$AEP Investment thesis

Atlas Engineered Products – $AEP.V

Atlas Engineered Products Investment thesis in a Nutshell

  • Serial acquirer in the Engineered Wood Products (EWPs) market: EWPs industry is highly fragmented, which is compounded with succession problems to create a perfect set up for a consolidation strategy.

  • Atlas has grown revenues at a 50% CAGR since 2016, coupled with significant improvements in operational performance: Atlas can leverage its size and financial resources to implement automation and achieve consistently higher margins than its peers.

  • Atlas is on a sweet spot, where it has managed to overcome past operating difficulties, and is now in a great position to capitalize on the consolidation opportunity.

Atlas Overview

Atlas Engineered Products (“Atlas”, “AEP” or “the Company”) is a small Canadian publicly listed company which designs, manufactures, and sells engineered wood products (EWPs). These mainly include roof and floor trusses, and wall panels. The Company follows a growth strategy, founded on two pillars. The first one is organic growth, via the introduction of new products, as well as cross-selling efforts to existing clients. The second pillar is inorganic growth. Atlas follows a roll-up model, whereby it intends to serially acquire smaller independent truss manufacturing facilities to create a national truss manufacturing company.

Atlas Engineered Products Background

Atlas was founded in 1999 by Hadi Abassi, current CEO and President, by buying an existing manufacturing facility in Nanaimo, BC. On November 9, 2017, Atlas saw the consolidation opportunity that existed in the industry and decided to go public to gain access to the financial resources needed to pursue this strategy.

During its first year as a public company, Atlas completed 5 acquisitions, including 3 of the 7 plants it currently owns. On October 2018, Dirk Maritz was appointed as CEO to manage the growing company, while Hadi remained as Director and advisor.

Atlas had some trouble integrating the 2018 acquisitions, and in the following years it continuously disappointed, with operational performance being an issue, and generating sales and EBITDA consistently below guidance.

In 2021 Hadi came back as CEO to try to turn around the company. Acquisitions were much slower during this period, which is explained by Atlas focusing on integrating the companies and securing robust operational performance.

Business Overview

Atlas has three main business lines:

  • Trusses: includes both roof and floor trusses, and accounts for roughly 76% of revenue.

  • Wall Panels: introduced in 2019, but still an insignificant revenue contributor. This is the line with the highest potential, and where organic growth may occur.

  • Engineered Products: any other EWP Atlas manufactures (I-joists, Laminated Veneer Lumber, etc.)

  • Design, Engineering and Permitting Services: Atlas works with developers and advises them on several fronts, such as regulatory and permitting issues.

Atlas revenue by product

Atlas’ main customers are single-family home builders and building yards. Atlas is able to work closely with property developers and sell them a wider range of products. Since relationships are key in this market, it is important for Atlas to work directly with developers to be able to establish long-term relations with them. The Company has an advantage over its smaller competitors regarding the supply to developers in two ways: first of all, it is able to offer a full lock-up package, providing all the elements from the roof and floor trusses to the wall panels. Secondly, Atlas is able to work with larger inter-state developers, as they can provide the same quality and design services across multiple locations in Canada.

Geographical Presence

Atlas has expanded from its initial Nanaimo facility to seven facilities across Canada as of today. It is present in British Columbia, Ontario, and Manitoba, with a more established business in the first two.

This geographical presence gives Atlas several advantages, one of the main ones being greater buying power. Atlas has supply agreements in place and is a more attractive customer to providers due to its size.

Having several facilities in relative proximity to each other allows Atlas to share resources between them, thus avoiding bottlenecks and allowing for a more efficient allocation of resources.

Lumber Prices Volatility. What it meant and current outlook

2020 and 2021 were characterized by high levels of volatility in lumber prices. We think of lumber prices affecting Atlas in two different stages. During the first stage lumber prices start going up. This puts pressure on margins, since the cost of materials increases, while Atlas is servicing contracts it had agreed to at lower prices. Over time, Atlas is able to transfer most of the price increases to its customers, thus achieving normalized margins again. The second phase sees lumber prices going down. This has the opposite effect as the previous phase. Atlas is servicing contracts that were signed at relatively higher prices, and is now sourcing cheaper lumber, which benefits margins. Atlas’ products then capture the decrease in prices, and margins normalize again.

Atlas was able to manage the volatile period of those years thank in part to int Vendor Managed Inventory program, which allow Atlas to maintain relatively high levels of inventory, and thus address the main concern during 2020 and 2021, which was not so much price, but rather securing supply. Atlas was also able to quote final order prices within a few days before actual delivery, which gave it great flexibility, and speaks of the relationship Atlas maintains with its customers.

