TerraVest Industries (TSX:TVK)
An Underappreciated Serial Acquirer of Niche Industrial Businesses
TerraVest (TSX:TVK) is a diversified industrial company serving predominantly the energy, agriculture, mining, and transportation end markets for commercial and residential use. In summary, the company is an acquirer of boring, niche industrial manufacturing and service businesses based in North America. The company has been written up several times in the public domain, however, TerraVest generally flies under the radar given that the company does not maintain an investor relations function, has no sell side coverage, and is a relatively small company (<C$700M market cap). To keep this write up short and sweet, I will direct you to other write ups to familiarize yourself with TerraVest’s underlying business, and will focus this write up on the company’s excellent capital allocation track record and why I think the company’s current share price represents an attractive entry point. In summary, at just 8.4x TTM PF FCF, you are buying a consolidator of industrial businesses that generate GDP-type growth and an incentivized and aligned management team with an exceptional track record of redeploying nearly 100% of cash flow generated at a ~20% ROIC.
Other Write Ups:
Guy Gottfried
Bonhoeffer Capital Management (starts on page 10)
Capital Allocation Track Record:
Since taking over as President and CEO in March 2017, Dustin Haw has tone a terrific job of creating shareholder value, with the company’s share price increasing ~4x in 6.5 years. Under his tenure, revenue, Adj. EBITDA, FCF, and net income have compounded at impressive rates (+20% on an absolute basis and ~25% on a per share basis).
This compounding has been achieved almost entirely through a series of acquisitions (underlying businesses generate low single digit organic growth). Since FY18, the company has completed 10 acquisitions, with deals generally getting done at less than 5x after-tax free cash flow. Over this period of time, Return on Incremental Invested Capital has been ~17%, and Return on Incremental Equity has been ~31%.
As outlined below, the company has utilized 62% of its cash on growth capital (acquisitions and growth capex), with the balance used towards share repurchases (15%), dividends (15%), and investments recorded on the company’s balance sheet (8%). Notably, acquisitions and growth capex of $185M exceeded the company’s CFO of $168M, highlighting management’s ability to deploy more than 100% of its operating cash flow into reinvestment opportunities with attractive rates of return.
Current Valuation:
Pro forma for TerraVest’s acquisitions of Highland Tank and LV Energy Services, the company is currently trading at a FCF multiple of 8.4x.
Footnotes:
Highland Tank acquisition was completed on 01-Nov-23 for US$78M. Acquisition metrics converted to C$ at $1.35 FX rate. Assumed to be 100% debt financed (US$5M equity roll by seller ignored for simplicity).
LV Energy Services acquisition was completed on 03-Nov-23 for C$25M. Assumed acquisition multiple of 4.0x EBITDA (in line with disclosed multiple of Highland Tank). Assumed to be 100% debt financed.
D&A for each acquisition has been assumed to be in line with TerraVest’s consolidated company maintenance capex as a % of Adj EBITDA (11%).
Acquisitions assumed to be fully debt funded at 8% interest rate (approx in line with company’s current interest rate). As mentioned above, US$5M of the Highland Tank acquisition was funded with equity, but that has been ignored for simplicity.
24.5% tax rate assumed, in line with TerraVest’s consolidated tax rate for the 9 months ended 30-Jun-23.
Illustrative Forecast:
I have put together an illustrative forecast to demonstrate the power of continued compounding. Key assumptions in my forecast include:
Organic growth of 2%
Capital allocation: 75% of FCF used for acquisitions, 15% used for share buybacks, and 10% used for dividends
Simplistically assumes acquisitions completed on first day of fiscal year
Acquisition multiples of 5x after-tax FCF
According to Guy Gottfried’s 2019 presentation, pre-tax acquisition multiples have averaged ~3.5x, or ~4.5x on a post-tax basis at a 24.5% tax rate
Company valuation multiple of 12x FCF
If the company continues to compound FCF/share at +20% over the next 5 years, I think a 12x FCF multiple will prove to be very conservative. Successful compounders / growth by acquisition businesses typically trade at multiples exceeding 20x FCF
Over a 5-year period, the forecast implies an IRR of 28% and MoC of 3.3x, and over a 10-year period, the forecast implies an IRR of 24% and MoC of 7.8x.
As outlined above, by continuing to use the lion’s share of the company’s FCF to acquire other businesses, the company’s FCF/share would grow at a 19% CAGR, which is conservatively below what the company has achieved over the last 5 years (+25%). In addition, using debt incremental to the company’s CFO to fund acquisitions (as done in the past) would represent an additional source of upside to the forecast. If the company manages to continue to grow FCF/share by 25% (in line with last 5 years), then the 5-year and 10-year IRR would grow to 35% and 30%, respectively. Per the model, this outcome can be achieved through the combination of utilizing 100% of FCF for acquisitions and lowering acquisition multiples from 5x to 4.5x. At the end of the day, I recognize that this is just spreadsheet math, but given the company’s track record, an upside scenario like this isn’t totally inconceivable.
Of course, as with all growth by acquisition businesses, the two big questions are always (i) how long is their acquisition runway, and (ii) will the company maintain pricing discipline as they scale. So far, I have no reason to believe the company’s acquisition runway is short. TerraVest is still a relatively small company, so starting from a small base helps, and on top of that, the company’s core and adjacent markets are large. In terms of pricing discipline, the company just completed its largest acquisition ever - Highland Tank - adding ~25% to the company’s consolidated EBITDA at a 4x EBITDA multiple. Pretty nice! Will they have to pay bigger multiples as they grow? Probably. In lieu of completing bigger deals, can they complete a series of smaller acquisitions while maintaining pricing discipline? Probably. That said, even if you bump the company’s acquisition multiple in the above forecast from 5.0x FCF to 8.0x FCF, 5-year IRR still remains attractive at 22%.
One of the points I am trying to emphasize is that you don’t need to rely on Dustin Haw becoming the next Mark Leonard or Nick Howley to have this investment work out. Although it’s worth pointing out that so far, Dustin has shown an excellent aptitude for capital allocation, and has demonstrated some nice CEO compounder bro qualities (decentralized organization, lean HQ, redeploy majority of FCF on acquisitions, minimize dividends, no time dedicated to investor relations, etc.). Being able to buy TerraVest at a ~12% yield (or 8.4x FCF) offers excellent downside protection for a company that’s been compounding FCF/share by +25% over the last 5 years. As gravy, if the company continues to redeploy nearly all of its FCF at attractive returns over the next 5 years, the investment could turn out to be a home run.
Management and Incentives:
In short, insiders (board and management) collectively own ~25% of the company. Nice insider alignment. In addition, management has been disciplined with dilution, with total shares outstanding declining by ~12% over the last 5 years.
Although Dustin Haw took over as President and CEO in 2017, he has been a member of the board since 2014. Mitchell Gilbert, the company’s CIO, has been with the company in his role since 2013.
Risks:
Pricing discipline on acquisitions slips
Deal flow dries up
Downturn in any of TerraVest’s core markets
Disclaimer:
Please note that the above write up does not represent investment advice and has been presented for information purposes only. The information contained above has been prepared based on publicly available information and independent research. The author does not guarantee the accuracy or completeness of the information provided in this document. All statements and expressions herein represent the author’s own opinion and are subject to change without notice. This write up should not be relied upon as a basis for investment.
Excellent work thank you