TerraVest Industries, Inc. (TVK.TO)

Summary

We focus on smaller companies with “Ft. Knox” balance sheets and large & sustainable free cash flow yields and we are typically seeking a double-digit FCF yield or higher or an unleveraged basis. The objective for the sustainable FCF to eventually drive up the share price to a more reasonable valuation through share buybacks, debt reductions, dividends, or accretive acquisitions. Obviously, it is important we have a management team that cares about shareholder value. We focus on small-cap stocks because there is a much better chance to find an attractive investment opportunity which is under-followed or undiscovered.  

TerraVest Industries, Inc. (TVK.TO) is a leading provider of products and services to niche manufacturing markets and is based in Canada. TVK manufactures and sells goods and services to energy, agriculture, mining, and transportation markets in Canada and the United States. It operates through three segments: Fuel Containment, Processing Equipment, and Service. The Fuel Containment segment manufactures bulk liquefied petroleum gas (LPG) transport trailers, LPG delivery and service trucks, LPG storage tanks, residential and commercial LPG tanks, and furnaces and boilers. The Processing Equipment segment manufactures and sells a range of equipment.  The Service segment provides well servicing to the oil and gas sector in the Southwest and Central Saskatchewan.    

(All numbers herein are in Canadian dollars unless otherwise stated). 

TVK’s shares currently trade at about $18 per share with about 19m shares outstanding for a market cap of $342m.  TVK has a “Ft. Knox” balance sheet with net debt position of about $69m as of 12/31/20 or about 1x LTM EBITDA.  TVK has a total enterprise value (EV) of about $410m.  LTM EBITDA is about $62m.  Free cash flow (defined as cash from operations less maintenance capital expenditures) for FY (ended Sept) 2019 and 2020 averaged about $40m+ per year.  TVK is currently trading at about 6.5x LTM adjusted EBITDA and a 10%+ unleveraged FCF yield.  TVK trading volume is light, so this idea is likely appropriate for PA accounts or small- and micro-cap funds. 

TVK was written up by mpk391 in Oct 2019 at about $12.50 per share which is an excellent write-up and well-timed and we recommend this for background.  Since then, adjusted EBITDA has increased from $50m to almost $62m, and net debt has been reduced from 2.3x adjusted EBITDA to close to 1x adjusted EBITDA.  While the stock price is higher, the enterprise value is not increased so much and the valuation is perhaps even more attractive today.

The Company’s businesses are not super exciting, which contributes to its low multiples, but it is deceptively profitable.  TVK trades at cheap multiples considering its demonstrated ability to grow over the past several years.  Consider that in FY (ended Sept) 2017 total revenues were $197m and adjusted EBITDA was $24m and three years later, by FY 2020, total revenues had increased to $304m, or 54%, and adjusted EBITDA had increased to $55m, or 129%.  TVK was able to achieve this growth due to several acquisitions completed during this period, including Iowa Steel, Vilco, Fischer, and Maxfield.  We believe TVK will continue to source and integrate similar type acquisitions over the next 3 to 5 years and investors are paying a modest price for this capability.  TVK is in a strong position to make acquisitions due to its strong market shares in existing operations and its ability to extract large synergies from new businesses due to its existing operations.  TVK has consistently achieved strong returns and rapid paybacks on acquisitions due to large synergies with existing operations.  The Company seeks out niche manufacturing businesses with low capital intensity.

We believe there is a misunderstanding of TVK’s business model as it is considered an oil and gas business.  However, if you were to break out the EBITDA by business, 80% of EBITDA is non-oil and gas related.  TVK products transport or store oil and gas and other products, which is more stable than oil and gas production. TVK builds propane and compressed gas distribution products. TVK is a consolidator of home heating oil products (mainly storage tanks), propane, anhydrous ammonia, and storage vessels (see attached photos below). TVK is the number one player in Canada and in the top three in the United States.  About 60% of total sales are in Canada while 40% of sales are in the United States. TVK is also a consolidator of oil and wellhead processing equipment, in which they are number one in Canada.

TVK has a strong management team and Board which owns over 30% of total shares outstanding and is highly shareholder-driven with a stated focus on “maximizing free cash flow per share”.  TVK’s turnaround has been driven by Clarke, Inc. (CLK.TO) which owned about 30% of total shares outstanding before distributing these shares to its shareholders in March 2020 and we believe Clarke, Inc. retains a strong interest in TVK’s success.  Clarke, Inc. is a successful value investor based in Canada led by George Armoyan.  The slide below highlights how CLK turned around TVK by exiting weaker businesses and adding stronger businesses with low capital needs and high cash generation.  Shareholder-oriented actions included special dividends, large share repurchase programs, and accretive acquisitions.

We believe TVK can sustainably generate $40m+ of FCF with current operations for an unleveraged FCF yield of close to 10% which we believe is attractive with 10-year treasury rates near 2%.  We believe TVK can use its free cash flow and “Ft. Knox” balance sheet to grow organically as well as via highly accretive acquisitions in existing or adjacent industries.  Based on 8x our estimate of adjusted EBITDA of $75m by FY (ended Sept) 2022 or 2023 less $50m in estimated net debt, TVK would have a market cap of $550m or about $29 per share vs. the current $18 share price (+60%).

Below is a slide from TVK’s home heating operations.

TVK is a leading provider of these home heating products, which are sold primarily to the North American wholesalers supplying the residential HVAC industry. TVK’s products includes furnaces, boilers, and radiators.

Below is a slide from TVK’s Storage & Transport Equipment operations:

TVK is a market leader in storage and distribution equipment to the propane (LPG) and natural gas liquids (NGL) markets in Canada and the United States. TVK is also a leading supplier of equipment to all parts of the anhydrous ammonia (NH3) supply chain in North America. The end user markets consist primarily of farmers and ranchers who require NH3 as a primary fertilizer source. The company’s manufacturer’s equipment is primarily for large fertilizer distributors who provide fertilizer to end users.

Below is a slide from TVK’s Processing Equipment Segment:

TVK is a market leader in the manufacturing of wellhead processing equipment for the energy industry in Canada and the United States. The company is also a leading manufacturer of unique equipment for high pressure wells in North America. TVK manufactures a variety of different sizes and configurations for commercial and residential refined fuel tanks in both steel and fiberglass.

Business Description

TerraVest Industries, Inc. (TVK.TO) is a leading provider of products and services to niche infrastructure markets. TVK manufactures and sells goods and services to energy, agriculture, mining, and transportation markets in Canada and the United States.

TVK was originally an underperformer, but the Company changed when Clarke Inc. started buying shares in the company, leading to an influential stake (see slide below).  In 2010, TVK started divesting subpar businesses, ranging from HVAC to furniture. In 2014, TVK started the next step of their transformation by acquiring Jerico and NWP industries at low single digit free cash flow multiples.

TVK has no analyst coverage or company research. We like these underfollowed companies that not many other people are looking at.

TVK has a history of successful acquisitions as shown in the chart below.

TVK is seeking companies to acquire with complimentary businesses, the ability to leverage expertise in metal fabrication, standalone operational capability, quality brand and reputation, and well as attractive valuations to shareholders. TVK also seeks to drive organic growth. The investment criteria for organic growth includes adding to product offering, expands capacity, improves efficiency, improves quality, and attractive return on investment. TVK also has demonstrated a successful history of organic growth as well. TVK operates in low multiple and “boring” businesses but these make for a good acquisition vehicle.

TVK has had strong growth in revenues and adjusted EBITDA since 2017 due also to organic growth programs as shown below.

Strong Management and Ownership Oriented Towards Disciplined, Long-Term Value Creation

TVK’s CEO is Dustin Haw, who has been on the Board since 2014, and became CEO in 2017, and was formerly a key employee at Clarke, Inc.  Charles Pellerin is Executive Chairman and combined his business with TVK in 2010 and owns almost 20% of total shares.  Dale Laniuk is also on the Board and a major shareholder (almost 10%) and former CEO of TVK.  This group, along with Clarke, Inc./George Aromoyan, have been the key architects of TVK’s shift away from direct oil and gas exposure and into more resilient, higher margin, and cash-generative manufacturing businesses with low capital intensity. 

We believe TVK’s growth strategy makes great sense, including new products, growing with the existing customer base, geographic expansion, and improved profitability.  TVK management has a conservative, disciplined, long-term and low-risk approach that we like.  TVK’s stated goal is to “maximize free cash flow per share” over time which we like.  Over time, TVK has paid special dividends and had large share repurchases to aggressively drive shareholder value.

Attractive Valuation with Large and Sustainable Free Cash Flow Yield

TVK is currently trading at about 6.5x adjusted EBITDA, which is attractive for a business that is growing mid-single digits organically with modest capital investment needs and strong free cash flow.  We believe TVK can sustainably generate free cash flow of $40m+ per year as compared to its current enterprise value (EV) of about $410m for an unleveraged FCF yield of close to 10%.  We believe this is attractive when compared to 10-year treasury rates near 2%.

Strong History of Growth in Revenue and Adjusted EBITDA. 

Over the past six years, led by CEO Dustin Haw, TVK has divested weaker businesses and acquired stronger businesses which has led to a larger, stronger, and more cash-generative business model over time.  Total revenues were $193m in FY (ended Sept) 2017 which have increased to LTM revenues of $306m over the past three plus years.  Similarly, adjusted EBITDA was $24m in FY (ended Sept) 2017 which increased to LTM adjusted EBITDA of about $62m over the same period. 

These strong growth rates have been driven by stable organic revenues, aggressive cost controls, and highly accretive acquisitions in existing or adjacent industries.  These acquisitions have been completed at attractive multiples of free cash flow and resulted in rapid paybacks as they have been integrated with existing operations. 

We believe TVK can continue to source and execute these small, adjacent, and highly accretive acquisitions over the next 3 to 5 years and build an ever larger, more cash-generative business model.  Investors are paying very modest multiples for this potential future growth opportunity as the market does not appreciate TVK’s ability to locate and execute these acquisitions.

The Company has not completed a major acquisition in some time, so it is possible that FY (ended Sept) 2021 could be a consolidating year with stronger growth in adjusted EBITDA in FY (ended Sept) 2022.

Leading Market Shares in Fuel Containment and Processing Equipment Segments

The Company has leading market shares in its major segments, Fuel Containment and Processing Equipment, with either number one or two market share positions.  This enables a highly resilient business model and allows competitive advantages in sourcing raw materials and rationalizing operating costs.  Many of TVK’s orders are customized for specific customer requirements and its strong market position enables it to respond more effectively than competitors.  It also creates opportunities for accretive acquisition opportunities alongside existing operations with superior cost structures and pricing positions.

Recent Acquisitions Have Driven Highly Profitable Growth

These include the following:

·         Argo Sales in Dec 2019, an Alberta-based company primarily focused on manufacturing processing and production equipment for the Canadian oil and gas markets.

·         Iowa Steel Fabrication LLC in Aug 2019, an Iowa based company primarily focused on manufacturing transportation equipment for the propane and anhydrous ammonia markets as well as structural steel products.

·         MaXfield Group Inc. in Jan 2018, focused on manufacturing high quality processing, storage, and transportation equipment for the propane, anhydrous ammonia, and oil and gas markets.

·         Fischer Tanks LLC, in Sept 2017, engaged in business of manufacturing and refurbishing propane tanks.

·         Vilco Group in Jan 2017, named Vilco Limited, Superior Tanks Limited and Vilco Realty.

Strong Cash Flow Generation and Cash-Generative Business Model

TVK generates strong cash from operations and FCF.  LTM cash from operations is $65m and FCF over the last two FYs has averaged about $40m, which are attractive compared to the current $410m enterprise value (EV).  Absent a severe recession or some other major economic shock, we believe these levels can be sustained and grow.  This reflects the highly cash-generative business model, which has limited working capital and capital expenditure requirements.  TVK believes maintenance capital expenditures are about $5m per year.

Over the past six years, TVK has generated close to $200m in cumulative cash from operations, which is almost 50% of its current enterprise value of about $410m.  Furthermore, with maintenance capital expenditures of only $5m per year, this leaves substantial cash flow available for organic and inorganic growth, dividends, and share repurchases.

Strong Results in FY 2020 and Q1 of FY 2021 Imply A More Profitable Business Model

TVK achieved strong results in FY (ended Sept) 2020 with sales of $304m versus $306m in 2019, while adjusted EBITDA for FY 2020 was $55m versus $49m in prior year.  While sales were impacted by lower demand for NGL storage and distribution equipment, and oil and gas processing equipment, both driven by the covid pandemic and commodity prices on an already challenged industry, acquisitions of Argo Sales and Iowa Steel both contributed to keep total sales stable.  Adjusted EBITDA improved due to the additions of Argo and Iowa Steel and favorable product mix and government wage subsidies. 

TVK received $13.4m in FY (ended Sept) 2020 of government wage subsidies and stated that, had this program not been available, it would have made significant personnel reductions to mitigate reduced business activity.

TVK similarly generated strong results for Q1 of FY (ended Sept) 2021 with sales of $82m versus $88m in 2019, and adjusted EBITDA of $19m versus $14.5m in prior year.  Sales were also impacted by lower demand for LPG and NGL storage and distribution equipment as well as oil and gas processing equipment for the same reasons as in FY 2020.  Argo and an improved product mix and government wage subsidies ($2.9m in Q1 of FY 2021) also drove improved adjusted EBITDA.  We believe TVK sales can improve during FY 2021 as the North American economy reopens further but FY 2021 could be a consolidation year for profitability relative to adjusted EBITDA. 

Over the past several FY’s, and in recent quarterly results, it appears TVK’s profit margins have increased considerably as recent acquisitions continue to generate greater efficiencies.

Solid Returns on Invested Capital

TVK does not have large capital needs, either in working capital or capital equipment, and consequently generates strong free cash flow and earns high returns on invested capital.  TVK is the type of business that we find attractive and like to hold for long periods of time.  At FY (ended Sept) 2020, TVK had net working capital (excluding cash) plus net PP&E of about $175m versus EBIT of about $35m or about 20% ROIC, which is solid for a niche manufacturing business.  TVK has a non-capital-intensive and highly cash-generative business model.  ROE and ROIC have greatly improved over the past 10 years as the businesses are better.

“Ft. Knox” Balance Sheet Reduces Risk and Creates Opportunities

TVK has a “Ft. Knox” balance sheet today with a net debt position of about $69m at 12/31/20, or about 1x LTM EBITDA.  We believe the Company’s strong balance sheet substantially reduces risk and gives the Company opportunity to take advantage of strategic opportunities which are both organic and inorganic.

Resilient Business Model

TVK’s results during covid-impacted FY (ended Sept) 2020 were quite solid, as TVK generated adjusted EBITDA of $55m versus $49m prior year.  Although this includes $13m of government wage support payments, we believe TVK could have further reduced costs and captured close to half this amount without government support.  We believe that TVK is a recession resilient business. Housing starts drive substantial demand for TVK’s products and there has been a migration of people out of cities since the covid pandemic began. There is a preference for houses in rural areas than in the cities, which drives demand for the Fuel Containment segment. Additionally, second homes such as lake houses, cottages, vacation homes, etc. all drive demand as well.   TVK’s home heating oil businesses are fairly recession resistant as customers need to heat their homes, especially in the Northeast U.S. 

Well-Positioned to Benefit from Reopening and Strong Oil & Gas Activity

TVK is well-positioned to benefit from a reopening of the North American economy post-pandemic with strong exposure to housing activity and industrial strength.  TVK also has some exposure to oil and gas which has been severely depressed in recent years and results in this segment could rebound strongly based on recent stronger oil and gas activity.

Seasonality

Seasonality includes the strongest quarters of Q1 (Dec) and Q4 (Sept) as the Fuel Containment segment generally has higher revenues during Q1 and Q4 as demand for residential, commercial, and industrial heating products increases in the winter months.  Q3 (June) is usually the weakest across all segments.  The Processing Equipment and Service segments generally have higher sales in Q1 (Dec) and Q2 (March) as majority of drilling in Western Canada occurs during this period.

Conclusion and Target Price

At 8x our adjusted EBITDA est. for FY (ended Sept )2022 or 2023 of about $75m less $50m of net debt, TVK would have a market value of close to $550m or about $29 per share (+60%).  We believe TVK can achieve this growth in adjusted EBITDA through stable organic operations and niche acquisitions of related businesses which offer strong synergies.  TVK has consistently acquired smaller, related businesses with attractive payback periods on its initial investments.  If TVK's management team continues to execute and its custom manufactured products market continues to grow, we think our target prices could be achieved.

(1)    Pellerin is on Board of Directors of TVK and Clarke, Inc. and is CEO of a major accounting firm in Canada.

(2)    Laniuk is former CEO of TVK.