Currently lumber prices hover around the $400/mbf mark, below the 2018-2023 median of almost $500/mbf.

Given this decrease in prices, we expect margins to come down as selling prices of Atlas’ products normalize. Going forward we believe margins will be more stable than in previous years, and likely at a higher level. This is likely the most important point to be aware of (evolution of margins). According to management, margins improvements are here to stay, and are in part due to increased automation and improved workflows. However, it is important to keep track of margins, to see how they evolve in a more normalized environment.

Engineered Wood Products Industry

Wood trusses are the main product of the Company. These are a key component of buildings in Canada, serving as support for roof and floor structures. They have a high strength-to-weight ratio, and are relatively cheap (around $10,000 USD for an average house, although with great variation depending on exact size, design, quality of materials and other factors).

Roof truss manufacturing is a 2 to 2.5 billion CAD industry, with over 200 independent manufacturers. These are usually small “mom-and-pop” shops, with annual revenues ranging from 3M to 15M CAD. Each facility is constrained in the area it can ship its production to, due to the relatively high costs of transporting trusses (trusses have low prices relative to their weight and volume, so long distance transportation is not viable). Each facility can ship its production to a radius of around 200 miles.

EWPs industry is highly cyclical, as is the housing market. Moreover, housing starts are characterised by a pronounced seasonality pattern, with winter months being much slower than warmer times of the year. This is particularly relevant in provinces such as Newfoundland and Nova Scotia, and less in British Columbia, for instance.

The slow pace of orders during the winter months damages the profitability of truss manufacturers, since they tend to take on lower margin jobs, just to retain skilled staff and keep the facility running.

Atlas Housing starts seasonality by province

Macroeconomic headwinds

2022 has been the year of rate increases, when virtually every “western world” central bank has raised rates in an attempt to bring inflation down. Canada’s Central Bank has raised rates to 4.5% as of January 2023. This has had a tremendous impact on Canada’s housing market, which came from a few years of constant (and fast) new home price increases. Recession fears started spreading among investors, suggesting a likely slowdown in housing starts in the near future. More recently these fears have dissipated somewhat, with market participants going from a view of “hard landing” to “soft landing” to finally “no landing”. Our view is that, absent an important economic shock, that seriously jeopardizes consumer spending, we will most likely experience a recession, although a mild one.

Housing starts, after a significant drop in 2022, are expected by ConstructConnect to rebound slightly during 2023 (more likely skewed towards the latter half), and continue upwards from there on, reaching 2021 levels by 2025. This is still to be seen, since a more severe recession than expected would be a very relevant headwind to housing starts during 2023.

Regardless of short term developments, we continue to believe that Canada faces a challenge regarding housing availability, and that underlying supply and demand dynamics remain supportive for the housing market. According to the Canada Mortgage and Housing Corp (CMHC), Canada would need to build 5.8 million homes by 2030 to satisfy demand. To put this in context, there are just 2.3 million units projected, and less than 300,000 housing starts in 2022.

$AEP Residencial construction Canada
$AEP total construction by province

Atlas Engineered Products Strategy

Atlas follows a growth strategy, with both an organic and an inorganic component.

M&A. Leveraging the consolidation opportunity

We commented above about the fragmentation of the EWPs industry. From 2018 to 2022, Atlas has completed 8 acquisitions, growing to 7 plants in operation today.

By acquiring facilities across Canada, Atlas gains economies of scale by being able to consolidate raw materials supply and implement more efficient standard workflows across its facilities. Moreover, it is able to share resources among facilities in the same area, which makes it more efficient. Atlas has an advantage over smaller independent owners, since it has access to financial resources that allows it to focus on automation and reinvesting money into the business, something smaller owners cannot always afford to do.

Atlas now has relevant experience in completing acquisitions, which we believe place it in a stronger position than before, as it is able to integrate new facilities more easily.

AEP has been relatively quiet on the acquisition front since the “buying spree” of 2018. This was due to a focus on streamlining operations and integrating the facilities, to create a robust company that would for the base for future acquisitions. With improved operational performance, and a robust balance sheet ($12.9M in cash), AEP is in an excellent position to continue its M&A strategy. As a final note, Atlas had some problems with its leverage in the past, breaching covenants a number of times. This will most likely not be an issue going forward, as it currently has a more flexible arrangement with TD Canada Trust, aside from the fact that it has a net debt of just $1M.

$AEP acquisitions

Organic opportunities

As described above, Atlas manufactures trusses, wall panels and other EWPs. Trusses are currently the main product. However, the Company’s view is to provide a full lock-up package, where they provide their full range of products to each project they work on.

