My Second Venture Venture: Avcorp

This is my second in a series of posts I am writing about smaller Canadian stocks which are either on the Venture exchange or should be, and that I have taken a bit of a bucket approach with.  I am buying small positions with the hope of taking advantage of the individual company dynamics as well as the larger theses that the Canadian dollar that will benefit their competitiveness and that there is an improving speculative investment atmosphere for Canadian stocks.

For those of you not very interested in stocks with a market cap in the double digit millions, I apologize.  I do not plan to become a penny stock guru, it just seems to be a place where some opportunities lie right now.  I did make a couple of tweets over the last week of two larger company’s that I have added in the last couple of weeks;  Sherritt International and Nordion.  I’ll try to come up with more extensive write-ups on both of these positions at some point, but because they are reasonably large well known entities I felt that the tweets were sufficient explanations of my rationale, whereas these micro names required further delineation.  Its worth noting that my positions in Nordion and especially Sherritt are significantly larger than what I am putting into something like Avcorp.

On to Avcorp

Avcorp (AVP) is an interesting little story that I have a small (less than 1%) position in.  Before I go too far into it, a word of warning; this is a stock that certainly might not work out and it may just languish at these levels indefinitely.  However there is a chance it breaks out to significantly higher levels if the stars align just right, and that’s why I have a position.

Avcorp fabricates parts and assemblies for airplane manufacturers.  They have contracts with Boeing, BAE and with Bombardier.  The contracts they have tend to be long-term;for example they just re-signed a Boeing contract for wheel well farings for a 5 year term.  They make things like floor panels, wing components, stabilizers, so a bunch of little pieces that go into the larger airplane assembly.

There are about 280 million shares outstanding and the stock trades at 16c.   So it has a very small capitalization stock at $45 million.  The company has cash on hand that more then covers its debt.

The company has no net debt as of the third quarter after receiving a large cash payment from Cessna after winning a large settlement.  Cessna was a former customer that decided to bring their work in house.  Avcorp sued Cessna for damages saying Cessna couldn’t revoke the agreement without Avcorp’s acquiescence.  Avcorp won the suit and appeal and settled for $27 million, which obviously is significant for a company this size.  Its worth noting that most of the move in the stock thus far (it used to be a 5-6c stock)

A  second litigation for a contract dismissal against Bombardier, was settled recently before going to court.  Unlike Cessna, Bombardier remains a customer.  I wouldn’t be surprised if Avcorp dropped the litigation in part for the promise of future work.  Indeed, last week it  was announced that Avcorp received a new contract from Bombardier to manufacture floor panels on the Aerospace Global 7000 and 8000 aircrafts.  The number of these planes currently on order looks to be over 100, but though I tried I was not able to get a good idea of the contract on a per plane basis, so I’m not able to comment on its significance.

When it comes right down to it, the investment thesis behind Avcorp is similar to ADF Group (ADF Group was the first of my series of small Venture stocks that I wrote about).  An improving economy should result in an improved order book, and the company has been given an added boost as they go after orders  from the 10% decline in the Canadian dollar.

But Avcorp is admittedly more of a flyer than most of the stocks I buy into.  You can go back all the way to 2009 in their financials and you’ll find nothing but negative EBITDA.  But 2013 showed the first signs of turnaround; in the first nine months of the year they generated $3.8 million in EBITDA on sales of about $60 million. The company is not cheap on these numbers, so my bet is being made on the anticipation that they can grow their business further as the economy improves.

Complicated Cash Accounting

The company has a very different way of recording cash, which I know that some of the folks are going to raise an eyebrow at.  If you look at this years cash flow, it has been negative even though EBITDA has been positive.  This was a big red flag to me at first.  But I dug further and I think its just a legitimate consequence of their customer funding.

Avcorp receives a lot of cash upfront from customers.  The cash pays for ramp up and tooling of new projects.   It gets passed through the cash flow statement via a financing activity called “proceeds from customer funding of program introduction”, so it doesn’t get recorded as typical operating cash flow. The money then goes on the balance sheet with the coinciding liability of deferred revenue

Avcorp then records some of the upfront costs that this money is paying for as capex.  That cash goes through the cash flow statement as an investing activity via payments relating to development costs and tooling.  I think this cash outflow sits on the balance sheet as “development costs”.

The rest of the costs and the revenues are expensed along with the deferred revenue and costs as the product is shipped to the customer.   But the net effect on cash from operations is negative because the cash from the deferred revenue has already been realized from the prior quarter.

I’m still trying to wrap my head around what all this means so by all means if you have a clarification to provide, either leave me a message in the comments or send me an email.

Panta Ownership

Another interesting aspect of this story is that they are majority owned by a Netherlands based private equity company called Panta Holdings.  Panta has been slowly increasing their stake in Avcorp over the last 5 years, including taking another 10% stake in December,  They own 64% of Avcorp.  Clearly given the daily volume of the stock they are not going to monetize this stake on the open market.  I hope for some sort of monetization of their stake through the sale of the company if operations do improve.

Clearly given the daily volume of the stock they are not going to monetize this stake on the open market. I hope for either some sort of monetization of their stake through the sale of the company if operations do improve, or possibly for Panta to take them fully private.

Conclusion

I’d really like to get some numbers to the incremental revenue from the Bombardier contract, but in absence of that this is a story where one hopes that the company can improve its backlog and increase its capacity utilization, thus leveraging some of the fixed costs. I have read from a couple of different sources that the facility in Delta BC is operating at half its full capacity so there is lots of fixed overhead that needs to be spread out over higher revenue. The thing is, the company is right on the cusp; its existing revenues are just enough to cover costs and a little bit more, but a relatively modest step change in revenue (let’s say from the current annual $80 million run rate to $100 million, or 20%), either from the new Bombardier contract or perhaps from new work from Boeing or BAE, could be extremely accretive to profitability.

This is the sort of company I am only investing in because I think the timing in the cycle may be ripe for it. You don’t invest in a tiny little parts manufacturer unless you think the economic expansion is going to mature, that capital investments are going to be made, and that the stock market isn’t going to be in for any strong macro-headwinds. Given the lack of liquidity in the stock, a dearth of any of these factors would be a major drag. As it is, I keep my position very small, watch it closely, and if there is a little bit of luck on my side maybe this company turns out to be a multi-bagger. Far from a sure thing, but not impossible either.