There is not much to read out there about Atlas Engineered Products. The company doesn’t even have a website (EDIT – now there is a website). But in that lack of information lies an opportunity for investors to get in on the ground floor of what should be a very successful capital compounding story.
Atlas manufactures roof trusses in Nanaimo, BC. The business was started by Hadi Abassi, an Iranian immigrant who seems to be a polarizing figure in the world of junior football. Mr. Abassi is staying on as the CEO, and the skill he has shown building the business hopefully translates now that the company is aggressively expanding. On Vancouver Island alone, roof trusses are a $30 million market, of which Atlas had about 27% market share. Atlas began trading publicly via RTO, in order to consolidate a very fragmented truss industry in Canada.
The president of the company is now Guy Champagne, who seems to have a long history as a businessman in BC, and Guy looks like he will be the face of the company going forward. On that note, here he is doing an interview, which as I write this has 98 views, let’s see how much it has after I promote it!
I think the easiest way to evaluate Atlas right now is to look at the financials Atlas released for the first quarter of fiscal 2018, then look at the first two acquisitions, and try to combine them to predict what the pro forma company looks like at this moment.
Atlas publicly released earnings just once, and I was quite impressed. Revenues were up 40% YoY, and net income was up 13% after taking off high professional fees related to the RTO.
In fiscal 2017, revenue was $8 million, and the RTO filing statements states that there is no seasonality to the business. Annualizing Q1’s revenue would imply almost $11 million of revenue, but I’ll assume $10 million in 2018 sales. EBITDA was $556,811 in Q1. At a 10% net margin and 15%, this obviously gives us $1 million in earnings and $1.5 million EBITDA. These should be sufficiently conservative assumptions.
Selkirk was the first acquisition Atlas announced. Located in mainland BC, it represents a geographical expansion.
We don’t know much about the company or the financials yet, but based on the purchase price I’m going to assume Selkirk is not very profitable. The original payment is $150,000 in shares. For a company with ~$2 million of revenue that is not much, and is what tells me Selkirk isn’t well run at the moment.
In addition to the original payment, there are possible incentive payments depending on earnings milestones.
- Another $200,000 if Selkirk earns $150,000 in fiscal 2018 (I assume fiscal year will be calendar year for Selkirk as the deal will close December 31st).
- Another $200,000 if Selkirk earns $400,000 over 2 years.
- And yet another $200,000 if Selkirk earns $1.1 million over 3 years.
All of the payments are in the form of Atlas shares. I’d rather they be cash payments, but this is a very minor quibble. For such a small purchase it is likely inconsequential.
As you can see, the worst case scenario is Atlas acquires Selkirk for 2.75x earnings (if Selkirk hits the first 2 incentives). That’s a very accretive deal if Atlas can squeeze any profits out of Selkirk. Any assumption of what the final purchase price or future profitability of Selkirk would be absolute guesses, so I won’t assume any earnings. For the purpose of the current state of the company, I’ll guess that Selkirk contributes $2 million in revenue and no earnings. As Selkirk adopts Atlas’ best practices, or Atlas invests in the business, margins should improve.
It’s also possible that Selkirk isn’t as without hope as I guess. If I was selling my business, I likely wouldn’t sell it for 0.075x sales. The owner of Selkirk must be fairly confident that they will be receiving at least one or two of the incentive payments.
Clinton Truss is the acquisition that gets Atlas into Canada’s other hot housing market, Ontario. Clinton is roughly 3 hours from the epicenter of real estate insanity, Toronto, but 60-90 minutes from Kitchener-Waterloo and London, both of which are among the more desirable housing markets in Ontario.
Clinton is a much better company, and as such commanded a higher purchase price. But the deal is still very reasonable.
While the press release again did not provide many financial details, one helpful Twitter user found what seems to be a business listing for Clinton. Revenue is over $3 million, and the business “cash flows” $500,000. The purchase price all told is $2.6 million, which includes $140,000 of shares and $10,000 monthly payments for the next three years, in addition to the initial $2.1 million cash payment.
If we discount the “cash flow” by 40% (who knows how accurate that number is or what expenses it excludes, and this would be 10% net margin), then this deal is done around 8.7x earnings. The deal includes $350,000 of inventory, as well as 5 acres of land, the plant, office and all equipment.
