|Shares Out. (in M):||25||P/E||8||6.7|
|Market Cap (in $M):||354||P/FCF||0||0|
|Net Debt (in $M):||392||EBIT||0||0|
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NOA was last written up on VIC in the summer of 2017, and, while it has been an excellent performer since then, I think it warrants another look. Down around 20% from recent highs achieved in September, and flat over the last year, I believe the stock is very interesting today. The company made a series of transformative acquisitions in late 2018, has already de-levered following these deals, will generate significant FCF in the second half of 2019 after a capex-intensive 1H, will generate even more FCF in FY 2020 (a ~20% yield on the equity), and will likely resume their buyback in size in 2020, after pausing it for the most part this year (again, due to maintenance capex requirements following the acquisitions of 2018). (Note: the share price refers to NOA.TO traded in Canada, and all $ metrics in this write-up are in C$ unless otherwise noted, as the company reports in C$. The stock also trades under NOA on the NYSE.)
As the company describes itself, “North American Construction Group is one of Canada’s largest providers of heavy construction and mining services. For more than 60 years, NACG has provided services to large oil, natural gas and resource companies.” Though this simplifies it too much, a big part of what the company does is move earth around in big trucks. They own and provide the equipment to their customers, but also schedule and operate it. NOA owns over 600 assets (rigid frame trucks, loading units, dozers, and 20+ recently acquired ultra-class trucks).
Major customers include the Oil Sands companies (Suncor, Syncrude, Canadian Natural Resources), as well as mining conglomerates like Teck Resources, Rio Tinto, Newmont, Ivanhoe, and various government entities.
The company claims that 90% of its revenue is recurring; a notable recent contract win was five years in duration. Contractual backlog provides committed revenue of $1.4bn over the next five years (and has been run-rating at about 50% of annual revenue recently). Oil sands projects are fairly low cost globally, and should operate consistently with oil above $40, and perhaps below.
The economics of moving dirt around in Canada are surprisingly decent. The company expects a double digit ROIC in 2019 and a 21-23% ROE. EBITDA margins are in the low-mid 20% range.
2016 – 2019E ROE (per company)
The company has been working to diversify their revenue away from solely oil sands projects. They recently won a coal mine contract in Wyoming, have been bidding on precious metals mine contracts in Canada, and have been pursuing large earthworks projects in the infrastructure sector (flood diversion, road building, etc).
2018 Transformative Acquisitions
November 1, 2018 – $43mm for 49% ownership in Nuna Group, a civil construction and mining contractor.
November 23, 2018 – $200mm asset purchase of heavy construction assets from Aecon Group, which removed a key competitor from the market, will drive over $200mm of annual revenue (at expected 25%+ EBITDA margins), and allowed for the formation of the Mikisew North American Limited Partnership (an oil sands JV).
The company financed these transactions with cash on hand as well as new borrowings (primarily a credit facility, but also a second convert). The company’s average cost of debt is 4.7%. Due to strong free cash flow generation and significant growth in EBITDA, the company will de-lever rapidly following the November, 2018 acquisitions.
A key part of the investment thesis is the quality of the CEO and management team. The track record since CEO Martin Ferron joined in 2012 is very impressive. Through a very difficult oil market backdrop, he improved margins, grew the business meaningfully, de-levered (and recently re-levered for a large deal), and has grown the earnings power of the business astronomically.
He has proven adept at growing organically, acquiring companies and assets (inorganic growth), as well as improving operations to enhance margins. My sense from the research that I have done is that customers are very happy with NOA, and would like to give NOA additional work (the company’s foray into operating ultra-class trucks on behalf of oil sands customers is an example of this).
This management team understands capital allocation, and I believe is likely to create value over the long term. Each element of organic growth, M&A, and share buybacks have been value accretive.
The company has repurchased 15mm shares since 2013 (at an average price of ~$5-6), compared to the current share count of 25mm.
Given the quality of management and especially CEO Ferron, I think it is notable that he sounds as optimistic as he does about the prospects and current valuation.
“I would like to start this call by stating emphatically that I could not be happier with the way things are going at NACG. Despite all the headwinds blowing at us by the macro environments, we keep finding ways to improve our performance, even in the toughest of overall industry times. Just imagine, what we will be able to do when these headwinds finally abate.” CEO on 2Q 2019 Call
I would be fairly skeptical of this coming from many CEOs – yes, it sounds a bit promotional – but Ferron is genuine and I believe he is the real deal. This is a good segue into a discussion on valuation and various future scenarios.
Valuation and Scenarios
The adjusted (for an in-the-money convert) market cap is ~$410mm, and the company has ~$340mm of net debt (also adjusted for said convert), bringing the enterprise value to $750mm. NOA should do over $175mm of EBITDA this year and over $200mm next year (just on growth from in-place equipment at YE2019).
