Empire Industries: investing in its hodgepodge of interesting businesses
Empire Industries is the next in a series of TSX Venture-like companies that I have found and made a basket bet with. Like ADF Group, Empire actually trades on the senior exchange, but as its share price (11c) suggests, its a Venture company in disguise.
When I set out to scour the TSX and Venture for companies worthy of an investment, I did not limit my criteria in any way. What is interesting though is that the first three names I have talked about (ADF Group, Avcorp and now Empire) all fit neatly into another theme; Canadian manufacturing companies that will benefit from the lower Canadian dollar. I think it will be a strong tailwind for all these names.
But as I have warned in my other post, these are all very small illiquid stocks and so I have been very careful to keep my positions small, regardless of how tempted I am to take advantage of the opportunity they present.
On to Empire Industries
Empire Industries (EIL) is a structural steel fabricator that has diversified into a couple of unique but profitable businesses out of necessity.
Before 2008 the company was a rather generic steel fabricator with facilities all over Western Canada. They got hit hard by the collapse in 2008 and by the subsequent rise in the Canadian dollar that began in 2009. In response they shuttered a lot of their operations and opened a fabrication facility in China. They focused on their existing businesses; manufacturing amusement rides and Hydrovac trucks. They also have a telescope business, which appears to have some interesting potential but that is very lumpy in its revenue generation (these aren’t stick it in your window telescopes, they are big domey looking observatory telescopes that cost $100’s of millions of dollars).
As I mentioned Empire trades at about 10 cents per share, which puts the market capitalization at $25 million. There is about $6 million of debt on the balance sheet for a total enterprise value of $31 million.
Empire is valued at a reasonable EV/EBITDA multiple if you think the current level of business is sustainable, and at a cheap multiple if you think they can grow further. If you annualize the Q3 numbers they trade just under 4x EV/EBITDA, whereas if you take the 9 month numbers they are a little over 4x EV/EBITDA.
In this post you’ll notice that I am focusing on the 2013 results. This is because if you look further back the results aren’t all that great. The company was more reliant on low margin steel fabrication and I suspect taking marginal contracts to fill their employees time. They’ve barely been able to cover their expenses in the past. Which leads me to the point that you have to be buying this company because you think that the orders and backlog are going to improve off of current levels, not fall back to the norm of the past 5 years. If the company can’t build from its recent momentum, the stock is going to quickly drag back to the single digits.
The Operating Segments
Looking at a segment breakdown of their operations today, the generic steel fabrication business is a small piece of revenue. The amusement ride and hydrovac businesses dominate.
Both of these businesses look like they generate in the 15-20% gross margins. I suspect though that the number might be higher for their own internally designed rides.
The company started out in 2000 by manufacturing rides for companies like Disney and Universal. For example, they have designed 3 of the Harry Potter rides. There is a good list of a number of the rides that they have built on Wikipedia of all place. In 2011 they expanded to offer their own rides. They currently have 6 internally designed rides on offer. They recently signed a contract in the UAE for delivery of two rides for $25 million. In total they have sold $60 million worth of their own rides since it started in 2011. In this presentation, given to an investment group called the Richmond Club, they said that the sales focus of their rides would be on the Asia. They have shown some success in this regard. I tabulated the following contracts that have been announced since Q2 (note that not all of these are for their own rides):
- contract with US theme park for $30mm (Q2 2013)
- contract with China for $18mm (Q3 2013)
- another contract with China for $9mm (q3 2013)
- contract with UAE for $25mm (q1 2014)
The hydrovac business looks to be a solid but not spectacular grower. Below are the EBITDA results for the business for the last number of quarters. Hydrovacs have actually received quite a bit of attention in the Canadian investment world because Badger Daylighting, which performs daylighting excavation using these trucks, has been a regular recommendation on BNN and top performer on the TSX. I suspect however that the truck business, which is what Empire is in, is going to be more of a slow but steady business, growing at a few percent a year.
One wildcard in this story is the thirty meter telescope project. This is going to be the world’s largest telescope. The telescope is expected to cost $1.2 billion, and according to this article, Empire is expected to generate up to $80 million of revenues from the project. Thus, project approval would present a step change to the company (the article also notes that the company would double its workforce if the project is approved). However the Canadian government is dragging their feet on approvals. This article explains the situation. If the approvals come through, this would be a big boost to the backlog of the company.
Empire is in a few niche businesses that should do well if the world economy continues to improve. And you have the wildcard of a step change in revenue if the 30 meter telescope, or potentially another telescope project, gets approved. At 4x EV/EBITDA you aren’t overpaying for the potential that the company grows its top line from here. They also have $21 million in net operating losses.
So it’s a pretty simple playbook to follow. Watch the revenue numbers, watch for big contracts, watch the backlog and see if the company is really on an upward trajectory. If they aren’t, I probably sell my shares for 7-8 cents. But I would argue the upside is likely multiples of the current price. I accept the risk and the illiquid nature of the stock as fully discounted by the potential reward. We’ll see how it plays out.