Clinton’s sales and profits grew 35% in the last year. It should be conservative to assume that Clinton will provide Atlas $3.75 million in revenue. Even though earnings seem to be higher than this already, let’s assume 10% net margins and 15% EBITDA margins as Clinton increases marketing, sales activity, and hires more labour help. This puts us at $375,000 of earnings and $562,500 EBITDA.
Clinton should also show us what sort of value Atlas can add to its acquisitions. The company has been growing at such a high rate without marketing, with almost no owner involvement, and without a sales rep. The listing also seems to imply that the business has been turning down work. All of this hints at Clinton’s potential being much higher, and the potential being relatively simple to realize. I think in fiscal 2019 Clinton could very easily do $5.5 million revenue or more. But my thesis doesn’t rely on that upside.
Atlas Pro Forma
Adding these companies I calculate a run rate of $15.75 million in revenue and $1.375 million in earnings.
As of right now, guessing how many shares will be issued as part of the current acquisitions, Atlas is sitting at 33 million shares outstanding fully diluted. I’ve pieced this number together from a number of sources, so it could be off by a couple hundred thousand. But this should be immaterial. Using this number, and today’s closing price of $0.67, Atlas’ market cap is $22,110,000. This is roughly 16x my predicted 2018 earnings. For a company growing organically at 20+%, this is a fair value.
If EV/EBITDA is more your speed, the enterprise value is about $21,220,000, and with our assumed 15% EBITDA margin, this puts Atlas at 9x EV/2018 EBITDA.
The Goal of Atlas
The team at Atlas has stated their goal is to grow to be a $5o million revenue company in three years.
From what I’ve seen, this really should not be too hard to achieve. If Atlas did not make another acquisition, but continued growing organically at 20%, Atlas would have sales of $27.2 million in three years. Just one acquisition of $2 million sales per quarter would bring Atlas to over that goal. At least when it comes to this first company goal, I am willing to take them at their word.
He also states that ideally Atlas would be a $150 million company in five years. I like the ambition, and I could come up with numbers that make that goal seem reasonable, but I don’t think I’d be conservative in doing so.
The risks are easy to see with Atlas. I’ll list a few with some commentary on their likelihood:
- This is yet another investment that depends on housing, particularly housing on Vancouver Island and in Southern Ontario. This is a real risk. I won’t speculate on the likelihood of of a housing market correction, but there would likely still be new houses being built. It likely would halt growth, possibly reduce sales and margins. This is the biggest risk, one I am having trouble quantifying.
- I’ll admit it, I’m deathly afraid of dilution. At one time I held shares of Crescent Point Energy, ‘nuf said. Looking at the first two acquisitions, I don’t get the sense that Atlas will issue an inordinate amount of shares, but management doesn’t have much of a track record to get an idea of their thoughts on capital allocation. Right now all I have to go off of is the first two acquisitions, so right now I like what I see. But it is possible Atlas issues shares out the wazoo, so I consider that in my predictions.
- Eyes bigger than stomach. Who’s to say that Atlas can be successfully spread out to Ontario, having only operated on Vancouver Island? It’s a possibility that Atlas can’t digest these acquisitions well, which would most likely impact sales growth and increase expenses. There will also come a time when Atlas moves into other products where they have less expertise. This carries risk as well, though it should be a few years down the road.
- While it’s easy to say trusses are a fragmented industry, are there actually a lot of small companies out there that can profitably grow Atlas’ business?
- Will costs be managed now that the company is public? For instance, Mr. Abassi will be receiving a salary of $250,000 plus $18,000 vehicle allowance. That could be considered a lot for a company I predict will only have $1.375 million in earnings next year. But it can also be seen as a bargain for a CEO leading an aggressive industry consolidation. This is in addition to other salaries that are going up, costs associated with being public, etc. The costs I’ve seen in the filings are nothing to write home about, but there could be a rise, it remains to be seen.
There are others of course, but those are the five risks that most worry me most.
I can’t say what Atlas should trade at now, but I do feel confident saying that in three years the share price will be much higher. How much higher will it be in 2021?
Atlas and the two acquisitions grow at 20% per year, Selkirk improves to 5% margins. Atlas price on January 1st 2021 – $1.16, 20.8% CAGR
This is the lowest I can imagine Atlas shares in three years, and an investment growing at 20.8% per year is definitely okay in my book. I’d be a bit disappointed based on Atlas’ potential but in absolute (and relative to market) terms it is a superior result.
