked to several experts in the field who have mentioned a new trainee can get up and running on a job in less than a week and can be a very good operator in less than a month. Besides, as Badger has a very high turnover culture, the job market is full of former Badger employees who were well trained by Badger. Therefore, access to quality labor pull is not a big issue for competitors.
· Verna10’s view: Franchisee were bought back due to underperformance
o All I am saying is that some of those franchisee operations that Badger bought back may have not been done ethically and legally, and therefore may be challenged in the court in the future. We have already seen one lawsuit filed, that the company last month settled for $7.5mm. As Warren Buffet said in his 2014 letter: "In the world of business, bad news often surfaces serially: you see a cockroach in your kitchen; as the days go by, you meet his relatives." Based on my conversations with former employees it seems more likely that more lawsuits will be filed than not filed.
· Verna10’s view: Mgmt commentary is consistent with Benko/Shoring performance
o I would disagree that management’s historical commentary and business plan explains the large up and down jumps and outsized growth in (Benko+Shoring) revenue
· Verna10’s view: Mgmt has no incentive to overstate the size of the fleet
o Market multiples depend on EPS and FCF/sh growth. Since fleet growth is an important contributor to the growth of those two metrics, investors closely track fleet growth. So there is definitely incentive to overstate the fleet size.
o The error in the expected retirements and actual retirements is way too high (thrice the expected number) to be explained by just better fleet management. See exhibit 2 and the related commentary in my writeup.
· Verna10’s view: It doesn’t make sense to value the company on the cost of constructing trucks when ROIC is higher than cost of capital
o You are right that it wouldn’t make sense to value a business on book value when ROIC is much higher than cost of capital. I am using book value as a gauge of how this business could be valued when the business gets commoditized. Over time, as the business gets commoditized, ROIC will approach the cost of capital and such businesses will be valued close to book value. I use this valuation method more of a sanity check than an actual valuation metric to determine target price
· Verna10’s view: Company is well followed on the sell side
o I only see 3 brokers on Bloomberg (Canacord, Cormark and CIBC) who are submitting estimates for Badger. So I assumed those are the only three brokers covering this name. I apologize if there are more who do not show up on Bloomberg.
|Subject||Agree with short|
|Entry||01/13/2016 09:01 AM|
Thanks iLoveStocks for the write-up - we haven't dug into funny business around the reported locations but I agree with most of your points and the conclusion that this is a good short. There are limited barriers to entry in this business, competition is intensifying, market conditions worsening, and the valuation is still very high. I think its a big mistake to rely on the historical ROE or the mgmt FCF has you pointed out in your response to varna10.
|Subject||Re: The other side of the coin - an opposite view|
|Entry||02/09/2016 12:03 PM|
Varna, I am early on in doing my work in the Company and haven't come to a conclusion. However, I can't see how anybody would take comfort from the Glassdoor or Indeed reviews of the Company. Yes, management does seem to be very cost conscious. However, the culture is clearly high turnover, so it's hard to see how they have the best people in the industry.
More troubling, many reviews suggest that BAD regularly encourages employees to exceed the OSHA hours of services limits and may even fire employees who refuse to do so. I know that many Glassdoor reviews are sour grapes, but I think it's strange that a number of reviews make the same point about activity that is legally questionable. As you know, the US is increasingly trying to crack down on smaller non-public trucking companies who cheat on their log books. Again, I have no idea whether these Glassdoor comments are true, but if they are, this is not the way that an industry leader should operate.
|Subject||Key executives continue to leave|
|Entry||03/10/2016 11:17 AM|
Key executives/players continue to leave Badger. Now its the CEO announcing retirement until a replacement is found.
|Entry||03/28/2016 07:59 PM|
Badger reported pretty weak Q4’15 for sure. US biz was down 5.6% in constant currency and Canada biz was down 28%. When compared to Canaccord (the only analyst who reported estimates to Bloomberg), Badger missed topline (-10%), Adj EBITDA (-11%), Adj NI (-25%), Adj EPS (-22%), Revenue per truck per month (-11%). There was a lot of noise below EBITDA because of provisions for lawsuit and taxes so I used a normalized tax rate of 30% and eliminated the lawsuit impact to get to my Adjusted EPS estimate
Below is my summary of the quarter:
Quick Earnings Power Calculation
CEO may not be telling the truth about his reason to retire
|Subject||Re: Re: Earnings|
|Entry||03/29/2016 09:36 AM|
Thanks ILoveStocks. In general agree with your framework for earnings power and overall challenging backdrop. I was curious whether you've dug at all into the org changes in the Eastern Canada portion of the biz? They suggest mgmt changes there may lead to significant improvements in results, but I'm not sure what specific initiatives are underway. Sounded to me just like they felt like sales team wasn't aggressive enough winning new accounts, but not sure what else beyond that.
|Subject||Re: Re: Re: Earnings|
|Entry||03/31/2016 02:00 PM|
I don't have very many data points related specifically to Eastern Canada to cross verify the facts. I only have one source that suggested to me that Badger's pricing seems much higher than others in East Canada. That comment sounded consistent with whats happening to Badger's results: if your prices are higher than others, you will have to sacrifice on volume, which is what is happening to Badger's results in Eastern Canada. So in my base case I am assuming that Badger's pricing is too high in Eastern Canada, which won't help with volume recovery anytime soon.
