TerraVest Industries: An Engaging, Excessive Progress Play (TRRVF, TVK:CA)

The next section was excerpted from this fund letter.

Terravest Industries (TSX:TVK:CA)

TerraVest is a supplies fabrication and repair agency offering elements and companies for oil and fuel extraction, transportation, distribution, and industrial and residential utilization. TerraVest’s merchandise help the transportation and storage necessities for oil, pure fuel, LNG, and RNG throughout the US and Canada. TerraVest has three market segments as:

1. a producer of tanks for residential oil and fuel storage, furnaces, industrial oil, and water storage tanks and boilers, in addition to vessels for liquid pure fuel storage and truck transportation;
2. a producer of pure fuel wellhead processing, storage, and transportation tools; and
3. an oil and pure fuel companies supplier together with fluid dealing with, water administration, heating, leases, and effectively servicing using 21 servicing rigs.

TerraVest is a group of corporations competing with smaller personal companies or divisions of enormous corporations in area of interest markets described above. In every of its market niches, TerraVest is the primary or quantity two competitor. The widespread theme amongst these companies is steel bending for prime value-add functions.

Administration strategically acquires companies in direct negotiation with primarily family-owned sellers or out of misery for 4-5x money stream. By the point the enterprise is built-in, one other flip of money stream is realized from inherent synergies. In lots of situations, the households that personal these companies don’t have descendants who wish to take them over. About 30% of the acquisitions have been bought in distressed monetary conditions. The enterprise acquisitions are financed primarily by debt which is paid down from money stream generated from the acquired corporations. Over the previous seven years, administration has acquired fourteen corporations. The acquired corporations have ranged in dimension from $10 to $100 million in revenues with a median income of about $25 million. The dimensions of the agency focused (median deal dimension is $15 million) is under the scale of most personal fairness corporations’ curiosity, so the competitors is lower than it could be for bigger offers. TerraVest’s goal acquisition markets embrace not solely their core markets, but in addition corporations in adjoining markets equivalent to: inexperienced power containment and transportation (RNG and hydrogen), chemical tanks, septic tanks, air filtration and purification, and different steel fabricating functions. One of many two members of the senior administration workforce focuses on acquisitions.

TerraVest has 4 levers for money stream progress:

1. shopping for a agency of their core or adjoining market;
2. increasing inside present markets;
3. paying down debt; and
4. distributing extra money as dividends or shopping for again shares.

The acquired corporations generate money flows in extra of what’s wanted to modestly develop the agency, which is used to buy corporations in its goal or adjoining markets. If no corporations might be discovered that meet administration’s operational and valuation standards, then administration will purchase again shares because the shares have sometimes traded at modest valuations reflecting natural progress however not the worth of future acquisitions. Administration could be very selective within the corporations they purchase. With a full pipeline of deal alternatives, administration expects to spend 2/3^rd of its money stream to both purchase corporations, pay down debt, or purchase again shares. The remaining 1/3^rd might be invested in its present enterprise, together with progress alternatives which comprise about 2/3^rd of investments within the present enterprise.

TerraVest’s predecessor was an earnings belief that went IPO for $24 million in Canada in 2004. TerraVest initially held two companies—a wellhead processing tools agency and an agricultural tools agency. The latter was subsequently offered in 2011 for $15 million. From 2004 to 2005, TerraVest paid $88 million for corporations that have been subsequently offered in 2011 for $34 million. The poor choices by earlier administration led to poor outcomes, and TerraVest’s inventory value declined from $15 to round $2 per share by 2011. Following Clarke’s 2010 funding, TerraVest modified administration and recognized core enterprise areas (initially wellhead processing tools and companies) and divested non-core companies. The non-core companies generated $43 million in sale proceeds which have been used to pay a particular dividend, repay debt, and repurchase 36% of TerraVest shares excellent in 2012. In 2013, TerraVest merged with Granby to enter the gasoline containment and HVAC tools enterprise. From 2012 to 2015, TerraVest bought 4 extra corporations in its core markets of gasoline containment and HVAC tools and wellhead processing tools.

