In a recent interview with Brian Pow, vice-president and equity analyst from Acumen Capital Financial Partners Ltd., he discussed his positive outlook on four stocks for the year ahead: Park Lawn Corp., Hardwoods Distribution Inc., Andrew Peller Ltd., and Pollard Banknote Ltd.
Below are highlights from our conversation.
Before we delve into your picks, what is your criteria for your stock recommendations?
How we approach it is that we’re really looking for top-line growth and bottom-line growth. We really like to see a minimum of 10-per-cent top line and 10-per-cent bottom line growth, and that’s year-over-year growth. Some of the names are not necessarily achieving that all of the time, but there’s consistent year-over-year growth. [In addition], in most cases, the companies really have strong balance sheets. So, it’s not like they’re necessarily in need of the capital markets immediately to help them support their growth strategy. The common thread is that they’re very good allocators of capital.
Your first top pick is Park Lawn Corp. (PLC-T), which owns and operates funeral homes, cemeteries, and crematoria across Canada and the United States. What is your investment thesis?
It’s really a growth through consolidation story. It’s an industry that’s mature. It’s very fragmented with a large number of independent operators, and we have aging demographics so there is a natural trend in demand for the services they provide. You have aging operators who are looking to monetize the businesses they’ve established. You have two things driving growth. You’ve got organic growth naturally just because of the demand from population aging, and then you have acquisition opportunities just because of aging owners. Thirdly, there is a little bit of natural inflation in the business.
You are forecasting over 20-per-cent upside potential.
$23.75 is the target price using a 17 times EV/EBITDA [enterprise value-to-earnings before interest, taxes, depreciation and amortization] multiple on 2018 EBITDA. The stock looks relatively expensive on our 2017 estimates, roughly 19.4 times, but when you take into consideration acquisitions that they just had just announced in June of this year and actually just completed at the end of September, [based on] my 2018 numbers, [the multiple] goes down to about 13.5 times.
Strategic acquisitions are growth opportunities for the company. Where is management focused?
In Canada, there isn’t a lot of larger operations. so it would more likely be to bolt on to existing locations or operations. In the U.S., there is certainly some bolt on opportunities. There are areas that they would like to continue to expand in, like the Midwest if opportunities come up.
Since the company announced the Saber Management LLC acquisition and the corresponding bought deal financing in June, the stock price has paused from its upward momentum. What is going to resume its upward trajectory?
If you look at the valuation today, people haven’t fully integrated the acquisitions into their outlook. I think what will do it is if they continue to show positive organic growth trends and then they start demonstrating the benefits of the acquisition, and those will come out. You will see a bit in the numbers this year, but it’s really [as[ the 2018 numbers start rolling out [that] you start seeing the year-over-year comparatives, people will really get the idea of the scale that the business is growing.
What are your expectations for the upcoming third-quarter financial results?
I think its one of these quarters where maybe the activity in the industry hasn’t been as strong as normal. In talking to the company, there were very few deaths believe it or not in Toronto, so I think it’s going to be an underwhelming quarter to some extent.
Do you think the stock price may pullback then with the release of the quarterly results ?
I don’t think so because I think there is enough positive momentum behind the whole business. They will be able to give some outlook with what is happening with the acquisitions. I think they’re confident enough. They’re going to be hosting a conference call this quarter, which will be the first one for them, so I think they have some confidence to talk to the business as a whole and the macro trends that they are enjoying.
Your second stock recommendation is Hardwoods Distribution Inc. (HWD-T). B.C.-based Hardwoods is a distributor of hardwood lumber and wood-related products with distribution centres across North America. The stock is trading near an all-time high. Can you comment on the valuation?
So our target price is $24 and it is based on a combination of EV/EBITDA and DCF [discounted cash flow analysis]. So with the stock currently just over $20, [there is approximately] 18.6-per-cent upside [total return] and that includes the quarterly dividends, which is yielding about 1.4 per cent.
Why the strong conviction?
It’s all relating to housing starts in the U.S., more so than Canada because the U.S. is a bigger part of their business. They’re sort of the dominant player in North America with about 10-per-cent market share, which gives you an idea of how fragmented the market is. They’re well capitalized, they’re strong executors, very much good allocators of capital, and they’re riding the trend of, I’m gonna call it, the recovery of the housing market in the U.S., and then [there have been] recent acquisitions, [Rugby Architectural Building Products] was the one they did last year. That one really expanded their business into the commercial construction side so that gave them broader exposure to the whole economic recovery that is taking place in the United States.
Will further acquisition focus on the commercial construction side?
Much like any business, it’s what opportunities come up. I think they want to expand their footprint, maybe fill in parts of the market that they are not in today, in California they are probably under covered. It’s all trying to focus in on housing markets that are stronger so that’s southern U.S. and some of the northeastern U.S. markets that they haven’t necessarily been very well penetrated in.
With them sort of being one of the leaders and [yet] only have a 10 per cent market share, [this] gives you an indication that there are lots of opportunities for acquisitions.
Is the stock vulnerable to a pullback with interest rates heading higher?
I think it would respond, like anything else, but I think the real indicator you are looking at is [U.S.] housing starts, and the inventory in the U.S. is still well below the historical levels. To get the housing starts back to the level pre-2010, you need to have it pick up to 1.5 million starts. It has to be a lot higher. It’s around 1.2 million on a trailing 12-month basis and historically has been as high at 1.5 million on a 12-month basis.
The stock offers investors a conservative dividend yield of approximately 1.5 per cent.
