Description

Description

ATS provides automated manufacturing solutions for the life sciences, transportation, the food & beverage, and energy sectors.  ATS operates primarily in North America (50% of revenue) with the balance in Europe (40%) and Asia (10%). 

Roughly 60% of revenue is generated in ATS’ Solutions division (designs complete automation systems for enterprise), followed by the Services division (after market and design/analysis) and Products/Components (ATS-developed hardware/software).   

ATS operates in a very large market with long-term tailwinds, which will drive organic revenue growth, and management is laser focused on both efficiency (leading to margin expansion) and capital allocation (leading to inorganic revenue growth and superior total stock returns).  ATS should be a great compounder over time. 

 The Market

The automation market, globally, is a $250b market, meaning that ATS is currently capturing just 1% share with the ability to capture much more.  Industrial automation, on the whole, is predicted to grow HSD+ through the end of the decade, which provides a natural tailwind for ATS.  Recent wage inflation – and recent wins for unions and workers – should assure that automation spending will be top of mind as it comes to corporate capital expenditures going forward.  

ATS’ largest revenue generating segment is Life Sciences (~50% of revenue), which is also traditionally its largest driver of backlog.  Long-term growth trends in the Biotech/Instruments sectors are ~5-7%.  However, ATS acquired Biodot a couple of years ago, which allowed ATS access into the genomics industry, which should grow at 2x the rate of ATS’ more traditional life sciences divisions and provide a boost to organic growth.

The most interesting market is transportation – this has been the major driver of ATS’ backlog recently, as ATS is a player in the battery pack and assembly markets.   EV adoption is one of the strongest enduring trends in the world – with EV sales predicted to grow ~700% through the end of the decade – which is going to fuel capital spending in the space as car manufacturers build new facilities and retool old ones to shift from ICE to EV production.  As a datapoint, Volkswagen expects to 4x their EV sales over the next 5 years, and to spend $100b (more than half their capex) to ramp EV operations over the same time period.  This will be a long-term revenue driver for ATS for years to come as EV companies try to optimize margins while growing. 

ATS hit a major growth inflection point recently when it signed on as GM’s partner for battery cell assembly and testing.  Since this point ATS has been adding automotive bookings at a rapid clip almost every quarter (note that automotive backlog has since increased markedly from the end of last Q) –

EVs alone should generate most of the 10% organic growth for ATS in the immediate future, as this division is ~25% of revenue but 50% of a large backlog base.  I expect them to have more EV backlog wins in the future, as projects become larger and OEMs push for margin expansion.  

The balance of the company’s backlog - ~20% in food &  beverage, consumer products, and energy combined – will be a smaller driver of revenue but these categories will all grow at above average levels over time, as consumer packaging and nuclear sales are ESG beneficiaries. 

Overall I expect ATS to outgrow the automation market on an organic basis, and average a ~10% growth rate over time.  LTM Order bookings were up 38% YoY and Book to Bill went from 1.15x to 1.29x over the same time frame. 

Margins and Management

One of the reasons that ATS is so interesting is because they are building a uniquely efficient culture, inspired by their CEO, Andrew Hider.  Hider is a former president of a division within Danaher, and it was immediately apparent that he wanted to implement the Danaher playbook at ATS.  Even the language and colors of the “ATS Business Model” mirror the Danaher Kaizen materials (“People, Process, Performance”). 

Hider’s goal is to have the company generate shareholder value through optimized return on capital – the very first line in their strategy statement is actually just the simple goal of driving “long-term sustainable shareholder value.”  They plan to do this by outpacing “the growth of [ATS’] markets” and aligning the organization to “continuously improve robust and disciplined business processes.”  The result, as they put it, will show up in “world-class performance for ATS’ customers and shareholders.”  It’s a very no-nonsense approach which eschews a lot of the feel-good language that slows down more bureaucratic companies.  This is a company being run for shareholders.

Hider’s efficiency influence is most easily seen in margins.  Around the time of Hider’s start in 2017, EBITDA margins were 11%.  Margins improved to 13% over the next 2 years then leaped to >15% in FY2022, but have since settled back in the ~15% range. 