The company is trading for 4.3x 2019 EBITDA and 3.7x 2020 EBITDA.
Here is the 2017 – 2020E EPS trajectory:
$0.31 $0.99 $1.6-1.90 $1.90-2.30
The business is currently trading for 8x the mid-point of the 2019 EPS guidance, and 6.7x the midpoint of the 2020 guidance.
- Despite the fantastic stock-price performance over the last few years (up 175% since Spike’s write-up in the summer of 2017), the EV/EBITDA multiple is almost exactly the same depressed value it was when the stock was under $5, and the P/E multiple is almost half of what is was at that time.
- On 2020 EBITDA estimates (by the company, which have generally proven anywhere from slightly conservative to vastly conservative), the company is trading at a 3.7x EV/EBITDA multiple (on the 2Q2019 balance sheet – ie, I’m not giving them credit for any future deleveraging, which is happening rapidly).
- Using a 5x multiple on 2020 EBITDA, the stock price would be $22 (+57%), and at a 6x multiple (still the low end of where many peers trade), the stock price would be $29 (+107%). Neither of these scenarios give them any credit for FCF generation between 2Q 2019 and YE 2020, which should be substantial ($100-150mm depending on growth capex, or $3-5 per share).
- I believe a reasonable downside case would be a 3.5x multiple on the low end of the company’s 2020 EBITDA estimates (again still giving them no benefit of the doubt on cash flow generation post 2Q-2019), which would put the stock at C$11 (-21%).
- The company’s guidance of generating $70-100mm of FCF in 2020 is around 20% of the current market cap. If we assume all FCF is used to reduce debt, a 3.5x EV/EBITDA multiple using the low end of 2020 EBITDA guidance and the YE2020 balance sheet would put the stock at $15.50, slightly higher than where it is currently trading. Said another way, the current multiple will drop from 3.7x 2020 EBITDA (on the 2Q 2019 balance sheet) to around 3.1x 2020 EBITDA (on the YE 2020 balance sheet) if the company just applies all FCF to debt reduction over the next 18 months.
- Of course, none of these valuation scenarios contemplate further accretive M&A or share buybacks, the latter of which are particularly likely in 2020. The blue-sky case three years out is a $50-60 stock on $250mm of EBITDA, 20mm shares outstanding, $250mm of net debt, and a 5-6x EBITDA multiple (which doesn’t seem heroic). Again, this is coming from a CEO who took EBITDA from $63mm in 2017 to $200mm+ targeted next year (based on a brief increase in leverage that will be paid down in <3 years). This CEO and management team deserves a savvy capital allocation premium, not the steep discount that they are afforded.
Share Count and Ownership
“As at July 26, 2019, there were 27,345,572 voting common shares outstanding, which included 1,656,144 common shares held by the trust and classified as treasury shares on our consolidated balance sheets.” Thus, the latest net share count was 25.7mm shares. The company has two issues of converts outstanding. $40mm which converts at $10.85 (I have treated these as if converted and increased the share count by $3.6mm and reduced net debt by $40mm) and $55mm which converts at $26.25 (which I include in debt and do not adjust).
Cannell Capital owns 11% of the company, and the CEO, Martin Ferrin, owns 6.1% (over $20mm).
I believe this opportunity exists because Canadian energy stocks (and indeed seemingly all energy stocks, for that matter) are out of favor. But NOA has fairly little leverage to oil prices (at least within a reasonable band of say $40-70), and solid growth prospects over the coming years that are independent of commodity prices. The CEO is good, and if NOA keeps trading at under 7x earnings and close to a 20% FCF yield, I expect we’ll see meaningful buybacks over the next few years.
I’ll conclude with another quote from the CEO, which I think clearly demonstrates how he is thinking about that topic:
“Those of you that have listened to me for a while, I affirm you wish it was 6 multiple on many occasions, but I honestly did not mean for that to be our EPS multiple. I really hope that the excellent Q2 results we have now posted provide an inflection point for our stock price performance, as we have delivered on the lofty post-acquisition expectation as we set. But if that does not prove to be the case, I'm sure that we will have some constructive Board discussions, both allocating our cash flow between deleveraging, stock buybacks and a dividend increase. After all, we should have sufficient cash flow to meaningfully do all three.” (CEO on 2Q Call)
Key man risk
- Meaningful FCF generation in 2H 2019 / FY 2020 to continue to de-lever the balance sheet.
- Share repurchases may increase dramatically again in 2020 (subject to the stock price, as management are savvy capital allocators and understand buying stock back only at prices below intrinsic value).
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