However, mgmt seems to be making other excuses to deny this reality to the market. Here is the chronology of mgmt excuses on Eastern Canada:
So you can see the pattern here.
The true reason could be that their pricing in Eastern Canada is much higher. So if they bring pricing down they will get more volume. But if they bring pricing down Rev/truck/month, EBITDA margin, EPS, FCF/sh and all the key growth metrics will get crushed, leading to the stock getting crushed as the bull case will be debunked. For the bull growth case to work, Badger has to be able to hold pricing and increase fleet size both in Canada and in the US. Pricing pressure hits badger really badly (1) offsets volume growth (2) 100% of pricing decline flows to EBITDA, crushing the margins. In such a scenario most likely EPS will compress not expand even if fleet size grows.
By accepting pricing pressure mgmt will debunk the bull case. So the best alternative for mgmt is to not debunk the bull case and kick the can down the road as much as possible.
This summarizes where I stand in my base case on Eastern Canada, and frankly other regions as well. Would love to hear if anybody else has an opinion on this issue.
|Subject||Re: Re: Re: Re: Earnings|
|Entry||04/06/2016 10:47 AM|
dont really agree with the characterization of the below but I can get to that at some later point.
Seeing Tor tomorrow, happy to ask any questions (from the longs or shorts) and relay the replies.
|Subject||Re: Re: Re: Re: Re: Earnings|
|Entry||04/08/2016 09:59 AM|
Sorry, Didn't take advantage of your offer to put in a list of questions for Tor as I just saw this message. Did anything interesting stood out during your meeting with Tor from the long or short side?
|Subject||Re: Mgmt Mtg?|
|Entry||04/08/2016 11:23 AM|
ill try to be fair for the longs and the shorts.
honestly though I was thinking about the aggresive bear case, which is made up locations and other shenanigans. If that was the case why would Tor quit now and let someone else find out quickly theres a scam going on? Wuldnt you stay and backfill locations ect. to cover your tracks?
|Subject||Re: Re: Mgmt Mtg?|
|Entry||04/08/2016 12:21 PM|
But even absent the aggressive bear/fraud case...how is this actually "cheap" here? The stock trades in the 20s P/E, over time the business should still become more competitive as the installed base of hydrovac's will only increase over time and you can drive around and compete on price, and it doesn't seem like the bottom is in yet. I guess I don't really understand the long case, at least at this valuation. Maybe at $12 it is easier to get more constructive (12x trailing EPS which may or may not be the bottom)...
Also, on the "covering tracks" point I think we need to wait to see who gets hired...I saw this in FRAN where the old CEO left and was replaced by the head of the audit committee. Some people said that means there must not be anything bad...in my view, that was probably the ONLY person that could take over. Again though, at least in my opinion, I don't think you need to believe in the fraud angle for this to be a good short. In fact, on that point, I'm not totally sure what benefit they get from saying they have a bunch more locations.
|Subject||Re: Hyrdrovac overcapacity|
|Entry||05/03/2016 04:38 PM|
Color on Badger from Federal Signals Corp’s Q1 call seems skewed to the negative as oil and gas market remains still seems to be deteriorating . However, Municipal market remains strong. Overall, very little changed from what they said in Q4’15 call in Feb.
Plans to build new hydrovac trucks in 2016
· End market conditions
· Pricing remains challenging in oil and gas areas but rational in municipal areas
· 2016 has little visibility
|Subject||Re: Increasing dividend +10% vs (29)% YoY EBITDA|
|Entry||05/18/2016 07:55 PM|
Raising the dividend is just a gimmick to hide weak performance. There wasn't anything in Q1 report that should make anybody bullish. Mgmt hid behind warm weather to mask the huge deterioration in the underlying business.