In 2013 and 2014, the present administration workforce of Dustin Haw (CEO) and Mitchell Gilbert (CIO) joined TerraVest to proceed its consolidation technique of corporations in its core markets. From 2016 to 2023, TerraVest bought 9 corporations in its core gasoline containment and HVAC and wellhead processing tools markets. From 2013, the portion of TerraVest’s gross sales related to cyclical oil and fuel companies declined from 45% in 2013 to 16% in 2022. These gross sales have been changed with extra recurring gross sales related to wellhead and transportation storage merchandise, in addition to HVAC tools and compressed pure fuel storage tools. Many of the opponents within the goal markets are smaller, privately held companies. Mr. Gilbert is concentrated on acquisitions and has developed a community of personal house owners of core market corporations as potential acquisition candidates. Given how central M&A is to TerraVest’s technique, the main focus of a senior government is essential. The funding has paid off, as TerraVest has a strong pipeline of offers and might selectively select the corporations it acquires. Subsequent to Mr. Haw and Mr. Gilbert’s arrival, TerraVest has made eleven acquisitions in its core markets and elevated CFO earlier than working capital from $18 million to $68 million—a 25% CAGR. The common post-synergy value of those acquisitions has been 3.5x pre-tax free money stream. The ensuing unlevered RoIIC (see calculation under) has been round 30%, which incorporates returns from each natural progress initiatives and acquisitions.

The enterprise sectors by which TerraVest competes are topic to economies of scale from associated merchandise and have route density traits as a consequence of delivery prices. TerraVest’s latest acquisition of a trucking provider ought to cut back the benefits native corporations have within the sale of apparatus in goal markets.

Business Segments

TerraVest competes within the HVAC tools and gasoline containment markets in Canada and within the Northeast and Nice Lakes areas United States. These companies have been bought over time by TerraVest’s administration. The corporate is a market share main participant within the residential and lightweight industrial oil storage tank and dispenser market in each metal and fiberglass product strains. As well as, TerraVest supplies bulk LPG transport trailers, LPG supply vehicles, and furnaces and boilers. Most industrial clients purchase these merchandise straight and generate repeat enterprise over time. Residential clients buy tools via distributors. This market is a slow-growing GDP progress kind of enterprise. It is a fragmented market and competitors is primarily from personal companies and divisions of bigger corporations. In 2023, TerraVest generated 56% of revenues within the gasoline containment and HVAC tools segments.

TerraVest additionally competes within the pure fuel processing and the LPG and ammonia storage and transportation tools markets. TerraVest supplies: wellhead processing tools and tanks; wellhead sanding models; central amenities processing tools; NGL, LPG, and ammonia storage tanks; bulk NGL, LPG, CNG, and ammonia transport trailers; and customised processing tools. Most of those merchandise are product of subcomponents assembled into ultimate merchandise by TerraVest. This section’s clients embrace upstream and midstream power corporations, fertilizer and propane distribution corporations, and liquids transportation corporations. Clients purchase these merchandise straight and generate repeat enterprise over time. It is a fragmented market and competitors is primarily from personal companies and divisions of bigger corporations. In 2023, TerraVest generated 28% of revenues within the processing tools section.

TerraVest additionally competes within the oil and fuel companies market. TerraVest companies embrace fluid hauling, water administration, environmental options, heating, leases, and effectively servicing. TerraVest supplies these companies by way of 21 oil and fuel servicing rigs positioned in Saskatchewan. In 2023, TerraVest generated 16% of revenues within the oil and fuel companies section.

Sources of progress for TerraVest embrace natural and acquisition progress within the gasoline containment and HVAC tools and processing tools segments. Natural progress in these segments is predicted to be 2% annual progress fee with another progress coming from recognized progress tasks, acquisitions (the biggest portion of progress traditionally), or share repurchases.

