Description

Hi, all --

I've owned this stock for years. On Thursday, it was up some 25% due to their "transformative" acquisition of the Mackellar Group, so I peeled some off. But then I started thinking about it after hours, and doubled my position on Friday morning, and I could be talked into doubling it again. The point of this note is to share the opportunity with fellow members and to get feedback, like, am I nuts or what?

Here's a table of contents:

Introduction

The Merger

A Bunch Of Pretty Subjective Stuff

Conclusion

Introduction

Basis of Presentation

My usual informal style, etc. I'm too lazy to pre-apply the denigrating tags this time, so I'll leave that to the peanut gallery.

NOA reports in CAD, so so do I. I'll do a brief translation back into dollars at the end.

Key Risks

NOA operates in the resource extraction industry. Pre-and-post merger, 50% of their EBITDA will be derived from "bad" carbon, although they will at least be moving from 50% Canadian oil sands to a mix of Canadian oil sands & Australian thermal coal. There's a lot of ESG risk here. There's also commodity price risk, although at the moment that is way out of the money.

The bull case here relies entirely on management representation; there's a .pdf and conference call and that's it.

Their financials are funky. Their adjusted #s are highly adjusted. In addition, they have a bunch of JVs with first peoples that they report using the equity method under GAAP, but they also present "combined" #s to show things on a look through basis. They have $130MM  in convertibles outstanding. These are now in-the-money, but they don't seem to be using the treasury method to calculate diluted shares, the second these went ITM 6MM additional shares hit the diluted share count. When I get around to presenting #s, they won't be precise, because I don't like their adjustments and any per-share metric you get from management is likely to just be wrong, and I'll be showing some management forecasts that presumably suffer from both these flaws.

Could those already involved either back me up or slap me down on the convert accounting?

Prior Art

This is the 4th VIC writeup on NOA. Here are the priors:

https://www.valueinvestorsclub.com/idea/NORTH_AMERICAN_ENERGY_PRTNRS/6555091137 -- wooly18. 2014

https://www.valueinvestorsclub.com/idea/NORTH_AMERICAN_ENERGY_PRTNRS/9220845482 -- spike945, 2017

https://www.valueinvestorsclub.com/idea/NORTH_AMERICAN_CONST_GRP_LTD/1747967271 -- milehigh, 2019

Woolie's write-up is I think far enough back in the past and focused enough on short-term issues as to be skippable (Sorry, Wooly!). Spike & Milehigh's are more relevant. You don't *need* to read these, but if you're new and find the idea of interest, you *should*, because a big part of the pitch is, "Management is really good as is evidenced by their progress," and Spike & Milehigh's writeups will give you a gread sense of the state-of-play in the past.

 What Do They Do?

They use their large fleet of heavy-duty equipment to move dirt for miners. here's a pic from one of their presentations to give you an idea:

The core of the current business is working for miners in the Canadian oil sands, where they have many competitive advantages:

-- Long & good track record

-- Expensive equipment with long lead times

-- Pretty much need a First Peoples partnership, and we're all out of First Peoples.

-- Harsh environment

The work there is structured as multi-year contracts that come up for bid, but at this point I'd imagine that "periodic re-negotiation" is more accurate than "bid", if they don't f*ck up or get greedy I don't see them ever losing one of these. Oil sands has gone from ~100% of EBITDA to 50% since Spike's 2017 writeup, we'll talk about that more in a bit.

How Good Are They At It?

Very, very good. I'm seeing a TTM return-on-starting equity of ~30%. Management calculates a 15% ROIC for Q2, a seasonally slow quarter. (NB, that # is not vouched for by me, and there's seasonality here, you can't just annualize a quarter). Over 2017-TTM, revenue/share has tripled from $11 to $32.5, while GAAP basic EPS is up 5x, from $0.61 to $3.03, so that's solid top line growth along with margin improvement.

More Info

Here's their investor presentation:

https://nacg.ca/assets/uploads/2023/05/NOA-IR-Deck-May-2023.pdf

Conference call transcripts are available on Bloomber and SeekingAlpha. They archive their quarterly decks.

The Merger

Concurrent with their 7/26 Q2 earnings release, NOA announced a $400MM acquisition of the Mackellar Group, which does what NOA does but in Australia. Here's the deck:

https://nacg.ca/assets/uploads/2023/07/Strategic-Acquistion-of-MacKellar-Group-FINAL.pdf

It's slated to close in Q4.