More likely case
Atlas and the two acquisitions grow at 20% per year, Selkirk improves to 5% margins, future acquisitions add $1 million to 2021 earnings, Atlas issues 2 million shares for some reason, trades at 15 P/E – $1.46, 29.6%
I feel safe saying that this is more likely. There are also good reasons to say that I’m being too cautious with most of my assumptions.
Margin of Safety
When reading my numbers above, you may think “these numbers seem to make no sense”. You very well could be right, I deliberately tried to err on the side of caution.
- Atlas grew revenues by 40% in Q1 2018 with no reason to think it was a seasonal spike, and had high growth rates in previous years. I use 20% growth for Atlas.
- Selkirk – Based on the incentive milestones, I assume that Atlas can get Selkirk much more profitable than it is currently. Assuming 5% margins in three years should be low.
- In the business listing Clinton states that earnings and sales grew 35% without marketing, sales reps, or owner involvement. The listing says that Clinton turns down business as well as having 1/6th of a year’s revenues in already booked sales. I assumed 20% growth for Clinton. I also think I understated Clinton’s current earnings and margins.
- Between underestimating the growth at Atlas, Clinton, and the margins at Selkirk, I think a 20% growth rate for the proforma company is very conservative. It wouldn’t necessarily be crazy to assume earnings grow at 25%-30% organically in the next three years.
- For a company growing by at least 20% at the start of its growth runway, using a P/E of 15 is too low. If I was forced to compare Atlas to one of my holdings, it would probably be Stella-Jones, which also grows organically (sometimes) and by acquisition. Stella-Jones was growing at earnings at 16% and I was happy to pay 17x earnings, and that has turned out to be a good decision. Now SJ is widely known as a great company, but I think the point stands – Atlas is growing like crazy and has a lot of opportunities to continue growing at these rates for a long time. A PEG of 1 should be fair, and as such trading at 20x earnings should be fair. And remember that is understating growth still. It would be pushing the valuation a bit, but even 25x earnings likely wouldn’t be overvalued.
- My predictions don’t rely too much on acquisitions. Guy has stated that Atlas has NDAs in place and is actively looking at more acquisitions. While the rate of acquisitions isn’t going to be one per month going forward, it should be safe to guess Atlas can acquire ~$500,000 of earnings per year. Even that could be low, but I feel uncomfortable guessing any more than that.
- 10% net margins and 15% EBITDA margins could be too low. In the first quarter EBITDA was over 20% of sales, while earnings were just over 12%. Margins will suffer in the short term from these acquisitions, but over time should expand as the companies realize synergies, adopt best practices, and are able to raise prices. 12% net margins long term would still be conservative.
- While shares will likely be issued, 2 million shares is probably too high.
When taking all of these into account, I could make a “best case” prediction that I don’t believe to be crazy. If margins are 12%, earnings grow organically at 25%, Atlas trades at 20x, future acquisitions contribute $1.5 million to 2021 earnings, and 35 million shares are outstanding, Atlas would be $3.00. I’m not saying it’s likely, but if Atlas were $3.00 in three years I also wouldn’t be shocked.
Insiders and Other Notable Shareholders
As part of the RTO, Atlas shareholders were entitled to 25% of the now public company. Looking at the insiders summary and including options and warrants, it’s approximately 29%. If I’m at all right about Atlas’ prospects, I expect to see insider buying in earnest even with the already high inside ownership.
Another shareholder is worth mentioning: Brisio Innovations, which bought shares via private placement. For those unfamiliar with the company, this is a good explanation of. That post also takes a look at the other investments that Paul Andreola has made with Brisio. Paul’s track record should be encouraging, and it gives me a small bit of validation that I’m invested alongside him. Looking at the investments he’s made previously gives me a bit more hope that my $3.00 in three years scenario isn’t wishful thinking.
I feel I’ve rambled on long enough. My thoughts can pretty well be summed up as Atlas is growing a lot and the market hasn’t fully appreciated it yet. I’m usually very late to these parties (as can be seen by buying Stella-Jones in 2017 but watching it for like six years). Luckily even I can see the growth ahead of Atlas, and the valuation here is compelling.
Disclosure: I am long AEP, and plan to buy more.