Wall panels are the biggest organic growth opportunity for Atlas, which holds the potential of significantly increasing the ticket price for each project. One illustrative example is an actual hotel project that Atlas worked on. The roof trusses part of the contract amounted to $120,000. However, since it also delivered the floor trusses and the wall panels, the final ticket for the project was $750,000.

On average, roof trusses cost between $7,000 and $10,000 per house. The addition of floor trusses increases the total by about 70%. Including wall panels can drive the project ticket to $60,000.

However, Atlas has as of yet been unable to realize this opportunity, with wall panels remaining a negligible contributor to the overall business.

Management and Capital Structure

Hadi Abassi, CEO, president, and founder (6,263,409 shares held, 10.9%)

Mr. Abassi founded AEP in 1999 by acquiring a roof truss manufacturing facility in Nanaimo, BC. He is well known in Nanaimo and was also the founder of Coastal Windows (sold to AEP) and VP of Elite Image Software. He returned to the role of CEO of Atlas in February 2021. Mr. Abassi holds a mechanical engineering degree from Swindon Technical College. As a community leader, Mr. Abassi has been nominated citizen of the year on three occasions, was nominated by the Government of Canada to carry the Olympic torch and established the Vancouver Island Raiders football club in 2005.

Melissa MacRae, Chief Financial Officer (117,350 shares held, 0.2%)

Mrs. MacRae is a Chartered Professional Accountant. She provides direction for the Company’s financial operations and accounting, financial planning and analysis and information technology. Her path within the company began as the in-house accountant in 2012, when AEP was a private entity, and since then she has honed her skills in strategy and financial leadership. These qualities have led to her consistent promotion to the positions of Group Controller, Director of Finance, Interim CFO, and now CFO.

Gurmit Dhaliwal, Chief Operating Officer (1,568,480 shares held, 2.7%)

Ms. Dhaliwal is in charge of the development of the operational strategy for all locations. She has been with AEP for almost 20 years and has been instrumental in driving the growth of the company from a small private entity to a public company with a national footprint. She has a track record of making strategic and profitable decisions. These strong leadership and operational skills have resulted in her promotions from Operations Manager, at AEP’s flagship location in Nanaimo, to Vice President of Operations, and now to COO. Ms. Dhaliwal is a results-oriented leader who has helped AEP achieve increased revenues, profitability, and productivity while developing and supporting the operational teams.

Management and insiders own 18.9% of shares outstanding. Atlas has a share option plan by which it may issue up to 10% of outstanding shares. Options vest in thirds every six months from the date of grant, and the strike price if the closing share price on the date of grant. To compensate for this, Atlas implemented a Normal Course Issuer Bid program, which was expanded to 10% of outstanding shares in December 2022 (it was 5% the previous year). Atlas is very committed to buying back shares, which is shown by the fact that it reached the 5% of outstanding shares limit under the previous NCIB, and the expansion of the program to 10% of the shares. This makes us confident that they have a clear intention of avoiding dilution and repurchasing shares. From the date of the NCIB renewal, Atlas has repurchased 568,000 shares.

Valuation of Atlas Engineered Products

Regarding valuation, we believe that a DCF analysis is not suitable for Atlas due to the unpredictability of future acquisitions, which will be a key value driver going forward. This is why we chose to do a simple “back of the envelope” value estimate for Atlas, taking just an EV/EBITDA multiple. As seen on the table below, Atlas trades at a higher EV/EBITDA than its comparablecompanies. We think this is reasonable given Atlas’ growth prospects and strategy. We chose to apply a 5.4x EV/EBITDA multiple, in line with the average multiple Atlas has paid for its acquisitions. This should be taken as a quick reference of where value may be at the moment. However, we insist that the key driver for Atlas will be the acquisitions it makes, which is ultimately impossible to reliably estimate.

$AEP valuation
$AEP Valuation EBITDA

Brief Comment on Preliminary Results

On February 22, 2023, Atlas announced preliminary results for Q4 and Full Year 2022. It only released information on revenues for Q4. As discussed above, Q4 is seasonally a weak quarter, and revenue decline from Q3 was in line with the QoQ comparable decline for 2019 and 2021 (2020 was an exceptional year, where there was actually a QoQ revenue increase due to demand recovering after Covid-19 disruptions). Revenues were, however, 7% higher than in Q4 2021, which shows continued growth. In summary, and taking into account that just revenues for the last quarter were announced, the sales decline was expected, due to seasonality, but were still higher than in the comparable quarter of 2021. As commented in a previous section, margins are the main concern right now, so we will need to wait until complete results are published to get an idea of the situation.

Author: Pablo Lucas Coronado @LuCoronado

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