Cliff Note #74 - ADF Group Inc. | $ADFJF, $DRX.TO
Backlog - Robotics and Infrastructure bills provide high-margin growth tailwinds
Themes:
GARP; Margin Expansion; Industry Tailwinds
Data:
Price: $5.34; CAD$7.28
Market Cap: CAD$128M
TTM Revenue: CAD$94M
LT Debt: CAD$45.9M
Current Portion of LT Debt: CAD$3.6M
Cash: CAD$43.98M
P/E trailing 12 months: 7.58x
P/E 2024 est: 7.66 on analyst EPS estimate of CAD$0.95. (we think this is way too low since the company crushed estimates by nearly 100% for the last 2 quarters).
EV/S trailing 12 months: 0.44x
EV/S on 2024 revenue est: 0.38x
What they do:
DRX Fabricates and installs complex steel structures and heavy steel built-ups, as well as miscellaneous and architectural metalwork services. In addition, the company offers products and services for various segments of the non-residential construction industry, including office towers and high-rises, commercial and recreational buildings, airport facilities, industrial complexes, and transport infrastructures. ADF Group Inc. was founded in 1956 and is headquartered in Terrebonne, Canada.
“Metal fabrication is the creation of metal structures by cutting, bending and assembling processes. It is a value-added process involving the creation of machines, parts, and structures from various raw materials.”
The company has one manufacturing facility in Canada (Quebec) and one in the U.S. (Montana). Even though the company is located in Canada, 85% of its revenue comes from the U.S.
DRX was founded in 1956. Despite the company producing a healthy amount of revenue throughout its history, until recently, the stock spent several years trading below its book value per share. While construction stocks can generally trade at low valuations, the company’s failure to consistently put up nice EPS numbers probably justified the stock not trading at premium or industry norm valuation multiples. However, a new focus on higher margin projects and facility modernization initiatives have put the company on the track for profitable growth and helped the stock to trade at 1.5x book (P/E of 7.58) finally.
More on Reasons to add to the Index, Content Supporting the Overarching Themes, Valuation, and Research Tasks…
Reasons To Track:
For a period of time, the company began taking on more “non-complex” projects that came with low margins. Part of this was due to their manufacturing facilities being unable to handle some higher volume “complex” work. However, at the beginning of 2022, the company began to modernize their Canadian facility by adopting robotics to be able to handle a higher volume of work. This has positioned the company for profitable growth. It’s worth noting that even though the company’s facility upgrades began in 2022, the company has put together 4 consecutive years of nice earnings per share growth.
Although some of the markets the company serves will be cyclical, management is putting extra effort into targeting non-cyclical areas like Pharma.
These moves are starting to dramatically impact financials. Coming in at 37 and 34 cents, EPS experienced a huge breakout in the last two quarters, nearly doubling analyst estimates. Their $573 million backlog is an all-time record (the previous record was $400M a few years ago), giving us an indication that growth can be maintained. Finally, gross margins have improved to 24,5% from 8.8% compared to 2022, while EBITDA margins have improved from 6.3% to 21.7%.
We like that analysts seem to not be updating their revenue and EPS estimates, given the growth progress and increased backlog. This should lead to nice upside EPS beat surprises.
The company has plans to also modernize its Montana facility, which should extend the company’s growth curve. This is interesting because this facility is more suited for “complex” projects.
Spending on the $1.2 trillion U.S. infrastructure bill passed in late 2021 will start kicking in soon. It appears that California and Florida will receive a disproportionate amount of the funding, which is good news since the company is aggressively targeting projects in these states, where it already has a strong presence. Furthermore, Los Angeles will be hosting the 2028 Olympic Games.
Continued expansion of valuation multiples as growth becomes more consistent and predictable.
Valuation:
At a trailing P/E of 7.58, the stock is in line with industry peers. The real question is, is there a chance that the stock’s valuation can expand? Given that the company’s backlog has probably given management multi-year visibility and that it appears to be targeting some less cyclical markets, we think the P/E could eventually approach 10x. But, even if it does not, shares probably have good upside potential even if the company just maintains its current P/E. Thus, we are setting an initial valuation target range of CAD$9.45 to CAD$13.50, based on the current run-rate EPS of about $1.35 and a P/E range of 7x to 10x. It’s worth noting that even though the company’s facility upgrades began in 2022, the company has put together 4 consecutive years of nice earnings per share growth.
Caveats:
The project-based nature of the business can lead to lumpy sales on a quarterly basis.
The industry could limit valuation through multiple expansions.
Will always have exposure to cyclical markets
Long-term Debt
Insiders have total control (have 90% of the vote through special shares) and do not want to change much, thus limiting valuation. They own only about 0.1% of common shares but own 100% of special voting shares.
Research Tasks:
When will the modernization of the company’s Montana facility begin?
What is the maximum revenue the company can generate from the current capacity, and what is their current capacity utilization rate?
Will the company look to pay down debt?
Inquire about plans to diversify into non-cyclical markets.
Quotes:
Investors Presentation:
Economic boom started in Florida. — ADF has been present in Florida since 1992. — Targeted efforts to position ADF for public infrastructure projects under the Federal Investment Program.
ADF's accelerated presence in California since 2019. — ADF's proximity to Western markets with our plant located in Great Falls, Montana. — ADF has completed several projects at Los Angeles Airport and public infrastructure projects on the outskirts of this important hub. — Focused efforts to position ADF to seize business opportunities from the Los Angeles 2028 Olympic Games.
California ($44.558 billion), Texas ($35.440 billion), New York ($26.922 billion), Florida ($19.098 billion) and Illinois ($17.814 billion) will get the biggest allocations from the Infrastructure bill.
Article: https://smartasset.com/financial-advisor/biden-infrastructure-bill-spending-by-state
Our disclaimer: We may hold a position in the stock. This article does not constitute investment advice. We are not registered investment advisers. Investing in microcaps carries specific risks best discussed with an investment advisor. Always do your own due diligence.