PFB Corporation (PFB.TO)

Summary

We focus on smaller companies with “Ft. Knox” balance sheets and large & sustainable free cash flow yields and we are typically seeking a double-digit FCF yield or higher on an unleveraged basis.  The objective is for the sustainable FCF to eventually drive up the share price to a more reasonable valuation through share buybacks, debt reductions, dividends, or accretive acquisitions. Obviously, it is important we have a management team that cares about shareholder value.  We focus on small-cap stocks because there is a much better chance to find an attractive investment opportunity which is under-followed or undiscovered.

PFB Corporation (PFB) is an under-valued manufacturer and marketer of insulating building products made from expanded polystyrene materials (EPS) for the residential, industrial, and commercial construction markets in North America. PFB is based in Canada and all numbers are in CAD unless otherwise stated. The Company offers EPS rigid foam boards used in insulating roofs, floors, and walls; flotation and buoyancy products; geotechnical engineered applications; packaging display products; and building systems under the Plasti-Fab brand name. PFB provides structural insulating panel systems products used in various residential and commercial building envelope applications including roof, walls, and floors. The Company also offers timber frame structures under the Riverbend brand; and handcrafted log, timber frame, and hybrid log structures.  PFB has a vertically integrated strategy which it calls “molecules to mansions”. The Company sells its products directly through sales representatives, as well as through independent sales agents, and registered dealers and distributors in Canada and the United States. PFB is headquartered in Calgary, Canada.

 PFB’s shares currently trade at about $12 per share with about 7m shares outstanding for a market cap of $84m.  PFB has a “Ft. Knox” balance sheet with net cash position of about $15m as of 9/30/19 for a total enterprise value (EV) of about $70m.  LTM EBITDA is about $15.8m. LTM free cash flow (FCF) is about $12m. PFB is currently trading at about 4.5x LTM adjusted EBITDA and a 15%+ unleveraged FCF yield.  PFB trading volume is light, so this idea is likely appropriate for PA accounts or small- and micro-cap funds. However, some investment firms have been able to assemble meaningful stakes over time such as Baker Frank which holds 400,000+ shares or 7% of total shares outstanding.

 https://www.youtube.com/watch?v=DxfKtYcH_TA

PFB owns or leases a total of 11 facilities in Canada and 6 in the United States.  PFB is an industry leader and the only vertically integrated EPS company in North America.  PFB is an expert in EPS resin, building science applications, and geotechnical applications of its engineered EPS foam products.

 PFB’s strategy is to grow revenues to $200m (versus about $130m currently) and achieve a 15% EBITDA margin over the medium term (3 to 5 years).  This strategic plan is supported by its 1) integrated product strategy; 2) growth strategies for both organic growth and opportunistic acquisitions; and 3) growth in US operations, especially via a disciplined market by market expansion of its footprint.  PFB provides value-added, “green” insulation products which provide alternatives to traditional building products. These “green” products provide sustainable solutions to address the demand for energy-efficient buildings.

According to PFB, almost 40% of total energy consumption in North America occurs in building structures and, consequently, state and local governments are seeking to drive improved energy efficiency thru upgrading building codes.  This is potentially a major growth opportunity for PFB and its insulation-oriented products. 

Importantly, PFB manufactures custom-oriented and niche type products.  These include Plasti-Fab, Insulated Concrete Forms, and Insulspan. Plasti-Fab is a leader in the North American EPS industry. Plasti-Fab provides customers with nationally branded EPS Insulation Solutions, often including custom design for energy efficient buildings and other applications. The market segments for Plasti-Fab include roofing, exterior finish systems, insulation, reseller channel, OEM, processor, geotechnical applications, and radon gas mitigation.  Plasti-Fab is essentially a type of EPS. It is a molded EPS formed into easy to cut boards. The rigid closed cell structure assures long lasting thermal insulation properties. Plasti-Span insulation is used in floors, walls, and roof systems.

PFB has grown revenues from $99m in fiscal 2015 to $135m for LTM ended 9/30/19, or about 15% per annum.  Adjusted EBITDA grew from $12m in fiscal 2015 to about $16m for LTM ended 9/30/19. We believe adjusted EBITDA will be in the $16m range in fiscal 2019.  We think adjusted EBITDA can grow modestly by fiscal 2021 to about $18m. PFB has a medium-term target, over the next three to five years, to reach $200m of revenues and achieve a 15% EBITDA margin (EBITDA margin today is about 12%).