Incremental EBITDA margins hovered around 20% between 2018-2020 before experiencing wild swings related to pricing and shortages.  I expect ~20% incremental EBITDA margins going forward which should lead to double digit EBITDA growth – there will be slight variance as revenue shifts between sectors, but I don’t believe the net change in incremental EBITDA margins will move much, as they are scaling up quickly. 

Management’s official margin target is a 15% “earnings from operations” (adjusted EBIT) target.  There is a ways to go - the most recent EBIT margin was ~12.5%.  In the second quarter of FY2023, despite a banner LTM period, the company underwent a restructuring to improve the cost structure and expand margins.  This should add an additional 60bps (5% growth to adjusted EBIT) alone, and I expect them to constantly launch cost structure improvements as time goes on. 

One recent headwind on margins has been the rapid increase in transportation revenue – while margins will be roughly in line with the rest of the business over time, ATS is forced to invest ahead of the growth.  As the EV projects mature and new repeat business begins, margins naturally rise as the initial investment is smaller.  Given this, I believe that over the next 5 years ATS will hit their 15% target and expand margins ~50bps per year.

Capital Allocation

ATS’ capital allocation policy is simple – they will use FCF (and debt, where needed) to acquire tack on businesses, then drive efficiencies.  The goal is to expand in their core areas (life sciences + EVs), where growth is virtually assured, and the industries promise (relatively) low cyclicality and high recurring revenue (while the business is project-based, ATS generates “recurring revenue” through post-project service contracts and winning successively larger bookings from repeat customers - historically ~75-90% of bookings are from repeat customers).  Every acquisition must have potential synergies and will be right-sized quickly as ATS implements the Danaher-esque ATS Business model transition.  All acquisitions are judged on a ROIC basis. 

Given the acquisition criteria, ATS is selective and that historically led to relatively small deals, with an occasional purchase of an unusually large business.  An example of this would be the SP Industries purchase in 2021, which they acquired for ~12% of ATS market cap at the time, and immediately looked to increase EBITDA 30% through synergies. 

I believe the net effect of acquisitions will lead to a ~3% increase in revenue/EBITDA in an average year, while still allowing them to expand margins over time. 

Cash flow at ATS will be lumpy due to working capital and project timing, especially as it relates to some of the larger EV projects, and they’ll use debt as needed to accomplish their capital allocation goals. 

Valuation 

ATS trades around ~23x consensus 3/31/23 earnings, but I think over time the stock will compound at an above average clip as they continue to grow topline organically due to exposure to EVs and Life Sciences, fuel revenue growth inorganically through M&A, and expand margins. 

Over the next 3 years I expect at least 10% organic growth on average – largely fueled by the rapid uptick in bookings in EVs and augmented by the fast-growing life sciences sector.  In addition, I expect ~3% growth/year due to acquisitions. 

I assume 50bps in margin expansion a year, as they see above average incremental margins as they scale the EV business, plus additional margin expansion from constantly refining their cost structure as they run the Danaher playbook. 

Given the growth and today’s starting base, ATS should generate ~$610mm in EBITDA 3 years out.  Using a 14x forward multiple (a large discount to ROK and a ~1x premium versus ATS’ multiple over the last few years to account for higher growth) and subtracting out net debt yields a ~$7b market cap, or 38% higher (17.4% CAGR over 2 years) than today’s level. 

Over a longer period of time, I expect a low-to-mid teens CAGR for ATS’ stock, as they gradually take market share while expanding margins and becoming a more recognized and respected company. 

Disclaimer: The information contained herein reflects the views of the author as of the date of publication. These views are subject to change without notice at any time subsequent to the date of issue. The author has an economic interest in the price movement of the securities discussed in this presentation, but the author’s economic interest is subject to change without notice. All information provided in this presentation is for informational purposes only and should not be deemed as investment advice or a recommendation to purchase or sell any specific security. While the information presented herein is believed to be reliable, no representation or warranty is made concerning the accuracy of any data presented. In addition, there can be no guarantee that any projection, forecast or opinion in this presentation will be realized. All trade names, trademarks, service marks, and logos herein are the property of their respective owners who retain all proprietary rights over their use. This presentation is confidential and may not be reproduced without prior written permission from the author.

Catalyst

- Continued automotive/life sciences wins