ATLAS ENGINEERED PRODCTS LTD AEP.
January 28, 2020 - 10:22pm EST by
hack731
2020 2021
Price: 0.39 EPS 0.04 0.06
Shares Out. (in M): 75 P/E 10 6.5
Market Cap (in $M): 29 P/FCF 4 2.8
Net Debt (in $M): 13 EBIT 6 9
TEV ($): 42 TEV/EBIT 7.4 4.7

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Description

All amounts in Canadian (unless otherwise stated).

 

After a series of acquisitions over several years, Atlas is emerging as the only national supplier of roof trusses in Canada. Atlas currently has six facilities in three provinces (British Columbia, Manitoba, and Ontario). Currently, about 85% of company sales are roof trusses.

 

As we know from studying companies like Canada’s Boyd Group (a 200-Bagger since shares bottomed at ~$1 in 2006!), a few roll-ups work extremely well, but most roll-ups fail. A successful roll-up needs to combine several key ingredients, including: a fragmented industry with succession issues (i.e. many motivated sellers), a “boring” industry with low integration risk (generally, low-tech industries such as garbage collection, funeral homes, auto repair, etc.), and a steady history of making accretive acquisitions on day one with manageable debt (a history of strong fiscal discipline). Plus, to succeed in a meaningful way, the company needs to execute on a robust growth plan over many years.

 

KEY MANAGEMENT

 

Key management is chiefly two people: the original owner and the new CEO.

 

EVP Hadi Abassi, the former owner, acquired Atlas (Nanaimo location) in 1999 when revenue was ~$1 million and grew it to ~$10 million over the next fifteen years. After a multi-year knife fight, its major regional competitor exited (~2013). Their exit enabled Atlas to become (and remain) the #1 market leader in roof trusses with about 50% local market share for this area of Vancouver Island. The Atlas plant, which I’ve visited, is the “model plant” for the company, both in terms of the operating results and in terms of testing new products (below). Note: Vancouver Island (roughly the same size as Taiwan) is the warmest region in Canada and historically benefits from retirees and cost-conscious families relocating there from the relatively expensive B.C. mainland.

 

New CEO Dirk Maritz joined in November 2018. A rather fiery South African (“pants on fire!”), Dirk helped scale two companies before joining Atlas. From 2012-2018, he was in management at SMS Equipment (Canada), which organically grew sales from $1.1 B to $2.6 B. From 2004-2012, he was CEO of Tradelander & Fridgetech (South Africa, Middle East) where he helped grow sales and personnel more than 20x over that time.

 

Management and board own 16.0 m shares, which is 29% of FDS (54.3 m). Note: Based on the recently announced financing, which is moving forward, FDS will increase to 75 m.

 

CORE LOCATION: ATLAS (NANAIMO)

 

As mentioned, Atlas (Nanaimo) is the company’s “model” truss plant and enjoys local monopoly dynamics for this region of Vancouver Island. There’s a decent sized competitor in the city of Victoria, but that’s 110 km away. Due to the rather mountainous terrain, that distance is generally too far to profitably transport roof trusses. In addition to the difficulty of profitably transporting trusses over large distance, roof trusses are highly engineered building products, with various permitting issues. In summary, the twin pain points of roof trusses are transportation distance and permitting. Hence, perhaps unlike almost all other building product categories, the potential arguably exists for a maker of roof trusses to maintain a local monopoly. Evidence of its local monopoly, gross margin for this plant has been 37%, roughly double the gross margin for regional truss plants around metro areas like Toronto.

 

The culture at Atlas (Nanaimo) seems to be one of high-energy. For example, the operations staff openly tracks KPIs (Key Performance Indicators) on white boards. One KPI is “BDFT” (Board Feet) with cash bonuses awarded each week to each team member if they hit a certain level. In addition to high-energy, the culture of Atlas is one of product innovation. In recent years, Coastal Windows has been experimenting with pre-made wall panels that can include windows (see “new products” below).

 

GROWTH PLAN

 

CEO Maritz has repeatedly spoken about the three-leg growth plan of: 1) profitable growth, 2) organic growth (new customers, new products), and 3) acquisitions.

 

The first leg of the stool is “profitable growth”. In 2019, profitable growth meant turning away perhaps $10 million in sales (particularly in the Ontario region) that came with much lower gross margin. Anecdotally, I have heard that a regional truss company in Ontario was willingly accepting truss jobs with only 15% GM. Atlas turned business like that away in 2019. To improve profits, Atlas put together two partnerships in mid-2019: a partnership with MiTek Canada (note: since 2001, MiTek is a unit of Berkshire Hathaway; it’s the leading provider of connector plates as well as building-information-modeling (BIM) software in North America) and a lumber supply deal with an undisclosed North American lumber provider (note: about 50-60% of company CGS is materials; this supply deal purportedly alone improved GM by “several percentage points” through bulk purchases and allowing Atlas to flexibly pull inventory only when needed, a type of consignment model). The company is also standardizing IT systems across all six locations. Another margin enhancement is that the 20-person design (architect) team can be balanced and shared across the six facilities.

