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IBI Group could be a solid turnaround opportunity
Tuesday, February 09, 2016
Investors typically think the only way to make big money is to roll the dice on a high-growth small cap. While that can work, you can make the same return with less risk by investing in a sound turnaround story. I've shared a few of these in this space over the years - New Flyer, MegaBrands, Brick and Intertape Polymer to name a few - and they did well, with an average return in the healthy triple digits (two - MegaBrands and Brick - were bought out for nice premiums.)
Solid turnaround opportunities are rare, but I think I've found a very interesting one. Before I get to it, though, it's useful to describe what a good turnaround story looks like.
First, it's a company that's been around for a long time. This makes it easier to study, because it's found a comfortable niche, has proven it can compete and has several years of financial statements to study in order to figure out what the company can earn under normal circumstances.
Second, the business should be simple. Getting back to the above examples, duct tape, toys, furniture and buses are easy to understand and always in demand.
Third, the stock will at some point have traded for a much higher price than it's quoted at today. That's not to say it will get back to that price - it probably won't. But it's a sign that there is real upside potential and that investors won't rush for the exits too early.
Fourth, it's a name investors don't want to hear about or have never heard of. That's a sign that the stock is truly washed out and at or near the bottom.
And fifth, the company should have a lot of debt, and the cash flow to pay it down over time.
This gives an investor leverage.
As the debt is paid down, the price-to-earnings multiple will rise because the risk of default is abating. This is what I call the double-barrelled shotgun - rising earnings as interest payments dissipate and a rising multiple on those earnings.
All of the examples I mentioned earlier met all of these criteria, and so does IBI Group, a stock I've been buying because I think it's about to take wing.
IBI Group is an architecture and engineering firm. It helps build things such as transit lines and stations, buildings and infrastructure. The company has been around for decades. The stock, recently quoted at $2.20, used to change hands for almost 10 times that. Investors who owned it in the past, when it was a high-flying income trust that paid fat dividends, will certainly not want to hear the name today given that the dividend disappeared and the stock dropped as much as 95 per cent from its high.
And it has lots of debt, although it recently paid back a significant portion of it and is generating rapidly improving cash flow to take care of the rest.
So IBI Group meets the criteria for a sound turnaround. To add colour to the analysis, IBI Group specializes in urbanization, which is a powerful theme around the world. Urban economies are growing at faster than national GDP and urban infrastructure spending is growing faster yet as societies, including our own, struggle to meet the needs of growing cities. It doesn't hurt that the Liberal government has announced significant infrastructure spending, which one has to expect will increase as the economy remains weak, here and abroad.
IBI has significant U.S. operations and is benefiting from a favourable exchange rate.
In Canada, IBI is currently involved with two major Canadian transit lines, one in Edmonton, the other in Toronto. While this is government spending, when the lines are done lots of new, private work regarding developing the areas around new subway stops becomes available and IBI tends to win lots of that.
The company's backlog is very healthy, so that investors can see at least a full year's worth of booked revenue, adding to certainty.
Profitability has been improving rapidly since the company, led by chief executive officer Scott Stewart, began implementing a turnaround strategy a couple of years ago when it looked as if the company's stock might become worthless. Profit margins have been trending toward 11 per cent, higher than the industry average, and revenue is growing.
The company also raised some money in the fall via a rights issue (which gives existing shareholders the right to buy new shares in proportion to their existing ownership). Insiders participated and in fact increased their position to own more than a third of the company, a sign of confidence. The company used the proceeds to retire debt.
I spoke to Mr. Stewart twice over the past couple of months and he came across as very optimistic. "We're in a very good position. I couldn't be happier than where we are right now," he said, referring to the industry landscape and particularly the backlog.
IBI is a cheap stock today (it closed Monday at $2.30; analysts have $4 targets that have been trending higher). But I think it can be a $9 stock within a few short years when I figure it will be conservatively earning $50million in EBITDA, from about $40-million today. A modest multiple of eight takes the enterprise value to $400-million, from which we subtract a debt of about $110-million, which assumes only modest repayment in the meantime.
Divide by the number of shares (about 32 million) and you get about nine bucks.
While most stocks are falling these days, there's always something going up. I think this will be one of those rare stocks.
Disclosure: The author owns shares in IBI Group.
Fabrice Taylor, CFA, publishes the President's Club investment letter, for which The Globe and Mail provides marketing services and receives compensation.
IBI Group (IBG) Close: $2.30, up 5¢
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