We believe PFB can sustainably generate $12m+ of FCF with current operations for an unleveraged FCF yield of 15%+ which we believe is attractive with 10-year treasury rates near 2%.  We believe PFB can use its free cash flow and “Ft. Knox” balance sheet to grow organically as well as via niche acquisitions. Based on 8x our estimate of adjusted EBITDA of $18m by FY 2021 plus $25m in estimated net cash by FYE 2021, PFB would have a market cap of $170m or about $24 per share vs. the current $12 share price (+100%).

https://www.youtube.com/watch?v=CbjDRSyOu-o&list=PLCCD0BEF1269E75E9&index=2

 Business Description

 PFB Corporation manufactures and markets insulating building products made from expanded polystyrene materials (EPS) for the residential, industrial, and commercial construction markets in the North America. The Company offers EPS rigid foam boards used in insulating roofs, floors, and walls; flotation and buoyancy products; geotechnical engineered applications; packaging and display products; and building systems under the Plasti-Fab brand name. It also provides structural insulating panel systems products used in various residential and commercial building envelope applications, including roofs, walls, and floors; and SIP blanks used as raw materials in the products of original equipment manufacturers under the Insulspan brand. In addition, the Company offers timber frame structures under the Riverbend brand; and handcrafted log, timber frame, hybrid log, timber, post and beam, and milled log options under the PrecisionCraft brand. Further, it provides design services for various building styles under the M.T.N. Design brand; energy efficient homes under the PointZero brand; custom luxury outdoor wooden structures made of log or timber materials under the TimberScape brand; and insulating concrete forming system foundation under the Advantage brand.

Advantage supplies various forms of insulating concrete to be put into foundations and walls. These insulating concrete forms are designed to build insulated foundations and walls from concrete in residential and commercial markets. There are various benefits to utilizing these insulated concrete forms including higher energy efficiency, lower utility costs, environmentally friendly, lower labor costs, and greater flexibility in design.

 Insulspan supplies structural insulated panels used for walls and to replace roof trusses. These panels provide an energy efficient structural envelope. They also create higher effective thermal resistance and lower air infiltration than conventional stick-frame systems. Structural Insulating Panel Systems also support recent building code changes to higher R value requirements as well as shortens construction time, ultimately saving labor.

What Is Expanded Polystyrene Foam?

Expanded Polystyrene Foam (EPS) is a fine laminate that is only typically 2-3 mm thick. It is made from expandable polystyrene, a rigid cellular plastic containing an expansion agent. EPS is obtained from oil and has a wide variety of uses, including packages for electrical consumer goods, chemical transports, and insulation panels for buildings.

The EPS packaging system is often the best alternative in terms of cost, versatility, and efficiency. It is easy for workers to handle because there are no sharp edges or staples. It is used in many aspects of building projects such as roads, bridges, and railway lines. EPS has the following advantages:

• Low Thermal Connectivity: EPS inhibits the passage of heat or cold as there is a high capacity for thermal insulation.

•  Low Weight: EPS is very lightweight, and many workers like to use EPS as it is safe and easy for construction and building.

•  Low Water Absorption: EPS does not absorb moisture. This makes it a durable material to use in buildings as well as transport perishable food items.

• Chemical Resistance: EPS is compatible with plasters, cements, salt, and water. The chemical resistance component of EPS is another reason that EPS is an ideal material for building products.

• Versatility: EPS is highly versatile because it can easily be cut into shapes and sizes.

• Aging Resistance: The properties of EPS are retained over the entirety of the materials life. Fungi or parasites find no nutritional value in EPS.

The Styrene Market:

EPS is manufactured from styrene monomer. The styrene market is expected to register a CAGR of 4.9% between 2018 and 2023. The market is likely to be fueled by increasing demand for expanded polystyrene in the construction industry and the automotive industry.

Styrene prices are tied to world oil markets and as oil prices move, styrene tends to follow.  We believe PFB can adjust prices accordingly to its end customers but there can be a one or two quarter lag in price changes to PFB’s end customers.

 Strong Management and Ownership Oriented Towards Disciplined, Long-Term Value Creation

 PFB’s CEO is Robert Graham.  He has been on the Board since March 2018 and previously served as the Executive Vice President of PFB.  We believe PFB’s growth strategy makes great sense, including new products, growing with the existing customer base, geographic expansion, and improved profitability.  PFB management has a conservative, disciplined, long-term and low-risk approach that we like. Alan Smith is the Executive Chairman of PFB as well as the President of Aeonian Capital Corporation. Aeonian Capital Corporation and inside management have a combined ownership of 64% of the company. We believe there is strong commitment to driving shareholder value for the long-term.

Attractive Valuation with Large and Sustainable Free Cash Flow Yield

PFB is currently trading at about 4.5x adjusted EBITDA, which is attractive for a custom manufacturing business that is growing mid-single digits organically with modest capital investment needs and strong free cash flow.  We believe PFB can sustainably generate free cash flow of $12m+ per year as compared to its current enterprise value (EV) of about $70m for an unleveraged FCF yield of 15%+. We believe this is attractive when compared to 10-year treasury rates near 2%.  We describe below some reasons why PFB’s results might be more sustainable than its current market valuation would indicate.