TerraVest operations have turn out to be higher over time, as Dustin and Mitchell carried out a value-added acquisition technique using economies of scope and manufacturing density. The return on property have elevated from 11.7% in FY2013, to 13.4% in FY2023; and the return on fairness elevated from 14.3% in FY2013, to 27.0% in FY2023. The drivers included will increase in internet earnings margins from 6.4% in FY2013, to 7.1% in FY2023, and will increase in mounted asset turnover from 3.1x in FY2013, to three.5x in FY2023. Leverage additionally elevated barely from 2.2x, to 2.4x EBITDA.

The incremental return on invested capital over the previous 5 years is near 30%, which has elevated TerraVest’s RoIC over the previous 5 years. See the calculations under.

Draw back Safety

TerraVest’s dangers embrace each operational leverage and monetary leverage. Operational leverage within the gasoline containment and transportation tools market relies upon the mounted vs. variable prices of the operations. There are some average economies of scope by way of associated product growth and native economies of scale, because the enterprise is primarily positioned in New England/Jap Canada, the Nice Lakes, and Western Canada. A latest acquisition within the South ought to develop TerraVest’s geographic footprint.

Monetary leverage might be measured by the debt/EBITDA ratio. TerraVest has below-average internet debt/EBITDA of two.2 versus different steel fabricating industrials (like Trinity, Worthington, and Chart) and versus TerraVest’s historical past. The historical past and projected monetary efficiency for TerraVest is illustrated under.

Administration and Incentives

TerraVest’s administration workforce has developed an M&A engine and operationally environment friendly corporations in worthwhile niches of the fabric fabricating trade. They carry out M&A when targets can be found on the proper value partially financed by debt, pay down debt, and return capital by way of buybacks when there aren’t alternatives to take a position organically or by way of M&A.

The bottom compensation for the administration workforce (prime 5 officers) is roughly the identical from C$270k to C$320k per 12 months. The CEO and CIO have the best whole compensation, C$2.5 million collectively, primarily as a consequence of their choice holdings. Over the previous three years, their whole compensation was about $600k per 12 months, about 1.3% of internet earnings per 12 months. The CEO and CIO presently maintain 1.09 million shares and choices (value C$6.8 million), which is greater than 7.8 instances their 2022 salaries and bonuses of C$867k. The CEO’s compensation is structured to incorporate a C$270k base pay and as much as a C$214k efficiency bonus. The entire senior executives’ base compensation was lowered by 20% for six months in 2020 because of the uncertainty of how the Coronavirus would have an effect on operations. Non-options-based incentive compensation for the manager workforce is ready and accredited yearly by the board of administrators.

Board members have a big funding in TerraVest. Charles Pellerin, who was the unique activist from Clarke, owns 3.5 million shares, and the retired CEO, Dale Laniuk, owns 2.1 million shares. Possibility grants, offered to the CEO and CIO, have been equal to 2% per 12 months of the shares excellent over the previous three years.

Valuation

Click on to enlarge

The important thing to the valuation of TerraVest is the anticipated progress fee. The present valuation implies an earnings/FCF enhance of 0.5% in perpetuity utilizing the Graham method ((8.5 + 2g)). The historic 10year earnings progress has been 35% per 12 months together with acquisitions and the present return on fairness of 24%.

A bottom-up evaluation based mostly upon market progress charges of TerraVest’s markets’ (HVAC and gasoline tools, fuel processing tools, and oil and fuel companies) outcomes was used to estimate an natural progress fee of two% for TerraVest. That is based mostly upon the income progress assumption for the 2022 goodwill impairment and the historic five-year natural income progress fee of three%. This doesn’t embrace any future acquisitions. If we embrace 13% progress for acquisitions, then the bottom EPS progress fee is 15%. Traditionally, TerraVest’s EPS progress fee was 35% per 12 months pushed by 14 acquisitions over seven years. If we assume half of the variety of acquisitions over the following seven years and a ahead return on fairness of high-teens to low-twenties, declining from the present fee of 24%, retaining 85% of earnings, then the incremental 13% progress per 12 months is conservative. Utilizing a 15% anticipated progress fee, the ensuing present a number of is 39x of earnings, whereas TerraVest trades at an earnings a number of of 10x. If we take a look at steel bending comparables, that are bigger however have slower progress prospects, they’ve a mean earnings a number of of 16x. If we apply 16x earnings to TerraVest’s estimated FY2023 earnings of $3.04, then we arrive at a price of $49 per share, which is an inexpensive short-term goal. If we use a 15% seven-year progress fee, then we arrive at a price of $113.58 per share. This leads to a five-year IRR of 32%.

