Description

A micro-cap well suited for PA, AEP is trading at ~3x EV / LTM EBIT with EBIT growing strongly and a clean balance sheet.

Background

The company listed in 2017 and was mainly focussed on designing, manufacturing and selling roof trusses. Since then, the company expanded – organically and via acquisitions – to include floor trusses, wall panels and windows. AEP currently manages various operating companies serving regional construction markets.

AEP’s strategy is two-fold: Consolidate the industry and pursue organic growth / efficiency improvements.

M&A. By virtue of the end product specifics, the market for trusses, wall panels and modular systems has always been local as transportation of such large items over long(er) distances is inefficient and expensive. Permitting is often an issue as well. The market is extremely fragmented and many companies are family owned. AEP estimates there to be hundreds of small regional operators in the manufactured wood products industry with managers in need of succession planning.

AEP has an active strategy to consolidate the market. Strong benefits from enhanced scale economics can be achieved, such as in procurement, design & engineering and transportation, as well as technological improvements given that many small regional operators are unable to invest in technology and / or automation.

Since 2017, AEP has made several acquisitions, the last one in February of this year. AEP acquired shares of Hi-Tec for CAD 5.8m cash and land and buildings for CAD 3.25m cash. During its last fiscal year ending Aug 2021, Hi-Tec earned CAD 1.25m normalised EBITDA for a 25% margin. Interesting about this acquisition is the relatively large size as well as the non-dilutive financing (cash on b/s, term loan and mortgage). As AEP’s ‘flywheel’ gains momentum, we can expect it to acquire larger companies.

Historically AEP focused on the Pacific Region, Ontario and the Canadian Prairies, given the buoyant residential construction market as the relatively large number of truss plants. I expect the company to remain focussed on these regions, though given their opportunistic character I would not be surprised to see the company expand its footprint should an opportunity arise.

Profitable, organic growth. The integration of new companies adds products to the portfolio. AEP ‘s focus is on the higher added value and most scalable products. Lower margin business is quickly sold and / or wind down. The target is to be able to sell all of the company’s products in all the locations. Besides the core product offering, management is focused on the large growth potential in complementary product lines mainly related to engineered wood.

In addition, given the labour intensiveness of the products and the smaller, family owned character of the business, automation has in general not been a particular focus point of operators. AEP has a continuous program of equipment upgrade and automation across all locations.

Thesis

AEP organic and roll-up story has been regaining serious traction over the past year. The thesis has been improving since 2018 but was delayed in 2020 following the covid lockdowns. AEP has successfully been able to manage high cost volatility and labour shortages. Now the company seems back on track and has been able to generate strong results over the past 1,5 years.

1Q22 was particularly strong, with AEP generating CAD 12.4m revenues and CAD 2.3m EBIT in what is generally the weakest quarter. Taking this as an indication of this year’s performance, 2022 is setting up to be a banner year for the company.

The exposure to the cyclical housing market is obviously always a risk, particularly given the extreme bullish activity over the recent period. Demographics remain a tailwind however and while housing starts over the past decade have ticked up a bit recently, they remained in the 200-250k region over the past decade. It is reasonable to expect a cool off in housing activity given the strong activity over the past few years and rising interest rates, though supply-demand conditions remain overall tight.

AEP today is larger and more efficient compared to a few years ago. The company has been able to manager input cost volatility and labour shortages and seems ready to continue to ramp over the next few years. Q1 results showed a continued improvement in the company’s operations and I expect the company to continue to do well over 2022 and further as the flywheel gains momentum. A potential recession is always a risk, but the company should be able to manage it given the improved efficiency (following covid headwinds) and the strong balance sheet. In addition, a recession would slow down organic growth but increase acquisitions, as many smaller players will be up for grabs.

Valuation

AEP generated CAD ~15m normalised LTM EBITDA and CAD ~12m LTM EBIT. Assuming CAD ~3m net debt, that makes ~2.4x EV / LTM EBITDA and ~3.1x EV / LTM EBIT.

Looking out the rest of the year, assuming a similar earnings progression as Q1 for the rest of the year, AEP could generate CAD 17m EBIT over 2022. Assuming zero net debt, 67m FDSO and 6x EV / EBIT, that would result in a share price of CAD ~1.50 per share, almost 3x the share price today.

There are of course several risks, such as rising interest rates slowing down the market and continued input price volatility. Also, AEP is a micro-cap stock with limited liquidity which warrants a relatively low multiple. But the company seems on track to execute on its stated strategy. Given time and proper execution, AEP will grow and liquidity improve, leading to much higher multiples. At 3x EV / LTM EBIT, I would argue we don’t pay much to find out.

Catalyst

Execution of organic and inorganic growth initiatives

Improving liquidity