 Custom Manufacturing and High Transportation Costs Create A Competitive Niche

 PFB’s business model has certain characteristics which we believe help create a competitive niche:

(1) almost everything PFB does is customized for the end user.  Most of PFB’s competitors do not make to order and are less customized manufacturers; (2) the footprint range for the products PFB makes in its plants in North America is about 250 to 300 miles due to transportation costs, etc.  This requirement to be close to the end customer helps limit competition to local players that are within that range; (3) PFB has relatively low inventory as they produce highly customized products and can quickly convert inventory into products over a short manufacturing cycle. They pride themselves on their fast and timely production, which is a major competitive advantage for PFB.  They believe they can achieve premium prices because their business model provides premium value to customers; and (4) PFB has limited direct competitors because there is no one that takes a similar “highly customized” approach. Regionally, they often compete with concrete and foam suppliers. PFB’s solutions are highly engineered as they solve problems and sell the demand. They have the reputation of being the “if you need the proper engineered answer,” go to PFB. They are known for solving the higher margin problems, problems which competitors cannot solve.

 Strong Cash Flow Generation and Cash-Generative Business Model

PFB has generated strong cash from operations and FCF for LTM 9/30/19.  LTM cash from operations is $17m and FCF is almost $12m. Absent a severe recession, we believe these strong levels of cash from operations and FCF can be sustained and can grow over the next few fiscal years.  These results reflect PFB’s highly cash-generative business model, which has limited working capital and capital expenditure requirements. PFB believes maintenance capital expenditures are about $2.5m per year.  This compares to almost $16m in LTM adjusted EBITDA.

 PFB has several tools at its disposal to drive long-term shareholder value. We believe PFB is likely to use its strong cash generation to drive shareholder value over the next few years via accretive acquisitions, special dividends, or share repurchases.

Footprint Expansion Potential in the U.S.

PFB has entered the U.S. market on a market by market basis, since competition is generally local and limited to a specific range due to transport costs, etc.  The Company can specifically target local high population areas in the U.S. where it believes its products can do well against existing local competition and which have strong long-term growth potential.  There are a substantial number of attractive local market footprints which remain and offer PFB excellent growth potential in the U.S. We like this measured and targeted growth strategy for the U.S. and believe it could enable PFB to build a much larger company in the mid term (3 to 5 years).

High Returns on Invested Capital

 PFB’s custom and make-to-order manufacturing operation results in a business model with limited working capital and capital investment requirements.  Consequently, PFB has been able to earn high returns on invested capital and generate substantial free cash flows over the last several years. To evaluate return on invested capital or ROIC, we like to look at operating earnings (EBIT) or free cash flow (FCF) compared to the net investment in tangible assets which is the investment in: (a) net-working capital excluding cash, plus (b) net PPE.  These are the tangible assets the business requires to generate the EBIT or FCF. At 9/30/19, non-cash working capital for PFB was about $10m and net PPE was about $35m for a net investment in tangible assets of about $45m. This compares to LTM FCF of about $12m+ or about a 30% return on invested capital (ROIC), which we think is attractive for a niche, custom manufacturing business.

 Energy Efficiency Growth Opportunities

PFB notes that 40% of all energy consumption in North America occurs in buildings and state and local governments are focused on upgrading building codes to improve energy efficiency.  Building code changes require owners to upgrade the energy efficiency of buildings and this drives additional demand for PFB’s insulation products as buildings are retrofitted. In New York City alone, there are thousands of buildings that may require energy efficiency upgrades and drive demand for PFB’s insulation products.

 The U.S. insulation market is an $8b market controlled by Owens Corning, Dow Chemical, Johns Manville, CertainTeed, and Knauf Insulation.  (see Comparable Chart attached). The U.S. insulation market is expected to reach $77b by 2025, according to a July 2019 report by Grand View Research, Inc. The industry is anticipated to expand at a CAGR of 5.7% during the forecast period.

 “Ft. Knox” Balance Sheet Reduces Risk and Creates Opportunities

PFB has a “Ft. Knox” balance sheet today with a net cash position of about $15m at 9/30/19.  We believe the Company’s strong balance sheet substantially reduces risk and gives the Company opportunity to take advantage of strategic opportunities which are both organic and inorganic.

Recession Resistance Via Energy Efficiency and Retrofit Opportunities

PFB believes their strong position in driving energy efficiencies in buildings in North America will help them continue to perform reasonably, even in a difficult economic environment. Their position allows them to prepare for an economic downturn because they are positioned into two ways: (1) PFB has a strong position in the commercial side. They provide commercial/industrial roofing services for Lowe’s, Amazon, etc. As building codes continue to be upgraded and changed, owners need to have higher requirements with insulation. This allows PFB to step in and utilize their insulation services; and (2) when residential slows down, people will not focus as much on the custom-home building but will focus on the renovations and retrofits; building codes will continue to come up along with insulating requirements which will ultimately create a lot of renovation business which can counter the residential slowdowns.

Conclusion and Target Price

At 8x our adjusted EBITDA estimate for fiscal 2021 of about $18m plus $25m of net cash at fiscal year-end 2021, PFB would have a market value of close to $170m or about $24 per share (+100%).   If PFB’s management team continues to execute and its custom manufacture and marketing business of insulation products from expanded polystyrene (EPS) foam products continues to grow, we think our target prices could be achieved.