Progress Framework

One other method to take a look at progress and the valuation of corporations is to estimate the EPS 5 years into the long run and see how a lot of immediately’s value incorporates this progress. Utilizing the identical income described above leads to a 2027 EPS of $6.25, or 4.5x the present value. If we assume a steady-state progress fee from 2026 on of seven%, then this leads to a good worth Graham a number of of twenty-two.5x or $140.71 per share, just like the five-year-forward valuation above of $113.58 per share.

Comparables and Benchmarking

Under are the gasoline containment and storage and pure fuel processing tools corporations positioned in america and Canada. Most of TerraVest’s opponents are personal corporations. In comparison with these corporations, TerraVest has debt on the low finish of the vary and has higher progress prospects and a below-average a number of. TerraVest additionally has the best RoEs and the best five-year progress charges.

Click on to enlarge

Dangers

The first dangers are:

• slower-than-expected acquisition progress (presently projected to be 50% of the historic acquisition progress fee);
• lower-than-expected progress in TerraVest’s finish markets of pure fuel and oil processing, storage, and transportation and HVAC tools alternative (presently projected to develop at 2% per 12 months); and
• an absence of recent funding alternatives (mergers and acquisitions) coupled with increased inventory costs making buybacks much less accretive.

Potential Upside/Catalyst

The first catalysts are:

• higher-than-expected acquisition progress;
• sooner progress in TerraVest’s finish markets; and
• elevated native scope or buy of native scale in new markets.

Timeline/Funding Horizon

The short-term goal is $49 per share, which is nearly 75% above immediately’s inventory value. If the continued acquisition/consolidation thesis performs out over the following 5 years (with a ensuing 15% earnings per 12 months progress fee), then a price of $125 (midpoint of the 2 strategies described above) may very well be realized. It is a 35% IRR over the following 5 years.

Disclaimer

This letter doesn’t comprise all the data that’s materials to a potential investor within the Bonhoeffer Fund, L.P. (the “Fund”). Not an Supply: The data set forth on this letter is being made out there to typically describe the philosophies of the Fund. The letter doesn’t represent a suggestion, solicitation or advice to promote or a suggestion to purchase any securities, funding merchandise or funding advisory companies. Such a suggestion might solely be made to accredited buyers via supply of a confidential personal placement memorandum, or different comparable supplies that comprise an outline of fabric phrases referring to such funding. The data revealed and the opinions expressed herein are offered for informational functions solely. No Recommendation: Nothing contained herein constitutes monetary, authorized, tax, or different recommendation. The Fund makes no illustration that the data and opinions expressed herein are correct, full or present. The data contained herein is present as of the date hereof however might turn out to be outdated or change. Dangers: An funding within the Fund is speculative as a consequence of quite a lot of dangers and concerns as detailed within the Confidential Non-public Placement Memorandum of the Fund, and this letter is certified in its entirety by the extra full info contained therein and within the associated subscription supplies. No Advice: The point out of or reference to particular corporations, methods or devices on this letter shouldn’t be interpreted as a advice or opinion that you need to make any buy or sale or take part in any transaction.

Editor’s Word: The abstract bullets for this text have been chosen by Searching for Alpha editors.

Editor’s Word: This text discusses a number of securities that don’t commerce on a significant U.S. change. Please concentrate on the dangers related to these shares.