(647) 346-0464 guygottfried@rationalig.com Investment Idea: Tree Island Steel Ltd. (TSX: TSL) Building Products Manufacturer Snapshot *All financial figures pertaining to Tree Island are in Canadian dollars unless otherwise stated Shares 32.5 million
Recent Price $1.75*
Market Cap $57 million*
Background One of largest manufacturers of steel wire products in North America One plant in BC, three in California; annual capacity of 355,000 tons
Historically profitable business: strong earnings for at least 15 years* prior to financial crisis
Nearly went bankrupt before being recapitalized by investor group led by building products industry veteran Amar Doman Installed himself as chairman, replaced former management
After economic downturn, spent years preoccupied with balance sheet, cost-cutting and generally staying afloat Only in past couple of years has it been able to shift focus to sales growth *Going back as far as results are available Why is Tree Island Worth Your Attention? Trades at 3.6x normalized free cash flow (FCF)
Material organic growth potential for years to come with little incremental capex
Exceptionally well-run
Considerable insider ownership and recent buying Why is It So Cheap? Small, closely-held company
Underfollowed: until less than a year ago, had no earnings calls or analyst coverage
Business has been under-earning for five years, obscuring its true earning power Competitive Advantages Richmond, BC plant (accounts for bulk of Tree Islands capacity and sales) has important cost advantages
Purchasing: due to location (by Fraser River/Pacific Ocean) and scale, can source steel wire globally at dramatically lower all-in cost per ton than competitors whose size and/or location forces them to buy locally Imports from low-cost producers in China, South Korea, Australia, Chile etc.
Sales: location in rail/truck backhaul market enables it to ship products cheaply from BC to Eastern Canada, Midwest and Western US At same time, protected on its home turf from rivals in above regions (since much more expensive to ship from there to Western Canada than vice-versa) Capacity Utilization and EBITDA Profitable even with miniscule ~30% utilization, extremely leveraged to incremental sales *Amounts in millions 0.1 1.3 3.6 7.2 28% 32% 29% 32% 20% 22% 24% 26% 28% 30% 32% 34% 36% 38% 40% 0.0 1.0 2.0 3.0 4.0 5.0 6.0 7.0 8.0 9.0 10.0 2010 2011 2012 2013 EBITDA Capacity Utilization Organic Growth Case Study: Geographic Company leveraging its rail cost advantage to expand significantly in Illinois
Added approximately 6,000 tons in annualized sales year-to-date
Room for continued expansion; Illinois still a small market for Tree Island Organic Growth Case Study: Exploiting Competitor Weakness Agricultural fencing: won share from rival in Western Canada by offering farmers more frequent shipments of lower-volume orders while competitor insisted on full truckload deliveries
Rival recently withdrew from Canadian market, handing Tree Island even more business
YTD added approx. 4,000 tons annualized Organic Growth Case Study: Customer Wins Won fastener business with Lowes Canada in past year
Growth potential: Lowes still has small presence in Canada, seems intent on expanding (e.g. bid for Rona in 2012)
Opportunity to penetrate Lowes account and become supplier in Western US
Case studies illustrate strides Tree Island is making despite little help from macro environment; sales gains will accelerate if US (its main market by far) continues to rebound Further Evidence of Sales Traction From late Q1 through Q2, grew production staff in Richmond by 27% and at California plants by 13%
Adding labour cost-effectively; latest round of union deals provided for much lower wage rates for new workers
Results actually hurt in Q2 due to training costs, inefficiencies associated with spike in new employees; benefit from expanded workforce yet to be seen in financials
Staff additions suggest management anticipating continued pickup in volumes Management Case Study: 2012 Debt Repurchase When Tree Island faced financial difficulties, it obtained forbearance agreements on its payables from its two main steel vendors Instead of being immediately due, amounts would be repaid on installment basis at 7% interest
In 2012, renegotiated these agreements as follows: Vendor #1 (owed US$16.7mm): debt fully extinguished in exchange for US$5mm payment; 70% haircut Vendor #2 (owed US$15.8mm): no payments for six years, principal will be repaid from 2018 to 2028 with interest at 4%, non-compounding and due from 2024 to 2028; approx. 60% haircut on PV basis Eliminated companys biggest liability at combined discount of ~65% without resorting to bankruptcy and with no equity dilution, creating tremendous shareholder value Insider Buying CEO, CFO and VP Sales have all paid between $2.30 and $2.40 per share in past half year (31% to 37% premium to current price); CEO has bought shares in seven of last nine quarters Insider purchases since July 2013 2,115 Diluted shares outstanding 32,530 Purchases: % of shares 6.5% *Amounts in thousands Seven insiders have bought 7% of company on open market in past 15 months How Much Can Tree Island Make in Normalized Environment? From 1998 to 2002 (prior to onset of US housing bubble), annual EBITDA ranged from $23mm to $34mm, averaged $28mm*
EBITDA of $25mm in 2006* despite Southwestern US housing market beginning to cool that year *Before foreign exchange gains in all years and one-time gain from wire rod price drop in 1999. Without these adjustments, EBITDA totals would would be substantially higher. Operating earnings should return to $25mm range and could exceed that level Tree Island has generated millions of dollars in fixed cost cuts since Doman came aboard Normalized FCF Multiple At FCF multiple of ten, even if it took five years to attain normalized results, investors would still earn CAGR of 23% *Amounts in millions EBITDA $25.0 Maintenance capex (1.5) Interest (2.3) Taxes (5.3) FCF $15.9 Per share $0.49 P/FCF 3.6 Catalysts Continued sales traction Earnings, FCF will soar as capacity utilization rebounds from 30%-range
