Description

OVERVIEW

DIRTT has a long runway to increase sales and margins.  Mason wrote up DIRTT 18 months ago and his writeup includes a great background on the company and product.  I wholeheartedly agree that their product is unique, superior, and has no real competitors right now.  So I won’t spend time on the actual product but will rather focus on the changes that have occurred since then.  In the short/medium term, both sales and EBITDA should accelerate as the effect of an energy collapse rolls off and investments over the last few years begin to bear fruit.

ENERGY SALES

Before 2015, DIRTT drove huge YoY revenue growth by selling their modular products to energy companies.  Energy-related revenue was ~20% of sales in 2014 and peaked at >25% of sales in early 2015, but by the end of the year that same revenue stream was falling apart, rapidly.

Fast forward to Q3 2016 and energy hit rock bottom at ~1% of sales.  During the period between energy sales peak and energy sales trough, total sales growth was buoyed by CAD weakness and strength in sales from other industries but that was not enough to prevent DIRTT sales from going negative YoY in Q1 2016.

The swing from ~70% organic growth in late to 2014 to negative growth 15 months later led the market to punish the stock with a ~50% drawdown between early 2015 and early 2017.  Currently the stock is still at the same levels it was around the time the company put up their best organic growth number (and is still 20% below its (admittedly lofty) peak).

The big positive is that the energy headwind is over and now represents a call option – at 1% of sales it can’t hurt the growth numbers and can only help, if the industry picks back up.  The rest of the business though, has done very well and continued to grow strongly over the last two years.  There was never a quarter where FX-adjusted growth dipped below the low teens and there was never a trailing 12 month period where it dipped below 16%.  In the most recent quarter the ex-energy growth was a little north of 20% and the trailing 12 month period should be approaching high teens again.  What this means is that total company revenue should have bottomed in Q1 2016 and will be growing high teens/20% going forward, with energy revenue as upside.  The company outlined a sales goal of $400mm in 2019 and now that energy is out of the way that goal suddenly seems a lot more easily achievable.

INDUSTRY

Construction trends on the whole are moving in our favor, especially in DRT’s core areas.  One particular area that should be a longer term winner is healthcare, where the company is making inroads.  It makes a lot of sense for a variety of reasons including that DIRTT walls significantly limit downtime versus construction and the absence of dust/other construction equipment creates a more sanitary environment off the bat – meaning the wing of the hospital/center being built is completed faster and able to take patients quicker.  The various glass/electronics customizations are a great idea that allow for layouts to be done in any matter desired.  My research indicates sales should be big here.

One other area that has a potential to be a sales driver is DIRTT’s VR setup that lets you design, customize, and virtually “walk” through your office on the fly.  The video was linked in the comments of the previous writeup and from what I understand what you see on the stage is the real deal.  So far it doesn’t sound like the VR has itself driven sales, but it has been a good deal closer for designers/distributors.  Time will tell how much the VR matters, or if it will ever by fully monetized, but it is a good representation of the different type of culture/thought process that goes on at DIRTT versus largely stagnant competitors.

CULTURE/MANAGEMENT

DIRTT seems to fancy themselves akin to a startup and has a lot of quirks that most likely flow down from the founder Mogens Smed.  Mogens is the creative force and driver behind the company and the majority of diligence I’ve done on him comes back positive - he seems to be a well-liked innovator (sometimes dreamer) that is laser focused on technology and is “one of the best visionaries in the business.”  While Mogens tends to focus on innovation and long term strategy, Scott Jenkins, the president of the company, was brought in to actually manage the day to day business.  My diligence indicates Mogens has done his research and believes there is a huge opportunity to convert early adopters and make DIRTT’s modular construction become much more commonplace as buildings face the need to become more functional.

DISTRIBUTION

Distribution partners have skin in the game and are motivated to see the company increase sales.  Distributors in general seem to like the company and recognize DIRTT’s positive and negatives versus competing products.  They are seeing some (limited) wins in areas where the product may not have had a chance to sell a few years ago, due to price or unfamiliarity, and it seems like sales are primed to grow nicely into the future.

MARGINS

Margins have fallen since 2015 as the company ramped up SG&A and continued to invest in their business, primarily around selling.

Headcount has increased meaningfully and I think they are going to leverage that going forward – they’ll tell you as much.  They also invested a lot of money into the residential side of the business which until now has produced virtually no revenue.  Utilization at their big plants continue to increase which will help increase gross margins, and SG&A as a % of sales will fall as headcount growth slows down and the new salesforce stars generating revenue.  These factors should drive Incremental EBITDA above 30% in the coming years.

VALUATION

DIRTT should be able to grow revenue north of 15% over the next few years (will be much easier to hit these numbers with energy as a low single digit percentage of sales and residential sales starting up) and hit their target of $400mm CAD.  There is upside to this if DIRTT’s can get a few large energy projects and if the political climate improves DIRTT’s offering versus traditional construction.  I think all the while they should be slightly increasing gross margins and really leveraging SG&A.  I think SG&A ex-D&A will, at some point, decline to 30% of sales and that number should decline to around 31.5% by 2019.  This would lead to an EBITDA margin above 20%.

Add all this up and you have a stock trading at ~14x 2019 earnings.  I think given a very long runway and a product which is absolutely better than anything else on the market, this should trade at at least 20x forward – a 40%+ gain with the potential for more.  However, I also think this could be a multi-bagger over a longer period of time and something that you could hold for the long run.

Helping the cause and adding potential fuel to the fire on EPS, the company has a very large net cash balance (~13% of market cap) and they recently announced they were setting aside money for a buyback (up to ~8% of shares).  I’m not convinced the cash will be used for a large buyback anytime soon but I think they’ll likely deploy it on smaller buybacks, or very quickly if the stock price has another significant fall – the cash would probably function like a floor on the price if it declined significantly again.  By the end of 2018 I think the cash balance will be meaningfully higher than it is today.  It’s entirely possible I see at least one acquisition or another creative use for the cash as well – I don’t think it will be used on capex and I think the company is done issuing shares.

Negatives –

Mgmt doesn’t own much stock, sold some recently

Company sometimes seems unfocused

Mgmt is willing to sacrifice margin for sales growth – not really a negative but could cause financial model to be off

Clear leader in their field but there are potential competitors – although I don’t believe DIRTT makes enough money yet to really increase interest in those potential competitors.

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

Sales Growth

Margin Expansion