Description

Opportunity Summary:

Investors are obsessed with opportunities in US infrastructure post the Republican election sweep.  And for good reason, as there has been significant focus on domestic stimulus – though the exact form of that stimulus is still unclear.  Still investors have not had much reservation about buying any stocks they can find that may benefit.

Forterra is one name that has been overlooked.  And it is one of the most levered stocks to US infrastructure stimulus.  And a credible case for >100% upside can be made, applying competitor multiples to reasonable forecasts for company EBITDA.

Background:

Forterra is the #1 producer of water pipes, drainage pipes, and related products in the US.  It was formed through the acquisition of Hanson Building Products (acquired from HeidelbergCement in 2015) and the subsequent rollup of various pipe and drainage assets, including US Pipe in April 2016, and various other bolt-on transactions over the last 2 years.

Forterra IPO’ed on October 19^th.  The IPO was a bit of a bust, as the stock priced at $18/share, below the $19-21/share marketed range, and subsequently closed at $16.50/share on its first day of trading.  This was the during the height of the fears that non-residential investments had peaked, and a generally weak environment for capital market deals.

But what a difference a month, and an election, can make.  With >45% of pro forma business tied to water and transportation infrastructure, Forterra was poised to benefit from infrastructure spending from various federal and state spending bills that have already been put into place such as the FAST Act ($300b+), SWIFT Bill in Texas for water infrastructure, and Prop 1 Bill for water infrastructure in California.  Investors should now have far greater confidence in these and potential new spending initiates that will drive industry spending and create tremendous upside for Forterra. 

Business Basics:

Forterra’s makes pipes and related products.  These are not high value-added products.  However, they do have some interesting features that allow the company to generate high returns on capital.  First, most contracts have made in America clauses that eliminate import risk.  And while these currently apply to ~60% of infrastructure projects (and growing), this is only likely to increase further under the new Administration and their stimulus plan.  Second, Forterra’s products are large diameter pipes and are relatively low dollar value/weight (just as in Vulcan/Marietta and other aggregates businesses), making this a very local business (as shipping costs are prohibitive beyond the MSA in which a manufacturing facility is located).  Therefore, competition is usually based on local scale.  And last, there is very little capital expenditure required (maintenance capex requirements are <3% of sales).  Forterra most recently produced 18% EBITDA margins (Q3 2016 results just reported), and has indicated that the business should produce significantly higher margins once integration of roll ups and cost cutting is completed.  Further, this margin achievement came before revenues have benefited from the multiple infrastructure initiatives.

Capital Structure and Valuation:

Post the IPO, Forterra now has $1,000m of net debt, a market cap of $1,200m (64m shares outstanding @ $19/share).  Consensus EBITDA for 2016 is $280m, leaving the company just over 3.5x levered, and trading at 7.9x current year EBITDA. 

Current Mispricing:

This is a very large discount to competitors including Mueller Water (MWA), which trades at 10.5x forward EBITDA or Advanced Drainage Systems (WMS), which trades at 9x EBITDA (despite an accounting issue that has prevented filing of a 10k for over 1 year).  Getting the 1x EBITDA turn to be in-line with WMS would provide 23% upside to Forterra stock.  Getting to the 2x+ multiple improvement in-line with MWA would provide >50% upside.  And while MWA has leverage to infrastructure spending, WMS is largely a residential and non-residential construction play, and only has about 10% exposure to infrastructure spending (vs. >40% for Forterra).

Future Opportunity:

It is difficult to quantify the exact upside in revenue and EBITDA in Forterra over the next couple years until there is better visibility on new stimulus plans.  However, the company was confident that existing infrastructure spending initiatives (FAST Act, Prop 1, etc.) would provide mid-single digit growth in revenue over the next few years.  Trump stimulus probably provides upside, but for this analysis, we will just use 5% and give greater confidence to achieving that over a greater duration.  Forterra will generate just north of $1,600m of revenue in 2016.  This gets to approximately $1,800m of revenue in 2018 if revenue growth can compound at 5%.  The company has also indicated upside to the margin just achieved in the most recent quarter.  Sell-side initiations do not incorporate margin improvement, but they miss the levers of upside management has cited including further cost cutting, integration, and value-added product sales.  In addition, scale from revenue growth should also improve EBITDA margins.  Achieving 20% EBITDA margins in 2018 would generate $360m of EBITDA.  With no debt paydown (despite $100m+ of FCF in each of the next couple years) and using the 9x 2018 EBITDA (lower than current comps), Forterra would be worth $35/share or 80%+ upside from the current price.  At 10x EBITDA, Forterra would be worth $40/share or 115% upside from the current price.   And again as above, even with no revenue improvement or EBITDA, but normalization of valuation comps, Forterra could achieve 20-40% upside as investors become more aware of this hidden infrastructure play.

Risks:

This is a new IPO.  The stock doesn’t have much trading history.  Management team is relatively new.  The company is a rollup and forward results require good operational performance.  Stimulus spending is key to drive revenue growth.  There is a large private equity ownership in this stock.  The company is also levered.

Catalyst

Water and transportation infrastructure stimulus plans.

Investor awareness of Forterra.