Tuck-in acquisitions Will add complementary products/relationships, enhance earning power
Dividend resumption Doman has history of favouring dividends at investee companies Low capex requirements, closely-held nature of shares (making buybacks difficult) support rationale for dividends Conclusion Materially undervalued Excellent management with major skin in the game Clear strategy toward restoring former profitability, strong evidence of successful execution Investment Idea: TerraVest Capital Inc. (TSX: TVK) Diversified Holding Company Snapshot *All financial figures pertaining to TerraVest are in Canadian dollars
Shares 18.6 million Recent Price $6.20* Market Cap $115 million* Dividend $0.40* (6.5% yield) TerraVest Today: Three Parts RJV Gas Field Services Manufactures wellhead processing equipment for oil and gas industry in Western Canada
Gestion Jerico Manufactures items such as propane dispensers, residential and commercial liquid containment units, bulk propane trucks
Diamond Energy Services Service rig operator in Saskatchewan Background Formerly a conglomerate with six divisions
Struggled as several subsidiaries underperformed, culminating in dividend suspension in 2009 Activist investor took control of company
From 2010 to 2012, divested four of its six divisions, used proceeds for special dividends, share repurchases Reinstated regular dividend in 2013
Earlier this year, acquired Jerico and began to pursue consolidation strategy Why is TerraVest Worth Your Attention? FCF multiple of 6.7 based on run-rate of current business Investors paying nothing for serious growth prospects
Valued at just 3.6x estimated FCF including likely acquisitions Aggressively pursuing consolidation at RJV and Jerico; numerous targets available at low-single-digit EBITDA multiples Can double FCF in next three years
Record of excellent capital allocation
Considerable insider ownership and recent buying Why is It So Cheap? Underfollowed: no analyst coverage or earnings calls before August
YTD results understated because Jerico acquisition closed mid-year; absent from 1.5 out of 3 quarters* including seasonally-strong Q1
Underappreciated growth potential: TerraVest in early stages of acquisition strategy after years of shrinking *TerraVests fiscal year ends on Sep. 30 Consolidation Opportunity: RJV and Jerico Both divisions in fragmented industries with many small operators Numerous targets available at low valuations (4-4.5x standalone EBITDA)
Both RJV and Jerico have inherent advantages that enable them to create sizeable cost synergies RJV: in-house manufacturing capabilities allow it to cut out costly contractors, earn much higher margins than peers Jerico: can source steel at meaningfully lower prices than competitors (this also helps RJV, which sources from Jerico) Combined, RJV and Jerico have opportunity to deploy $100mm-plus at 2.5-3x EBITDA after cost-cutting Capital Allocation Case Study: NWP Industries RJV competitor, first acquisition under new consolidation strategy; deal closed in August
Paid 4.25x EBITDA based on current results
Major cost-cutting opportunity from exploiting RJVs and Jericos cost advantages and from overall efficiencies Management has knack for finding way to remove costs
NWP not anomalous; multiple transactions with similar economics being explored by both RJV and Jerico Capital Allocation Case Study: Substantial Issuer Bid In 2012, TerraVest offered to repurchase 5mm shares (25% of shares outstanding) through substantial issuer bid at $2.75
Shareholders tendered 7.2mm shares; instead of pro-rating them, company elected to accept entire amount
Bought back 36% of its shares at low-single-digit FCF multiple and less than half of current price Insider Buying Not included above: Charles Pellerin (runs Jerico) received his portion of Jerico acquisition price entirely in stock, aligning his and TerraVests interests; now owns 12% of company Nine insiders have bought 8% of company on open market since February at average cost of $6.21 per share Insider purchases since Feb. 2014 1,426 Diluted shares outstanding 18,594 Purchases: % of shares 7.7% *Amounts in thousands FCF Multiple: Current Business Modest valuation even ignoring acquisitions; investors paying nothing for TerraVests sizeable growth prospects EBITDA run-rate $30.0 Maintenance capex (4.0) Interest (3.1) Taxes (5.7) FCF $17.2 Per share $0.92 P/FCF 6.7 *Amounts in millions FCF Multiple Adjusted for Probable Acquisitions in Next Two to Three Years In longer term, significant chance of additional transactions beyond level assumed in this calculation, making stock even cheaper Present run-rate $17.2 EBITDA from RJV acquisitions 13.3 EBITDA from Jerico acquisitions 20.0 Incremental capex, interest, taxes (12.3) FCF $38.2 Diluted shares outstanding: present 18.6 Shares issued for acquisitions 3.6 Adjusted shares 22.2 FCF per share $1.72 P/FCF 3.6 *Amounts in millions. Assumed $40mm and $60mm in acquisitions for RJV and Jerico, respectively, funded 75% debt and 25% equity, at 3x EBITDA after synergies. Catalysts Further acquisitions Large pipeline of deals available at bargain prices Will result in rapid growth for foreseeable future
Monetization of Diamond only segment not targeted for growth Stable earnings, leading share in its region; would be attractive addition for larger energy services firm Would provide significant capital to redeploy into RJV and Jerico Conclusion Anomalously cheap High degree of insider alignment, record of impressive capital allocation Investors havent caught on to enormous growth potential TSL and TVK: Important Commonalities Misunderstood: market ignoring fundamental changes at each business