The priority of allocation of capital is they want to make sure they have a clean balance sheet, or reasonably clean balance sheet, so that they can do further acquisitions. At the end of 2016, which was the year in which they completed Rugby, they had 2.1 times net debt-to-EBITDA, we’ve got them exiting 2017 at about 1.7 times. I think a comfort level for them [is that] they’ll go north of 2 [times] with the right acquisition but realistically I think they’d rather be closer to 1 times on a run rate basis.
What are the key downside risks to consider?
One, if we saw drastic interest rate hikes, I don’t see any execution risks. I think competitively they are well positioned. Two, it’s a thin margin business so if they lost their cost disciplines then you can certainly see that hurting their business, but we haven’t seen any reason to believe that would happen.
Last quarter, the company reported solid numbers and the stock price rallied sharply the following trading day. What are your expectations for this quarter?
We sort of expecting high single, low double-digit top line growth for the business, and we expect margins to hold and carry through that would probably result in fairly reasonable growth.
Ontario-based wine producer Andrew Peller Ltd. (ADW.A-T) is a stock you believe will offer investors attractive returns.
They’re focused on high grading the portfolio. Their focus is to increase the quality of the brands. They’ll thin out lower margin, lower demand SKUs [stock keeping units]. So they’ll have fewer SKUs, but the SKUs that they’re selling will be at a higher price point. They see growth organically coming from focusing in on revenue per litre, so trying to improve their revenue per litre, and then they also see growth opportunities through acquisitions and they just completed some acquisitions. It’s an industry that’s really growing in the low single digits and they’re sort of growing in the mid single digits.
What’s the end game? Will it be like Vincor International Inc. that was acquired by Constellation Brands Inc. years ago?
If you spoke with John Peller, there’s no immediate end game. It’s a business they’re proud of. It was his grandfather who started it. I think the end game is to be the No. 1 VQA [Vintners Quality Alliance] provider in Canada. They have moved themselves from number three to number one in BC with these acquisitions.
On the conference call, the chief financial officer mentioned that the three wineries purchased would be dilutive to earnings in fiscal 2018 and fiscal 2019. Could that cause the strength in the share price to pause because you are seeing a deceleration in earnings?
At the end of the day, the EBITDA will be trending positively. The top line revenue is going to grow from the acquisitions as well.
Your target price is $14 based on a blended EV/EBITDA and DCF analysis, using a multiple of 11.7 times your fiscal 2019 ?
What are the catalysts that will lift the share price higher?
I think the catalyst is when the quarterly results come out in early November. We’ll a good update on some of their premium products. In particular, their Wayne Gretzky brand has been exceeding expectations. I think those read thoughts into that business will be positive and then I think you’ll get some better indication of what these acquisitions can bring to the table.
Is there room for margin improvement, improved profitability ?
There is room to expand. Again, that comes again from what we spoke about [by an] increase [in] revenue per litre. The other way it comes is that they’ve really been focused in on driving costs out of the system, so if you sort of look at the numbers over the last number of years, they’ve driven more than a million dollars of costs out of their bottling.
An example is of the three wineries they bought, only one of them had bottling capabilities. The other two would effectively be dependent on a mobile bottler coming to their facility so their sort of paying for that extra service. Whereas, on a go-forward basis, they will effectively be able to bottle [wine] internally, so there is some procurement opportunity.
In your financial model, what do you have the margins expanding to?
Well, in the first year, we’ve effectively got about 90 basis points of improvement on the EBITDA margin from 13.1 to 14 per cent in fiscal 2019.
Let’s turn to your final stock recommendation, Winnipeg-based Pollard Banknote Ltd. (PBL-T), a leading provider of lottery products. You just increased your target price to $17, why?
Since we last updated it in August, we’ve seen some good business activity. I think we felt we sort of underestimated the potential organic growth from their new printer. Overall, directionally, we just like what the business is doing right now. They did an acquisition of INNOVA Gaming Group Inc, and I think that has the potential to provide some upside surprise. We’re using a factor of 9.6 times on our 2018 EV/EBITDA and arrived at a $17 target.
Why should investors consider owning this stock?
They are one of the leading players in the industry. They have two other competitors, one of them larger than them, the other a little bit smaller. This is a global industry, a $276-billion industry. [From] 2015 to 2019, we see a CAGR [compound annual growth rate] of about 9 per cent for the industry, and that growth needs to be serviced. Pollard spent about $25-million building a new printing press that is state-of-the-art, leading edge, and it’s allowing them to win some key contracts and get renewals on some key contracts as well.
Are there sizeable up contracts coming up for renewal?
They have sort of gone through the ones that were of relevance. We don’t see any major contracts for renewal in the coming year . There are some coming up over the next 18 months. Most of them are ones where they don’t have contract in place or they’re not the primary supplier, so there could be upside surprise on those ones.
I think really what you are going to see is with the scale they’ve introduced into their business from this printing press, your gonna see further efficiencies driven out of that, your gonna see top line growth driven just because they have the capacity and they didn’t have the capacity before, plus your gonna see efficiencies come from just executing better and better with that machine.
What are the major risks to consider ?
There is certainly currency risk. Stock liquidity would be another one. Because there are large contracts involved, part of it is timing of revenues, and we saw that at the beginning of this year. When they get larger orders from customers, if the orders don’t get shipped within the quarter, (that) can swing things. So if we look at this year, Q1 (first quarter) was a miss against what people were looking for and then 2Q (second quarter) was this tremendous beat. So people just can’t judge the story totally by every quarter, you have to look at it more on a six to 12 month basis to understand directionally where the business is going and if you did that you’d see there’s some pretty substantial year-over-year growth taking place.
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