North American Construction Group Ltd.

Nov 9, 2023

All in CAD unless specified otherwise.

On the shoulders of giants

NOA gets decent coverage on the Internet but nothing too crazy.

  1. VIC

  2. Discussions by Keith Smith:

  3. Manana Investing writeup

Great writeups and discussions save time. 

This is just an exercise of writing down my thoughts and observations which hopefully have minimal overlap with what had already been said.

Valuation

I’ll use TIKR numbers for LTM and the company's guided numbers for FY2024. This is not ideal but works.

Share price                             $27.90
SOI                                         26.7m
Equity                                     $744.9m

Cash                                        $40.4m
Credit facility                           $200m
Equipment financing                $77.4m
CDs                                         $129.8m
Mortgage                                 $28.6m
Net debt                                  $395.4m
EV                                           $1140.3m

LTM numbers
EBITDA                                   $206.4m
FCF                                          $45.4m
EPS                                          $2.35

Earnings multiple                      10.9
EBITDA multiple                        5.8
FCF multiple                             17.2
FCF yield                                  5.8%

FY2024 guidance (lower end)
EBITDA                                   $430m
FCF                                         $160m
EPS                                         $4.25

Earnings multiple                     6.7
EBITDA* multiple                     3.2
FCF multiple                            4.8
FCF yield                                 21% 

*EV = current MC + projected net debt leverage of 1.4 times lower end of EBITDA guidance

NOA’s adjusted numbers are a little too skewed to the positive side. However, even if we re-adjust their guidance using the ratio of TIKR numbers to what they report in presentations we roughly get PE of 7.1, EV/EBITDA of 3.7 and MC/FCF of 6. Let’s not forget the convertible debentures which would add 6 million shares to the register but would clean $130m worth of debt. 

Clearly, market just doesn’t believe the guidance. Company doesn’t have a history of overpromising and underdelivering. On the contrary, they often raise guidance, latest quarter included. I am not sure why market is so skeptical. Some conservatism is definitely warranted given how large the MacKellar acquisition is. However, giving zero trust to management numbers (which I believe current valuation implies) is a little too much of doubting Tom.

Another theory is that market believes these numbers belong to an over-earning bucket and soon in the future (2025, 2026) the revenues and earnings will fall off a cliff due to mine life expiries. This is a valid theory but I expect the demand to only grow in the near future. More on that later.

Management

These guys are really good at what they do, they are what one would call problem solvers. Buying new trucks is expensive - let’s try repairing old ones. Outsourced maintenance cost is high - let’s repair them in-house. Trucks break suddenly - let’s implement telematics. Not enough qualified mechanics - let’s create an apprenticeship program and train internally. Stock is down on transitory issues - let’s buy back a ton of shares.  

As a result of actions described above, we get the following numbers. NOA went from earning 17 cents per share in 2017 to $2.61/share in LTM while share count only increased by 7%. If the company hits their 2024 guidance EPS will be $4.25/share. This means the company will have increased earnings per share 25-fold in 8 years with minimal dilution. Since 2017 to date they more than doubled ROIC (now approaching mid double digits) and more than 6x-ed ROE (23% LTM). 

Martin Ferron has taken some chips off the table recently but still has more than 2 million shares invested in the company. Joe Lambert, current CEO, has more than 300,000 shares. Alignment is here.

Top-down

The following are considered to be competitive advantages of the business: low-cost service provider, ability to operate in harsh climate, indigenous people partnerships. While these are certainly important, I think whether the company will be able to continue to generate high ROIC depends a lot on the energy market. Yes, they diversified a lot from oil sands but the segment is still almost half of the revenues (shooting for 35% with MacKellar). Oil crash in 2014-2015 negatively impacted the entire ecosystem, NOA included.  

It is a known fact that fossil fuels sector has been undercapitalized for years while renewables and ESG folks have been placed on a pedestal. Well, reality is starting to sink in now that free money is gone.  We are starting to see more and more articles about how wind and solar projects are delayed, struggling or canceled altogether. In the meantime, coal consumption worldwide keeps hitting new highs and supermajors Chevron and ExxonMobil just finished their monstrous acquisitions indicating their bullish view on oil.  

Heavy equipment manufacturers:

  1. Caterpillar, US, EV US$150b. LTM revenue - US$63b
  2. Komatsu, JP, EV US$30b. LTM revenue - US$25b
  3. Hitachi Construction Machinery, JP, EV US$9b. LTM revenue - US$9b
  4. Liebherr, German-Swiss JV, private. 2019 revenue - EUR 12b.
  5. Volvo Construction, Sweden. 2022 Revenue ~ US$6b
  6. Doosan (acquired by Hyundai), Korea, EV US$1.2b, LTM revenue - US$3b
  7. JCB - J.C. Bamford Excavators Limited, UK, private. LTM Revenue - US$7b

All of these guys are signaling a rise in demand for their large machines. But the thing is that 200-ton and 400-ton haul trucks are not produced by millions a year. This is not a Toyota Camry. The count is in thousands. Should demand from mining and construction companies increase sharply, supply remains very limited.

Company added the following peers slide in their Q1 2022 deck:

I wouldn’t call any of these guys a true peer to NOA - many of them have various divisions, many are involved in construction and infrastructure industries. Closer peers would be Finning (FTT), Ashtead (AHT) and Emeco (EHL). Regardless, all of them are talking about a bright future, huge backlog of projects and increasing demand. 

Much loved (deservedly so) among investors Mader and Duratec are very bullish on the future as well. Obviously, these are not direct peers, but I’d say they go to the same high school as NOA.

All of the above is a complicated way to say that it is good to have competitive advantage but it’s even better to be in the industry with tailwinds.  

MacKellar

Interestingly, one of the peers mentioned - Emeco - operates in Australia and has been struggling a lot. I wonder if they were losing business to MacKellar. 

MacKellar seems to be a private business with great culture. Why? Well, when an 88-year-old founder still comes to the office every day and some employees work there for more than 20 years I think the word “culture” for once means something in this company. They are quite active on LinkedIn and share a lot of company news consistently but they never published the news about being acquired by NOA. I find this interesting.

It took two and a half years of due diligence and negotiations to acquire MacKellar so it was by no means a rush decision. Acquisition was supposed to be closed in November but the deal was actually finished on October 1st. I think it is a very good sign. You don’t see many deals done ahead of scheduled time in the modern day and age.

Bottom line

Stock is worth double today’s price.