Roughly speaking, the merger is +50% on all metrics. It delivers:

1: Increased scale, 

2: Increased diversifaction,

3: Some amazing economics, and

4: Finally pushed me over the fence on this company.

I'll discuss #4 in the "subjective" section. #1 & #2 I'll bucket under "Quality", and #3 under "Money". Let's look at Quality first, it's necessary context for Money.

Quality

I don't know, maybe "Investability" would be a better term. 

1: Obviously this makes the company bigger. If the stock price cooperates, this should soon be pushing $1B USD market cap. It's just more investable.

2: The merger decreases the existential risk from the oil sands exposure. Here's a before and after chart from the slide deck:

There's obviously something wrong with the last doughnut graphic, because I don't think "Other Canadian commodities" goes to 5% as a result of the merger, but you get the picture.

3: It makes earnings smoother and more predictable. The Canadian business is seasonal and subject to weather -- rain, the ground freezes too soon or thaws to late, etc -- and natural disasters like forest fires. 

4: For US investors, throwing in some AUD decreases Forex risk.

5: MG brings a hefty $2B backlog, or about 4 years of revenue.

I think the quality improvments alone are worth ... ? I don't know, +10-15% to pre-merger valuations?

Money

The economics sound too good to be true: < book, 2.7x EBITDA, 82.5% financed by vendors & current lenders at ~7.5%, coming with a 4 year backlog:

Here are some tables to show the impact on EPS & PE ratios:

 and EBITDA/EV/EBITDA:

Don't get too hung up on the #s here, they're derived from different sources and may not be coherent or correct, but -- Look at those pro-forma multiples!

 A Bunch Of Pretty Subjective Stuff

This is some ways a capitulation post. My history with the stock is: I bought a good amount on Spike's write-up, sold a chunk into rapidly ensuing double, sold a bit more at $8(USD) in 2020, probably to fund something else, I forget what, bought at $12 last year, and was maybe willing to begin exiting altogether until I started thinking about ...

These guys are just really, really good. They turned NOA from a speculative penny-stock into a $1B (I hope!) mult-national corporation in 6 years. I've been reading the transcripts all along and have great respect for management's candor and integrity. They're obviously very good operators. The asset allocation has been good. People seem to want to work with them. If they have a vendor or supplier they like, they can buy them on reasonable terms. I should never have sold a share! In fact, I should have been buying all along!

Despite the incredible progress they've made, the (pro-forma) multiples are about as low as they've ever been (outside of distress & covid). Here's Milehigh in 2019:

"The business is currently trading for 8x the mid-point of the 2019 EPS guidance, and 6.7x the midpoint of the 2020 guidance. Despite the fantastic stock-price performance over the last few years (up 175% since Spike’s write-up in the summer of 2017), the EV/EBITDA multiple is almost exactly the same depressed value it was when the stock was under $5, and the P/E multiple is almost half of what is was at that time. [...] The CEO is good, and if NOA keeps trading at under 7x earnings and close to a 20% FCF yield, I expect we’ll see meaningful buybacks over the next few years."

So, in some ways for me the 25% bump on the merger announcement wound up being close to zero ... say, +5% for beat-and-raise quarter, +10% for merger quality improvements, +10% for (finally!) recognizing superior management and a superior business, I'm in some sense getting the fabulous deal economics for free.

Conclusion

Valuing this is tricky. Based purely on financial metrics, it's a screaming buy at these prices -- quality management, 5x earnings growth over 5 years, 30% ROE going to lord knows what post merger, +50% next year, what kind of multiple would you put on that? On the other hand, you've got to assume that the oil sands/thermal coal businesses have some kind of finites lives -- more than 5, I think, but could they be gone in 10 years? Hard to rule out, although I believe that management will figure out some  sort of graceful transition. I'm hoping that the smart folks at VIC can help me out here.

At the moment I've got this as a 5% position (briefly, I've usually got: 0 to 1 20% positions, 0 to 2 10% positions, 8 to 15 5% positions, and then a bunch of stuff I'm trying to figure out what to do with) and if forced to close or double would probably go for double. There's no way I'd ever make this a 20% position due to not being enough of a sure thing, but am more than willing to add on weakness or passage of time. What do you think?

Yours,

Bowd

Catalyst

Merger closes.