 

The second leg of the stool is “organic growth”. Organic growth comes from new customers (driven by the sales team) and from new products (e.g. pre-made walls). With a recent new VP of sales, the sales teams have been significantly expanded from 5 to 20+ (Atlas going from 2 to perhaps 5-6; Clinton now with 1; Satellite now with 2; South Central with 2 including CFL star Andrew Harris; Pacer going from 3 to 8-10). In addition to the sales team growth, Coastal Windows (also based out of the Nanaimo location) has achieved almost $3 million sales run-rate with a focus on pre-made wall panels (with custom windows). Though this product line is yet to be validated outside Nanaimo, it promises to enable ~30% faster construction times at 20-30% less cost. One internal sales line has been “Ten days, money flows” (that is, Atlas helps construction companies reduce build time from as high as 8 weeks to as low as 10 days).

 

The third leg of the stool is “acquisitions”. The Canadian roof truss industry is about $1 B in sales, with hundreds of “mom and pop” operators with $3-15 million in sales. By adding several larger-sized acquisitions (perhaps each with >$15 million in sales) Atlas’ goal is to reach $100 million in sales by the end of 2021, which would represent 10% of Canada’s truss market. Sales for the first 9 months of 2019 was $25 million. So far, Atlas is the only roof truss company in Canada with a national footprint, which may give it a voice in helping set building standards and allow it to work with multi-site national builders. Importantly, Atlas has been quite focused on paying a reasonable price for the acquisitions: paying 5.2x TTM EBITDA gross of working capital, or 3.9x TTM EBITDA net of working capital. Overall, the company targets <2.0 times debt (currently $12.5 m including equipment leases) to EBITDA.

 

ROACE: A QUALITY BUSINESS?

 

Atlas is starting with a roof truss business with recent GM of 27%. Starting with high-margin (27+% GM) roof trusses, could Atlas become a “high-value” distributor and offer a full package of high-margin (27+% GM) pre-made wall and floor panels? It’s too early to tell but that seems to be Atlas’ five-year goal.

 

It’s not easy to understand the underlying ROC due to the high seasonality, the recent change in fiscal year, and the acquisitive history. Looking at year-end and quarter-end B/S metrics over the last eighteen months, ROACE (Return on Ave Capital Employed, where ROACE = EBITDA/ACE and ACE = Ave WC + Ave PPE) appears to range between +25% to +34%. That’s a quality business generally and especially so for building materials. Hence, we think Atlas has the potential to be a “high-value” distributor.  

 

CANADIAN HOUSING STARTS: CYCLICAL OR STEADY?

 

Of course, investors generally see homebuilding as highly cyclical. But, a top-down review of Canadian housing starts paints a robust story due to Canada’s steady population growth. Since 2003 (which I arbitrarily picked as a start-date), Canada population has steadily increased (perhaps largely helped by immigration) from 31.7 million to 37.6 million. That’s almost 400k new people a year. If each housing start is for 1.6 people on average (historical), then that implies an annual need for about 210k new housing units. Since 2003, housing starts have been remarkably steady around that 210k level (though there was a high year of 233k in 2004 leading up to the Great Recession and a low year of 149k in 2009 during the Great Recession). Over the last fifteen years, the major fundamental change was not the level of housing starts but the mix shift away from single family homes (56% single family v 44% multi-family in 2003) toward multi-family apartments (31% single family v 69% multi-family in 2018). The mix shift toward multi-family appears to me to be a long-term positive for the company: the trend toward larger projects arguably benefits larger construction companies and, in turn, the largest roof truss makers like Atlas that supply them.

 

VALUATION

 

Due to turning away of perhaps $10 million in low-margin sales in 2019, run-rate sales (annualizing first 9 months of 2019) are about $33-35 million with 25% GM and 13% EBITDA margin. With 2-3 larger acquisitions (perhaps ~$15 million sales each) and continued organic growth, the company plans to be at $100 million in sales by the end of 2021. Let’s assume they get there in 2022E. The margin goal for mature operations at that time is 30% gross margin and 15% EBITDA. That implies $15 million EBITDA. Assuming continued creep in FDS to 82 m and net debt of $18 m in 2022E (significant warrant exercise will help), we arrive at a $1.00 stock at 6.5x EV/EBITDA or 12x P/E, which is over +150% upside from today’s $0.39 stock. Good luck finding many stocks with moderate leverage with +150% upside potential based on modest multiples and looking out only three years! (If you have sincere interest in the company, I would encourage you to build your own bottoms-up model with each of the six locations. Perhaps spend some time pondering whether or not this company is indeed a “high-value” distributor. It’s a controversial notion, like Bowd57’s EVI.)

 

RISKS


Of course, the greatest risk is execution. Even the top-performing roll-ups typically struggle to prove out operations in the first 2-3 years. Company operations are roughly 3x larger than a couple years ago ($12 million to $33 million sales) but operations need to roughly grow 3x again to reach $100 million in sales. A sales level of $100 million with its target margin profile would be a strong achievement and, despite significant dilution along the way, nicely reward long-term shareholders, we would argue.    

 

CATALYSTS

 

Achieve $100 million in sales in 2022E with targeted margins.

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

Achieve $100 million in sales in 2022E with targeted margins.

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