When adjusting for one-time items I estimated 13 cents in normalized EPS for Q1’16. If I reverse the weather impact I estimate that the company would have made another 1.5 cents in EPS. So that leads to 14.5 cents in EPS for the quarter. If we assume that roughly 23% (average of last 5 year revenue in Q1) of the EPS is generated in Q1 , this leads to 63 cents in annualized EPS. Assuming this is a cyclical company and not a secular decliner, and assuming one would would pay 20x multiple on trough earnings, still gets me to $13 stock. But at $22 per share it trades at 35x times 63 cents. Keep in mind that only a proportion of the Petroleum segment (38% of revenue) is cyclical. So putting an egregious trough multiple is not a good assumption. Plus its not clear that in the next upcycle Badger will be the dominant player as other players are catching up pretty fast. As such, pricing will most likely be lower in the next upcycle.
|Subject||Re: Re: Increasing dividend +10% vs (29)% YoY EBITDA|
|Entry||05/19/2016 08:53 AM|
1. how are you getting 1.5c for frost differentials?
2. Who is ctaching up fast? Only other pure play, Lonestar, seems on the verge of bankruptcy
3. TTM fcf is 65mm or 1.75 per share. In arguably the worst macro enviornment you could have drawn up (oil collapse, warm winter). Not sure how 13x trough fcf is egregious.
|Subject||Thoughts on Q2'16 results|
|Entry||08/16/2016 06:44 PM|
Here are some key things to think about the quarter
Badger Daylighting’s 2Q:16 revenue of $92.0mn reported on August 12th was $8.6mn above street expectations of $83.4mn. Additionally Q2 revenues were up 2% yoy vs down 13% in Q1. This was surprisingly positive result as 40 days into Q2 when Badger reported its Q1:16 earnings results on May 10th, 2016 Badger had provided a weak outlook:
“Badger does not expect much improvement in financial results until the second half of the year. The reality is that the oil and natural gas sector has not yet stabilized and the general construction season does not start until sometime in the second quarter. As previously noted Badger manages for long term success. The opportunity to grow this business remains the same. When the oil and natural gas sectors begin to stabilize expected activity in the non-oil and natural gas sector will allow Badger to return to growth.”
The above facts imply that the last 50 days in the quarter were significantly strong. However, our conversations with people in the industry seem to indicate that business conditions worsened not improved in Q2 versus Q1. A senior executive of a large hydrovac competitor recently said the following:
““Badger has been instrumental in driving revenues and profits down for the industry. For non-union oil and gas, muni and utility work, Badger has moved to $200-$220 an hour rate vs. $280-$330 an hour previously. Surplus of equipment sitting around so slash and go - $200 to $220 vs. $280 to $335 a year ago. Badger been dropping prices over last year – noticeably over last 10 mos.”
So how is it possible that Badger is performing so well when competitors are struggling? An explanation can be offered by digging deeper into the accounting disclosures.
Badger’s Accounts Receivable (AR) increased by $6.5m in 2Q:16 over 1Q:16. This is inconsistent with business conditions and prior patterns. In Canada it’s a known fact that activity slows down in Q2 versus Q1 due to spring breakup. Fort McMurray fire caused addition slowdown in Q2 this year, which management acknowledged in the earnings release. So Canadian activity should have been sequentially down not up. The accounting metrics over the last four years support this seasonal pattern as Q2 AR balance has been lower than Q1 AR in each of those years except for this quarter; Canada segment revenue has been lower in Q2 than Q1 in each of those years except for this quarter; and Canada revenue per truck has been lower in Q2 than Q1 in each of those years except for this quarter.
If the $6.5mn in A/R weren’t booked in sales, reported revenues would have come in at $85.5mn, or down 5.5% y/y, in-line with $83.4mn street expectation and in line with business reality and commentary from competitors.
Is it possible the improvement in results is due to opportunistic revenue recognition that is out of line with historical patterns?
When we build Cash revenue and Cash EBITDA from the cashflow statement, we come to the same conclusion that revenue seems overestimated. Cash Revenue was down 9% yoy not up 2% as reported. Cash EBITDA was down 27% yoy not up 16% as reported. Cash EBITDA margin was 21.4% this quarter not 25.2% as reported.
FCF excluding growth capex was down 16% yoy. FCF including growth capex, when adjusted for $1.39mn spent on buildings in Q2’15, was down 12% yoy.
Given Badger’s weak accounting disclosures, cashflow statement is the mostly reliable way to analyze the underlying business trends. And based on the cashflow statement business is deteriorating.
If Badger’s business has improved why is the cashflow statement not confirming the recovery in the Income Statement?
|Subject||Results from Channel Checks|
|Entry||08/19/2016 11:14 AM|
Below is a summary of recent channel checks on Badger conducted in August 2016. Key takeaway is that both pricing and volume seems pressured in the US segment. In additional to existing ones, we now have one more data point contradicting the strong Q2'16 performance reported by Badger: