(Note: Potential investors are strongly advised to purchase Entrec shares on the TSX due to low liquidity in the OTC markets.)
As the US equity markets churn relentlessly higher, I find myself spending increasing amounts of time analyzing Canadian companies, companies who for various reasons still trade at a significant discount to their intrinsic value even in this overheated market. With this in mind, I submit for consideration Entrec Corporation (GM:ENTCF) (Referred to as Entrec for the balance of this article), a company currently trading at a 20%+ free cash flow yield and poised for future growth.
History
Entrec's history is slightly more complicated than most of the companies that I have analyzed in the past and to completely understand it, we must first begin by delving into a separate company: Eveready Inc. Eveready was a Canadian energy and environmental services company that was acquired in 2009 by Clean Harbors Inc. for $387M. Clean Harbors is an environmental and energy services company based in Massachusetts and pursued the acquisition to build out their presence in the Western Canada resource zone.
After the deal closure some of the Eveready senior management team formed EIS Capital Corp., a capital pool company created to identify potential acquisitions that had the potential to generate profits and build shareholder value. In the US this company would be referred to as a "blank-check" company. It is worth noting that former Eveready CEO Rod Marlin was the head of EIS Capital Corp.
In the spring of 2011, EIS Capital Corp. agreed to acquire the Western Canada based Entrec Transportation Services from Flint Energy Services. Subsequent to this transaction, Mr. Marlin folded EIS Capital into its new operating subsidiary and "Entrec Transportation Services Ltd." began trading on the Toronto exchange in August 2011.
With this acquisition, Mr. Marlin and his management team, which consists almost entirely of legacy Eveready senior management, had built a base for expansion into the heavy haul and crane services industry in the booming Western Canada Sedimentary Basin (WCSB). Recognizing that this is an industry built around scale economics, the new Entrec management team has worked to aggressively grow the business with a series of acquisitions to build out the company's equipment fleet.
These acquisitions have been consummated with a blend of equity and debt financing. As we enter 2014, the company's primary focus is to digest their slew of acquisitions and organically grow the business.
Business Model
Entrec generates revenue by providing heavy haul and crane services to a variety of industries in the WCSB with a primary focus on the developing oil sands industry in Alberta. Starting out primarily as a heavy haul service provider, Entrec has branched out to the higher margin crane services due to the complementary nature of the two service offerings.
Per company management, the majority of customers prefer to have a single vendor for both heavy haul and crane services so branching into this area was a natural fit for the company. Happily for company shareholders, this has resulted in increasing EBITDA margins due to the higher margin nature of crane services:
The company is currently focused on building out its crane fleet in order to continue to build out a "one stop" service offering to their customers.
Entrec's business model is levered to the level of activity in the WCSB, which in turn is mainly driven by Western Canadian natural gas and oil commodity pricing. As many are aware, there is currently a wide differential between Western Canada commodity pricing and US benchmarks due to supply bottlenecks being experienced in the region.
While over the short term there will most likely be volatility caused by these bottlenecks, Entrec's management team is very positive about the economic prospects in the region over the medium to long term as these logistical problems get addressed through increased pipeline capacity and the development of LNG export terminals (which incidentally the company hopes to assist in the construction of).
Entrec's revenue can be thought of as being divided into two main segments: Project Based and Service Based. As of now, Entrec's revenue is primarily driven by long-cycle projects in the region but maintenance, repair and operations (MRO) contract work is beginning to drive a significant amount of revenue as well with the company recently being awarded a 5-year contract to provide services to an oil sands customer that will add an incremental $15M in annual revenue to the company's topline. We like service revenue as it provides the company a stable and predictable source of income.
Entrec will succeed or fail based on its ability to maintain high levels of utilization on its equipment and successfully cross-sell its heavy haul and crane services to customers in the WCSB. While some of this will depend on commodity pricing, much will depend on management's ability to achieve the right economies of scale for the company and correctly position it within the industry. Luckily for company shareholders, Entrec has a proven management team with plenty of skin in the game.
Management Team
As we have discussed, the Entrec management is made up of Eveready alumni, a company that grew revenue from $46M in 2004 to $650M in 2008. While Eveready ran into some problems prior to its acquisition due to issues that were for the most part out of its control, namely the commodity pricing bloodbath of '08-'09, the key takeaway here is that Entrec's management team has been here before. They have built a business like this from scratch and scaled it up successfully.
(click to enlarge)
Furthermore, management is heavily incentivized to grow the company on a per share basis as the board of directors and senior management owns 31% of the company. Entrec's growth has been fueled by equity issuances; management's heavy ownership of the company helps to ensure that these issuances are accretive on a per share basis.
Valuation
Due to the capital intensive nature of the industry, Entrec generates relatively low amounts of net income in relation to its cash flow generation. In order to get a more accurate view of how much earning power the company possesses, we must back out the depreciation and other non-cash expenses and then add back maintenance capex to get an idea of how much cash the company can generate for shareholders:
As we can see, the company currently has an equity FCF yield of 19%, very high for a growing company that is most likely poised to generate significant top and bottom line growth. If you are of a mind with Mohnish Pobrai and believe that no growth companies should trade at 10% FCF yields then Entrec should be poised to double from here.
Let's try to analyze this another way. I have been asked in the past why I do not use EV/EBITDA multiples to value businesses. Part of the reason I eschew this methodology is that I do not like to use EBITDA in general. Charlie Munger has referred to this particular metric as "earnings before everything" and I tend to agree. Furthermore I have a hard time coming up with what a reasonable EV/EBITDA multiple is. Many people use peer comparison to come up with a multiple to use but peer comparison is the reason that Snapchat is being valued at $3B so the less we make use of that the better.
Nevertheless, perhaps we are overstating the case for Entrec by ignoring the debt on the balance sheet. While for many companies debt financing is just a normal component of their financing structure and for all intents and purposes can be perpetually rolled over (and thus never be paid back), it may not be prudent to make this same assumption for a capital intensive business such as Entrec where the fleet will need to be renewed at some point in the future.
I propose that we crack this egg by assuming that for the next three years, Entrec does not grow and it allocates all its free cash flow over the next three years to paying down its debt stack (below).
If we assume that all cash flow is used to pay down debt principal, the below tables show what our new debt position and FCF generation would be in three years' time:
As we can see, the total outstanding debt has become a de minimis part of Entrec's balance sheet and the free cash flow yield has increased due to the savings on interest expense. If we assume that a debt-free Entrec should trade at a ~10% FCF yield then the share price would be due to appreciate 129% over three years or 32% annualized.
After looking at the company's valuation from these different perspectives it appears that no matter what methodology we use, the company remains significantly undervalued.
Risks
Currency Risk: I have never considered investing in Canadian companies to be fraught with currency risk as the USDCAD exchange rate has been relatively stable over the past few years. However, in the course of my day job I have been inundated with predictions that the Canadian Dollar is due for a serious depreciation to the point where I can no longer ignore this risk. The predictions are mainly based on the idea that the Canadian housing market is overheated and due for a correction.
There is a couple of ways to think about this. The obvious negative would be that a CAD denominated investment would depreciate in value as the currency weakens. However, a possible benefit to this situation would be that commodity companies would be able to benefit by paying for capex and labor in CAD and then selling their products in USD. This could spur increased economic activity in the WCSB and thus create greater revenue opportunities for Entrec.
Nevertheless, no matter if it is ultimately a positive or a negative, this is a risk that must be considered.
Commodity Pricing: As we mentioned in prior sections, the company's economic fortunes are tied to activity in the WCSB. Should commodity pricing drop precipitously then companies will most likely cease capital expenditure programs in the region, which would have an adverse impact on Entrec's top and bottom lines.
Dilution: As discussed, Entrec has been on an acquisition binge over the past three years and most of these deals have included an equity component. While this is the price of doing business in an industry where scale economics are vital, this is still a risk that investors must be cognizant of. In the past, Entrec has used "bought deals" to raise equity financing, something I have never been a fan of. I am hopeful that these deals should be in the past as management now seems committed to growing the company through the utilization of its untapped credit line and internally generated cash flows.
Conclusion
In sum, investors currently have the opportunity to invest in a company that possesses a management team with a significant amount of skin in the game, yields 20% free cash flow, and is poised to grow organically as the company digests the slew of acquisitions it has made over the past 3 years. While there may be volatility in the short term due to Western Canada commodity bottlenecks, these problems will undoubtedly be solved over the medium term, which should provide the company with future growth opportunities. Company management has signaled that they are aware of this undervaluation and have announced a normal course issuer bid to repurchase up to 10% of the outstanding float, the most they can under Canadian law, over the next year.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. (More...)
This entry passed through the Full-Text RSS service — if this is your content and you're reading it on someone else's site, please read the FAQ at fivefilters.org/content-only/faq.php#publishers.
from SeekingAlpha.com: Home Page http://seekingalpha.com/article/1873491-entrec-corporation-a-20-fcf-yield-and-poised-to-grow?source=feed
Aucun commentaire:
Enregistrer un commentaire