NOA is a compelling opportunity for value investors with a longer-term time horizon to own a wealth-generating company which can be bought today near its tangible book value.
Although stocks have recovered much of the lost ground from their worst lows in March, PI Financial analyst Devin Schilling argues there are still worthwhile value plays being overlooked, particularly those linked to energy.
Mr. Schilling is responsible for special situations research at PI Financial, which he joined in late 2014. Focusing in particular on small-cap companies that are not widely covered by analysts, his coverage has spanned marijuana companies, industrial firms, and consumer staples businesses. A chartered financial analyst, he is based in Vancouver.
He observes: “The black swan event formally known as COVID-19 wreaked havoc on financial markets as global economic activity ground to a halt. From peak to trough, the TSX declined by 37 per cent while the TSX Venture dropped 42 per cent, leaving few companies unscathed from the market’s plunge.” However, despite the very broad nature of the drop, the intensity and endurance of individual stocks’ setbacks have varied.
“Equities exposed to oil, directly or indirectly, faced further challenges as oil demand plummeted when supply ballooned as Russia and Saudi Arabia flooded the market with cheap oil. This one-two punch resulted in the price of oil collapsing, which left this sector deep in the red,” says the analyst. Under these circumstances, he says, “we continue to believe that strong balance sheets, extensive backlogs, and favourable valuations are key characteristics to seek out during the recovery phase.”
A compelling opportunity for value investors
Accordingly, his “top pick” selection to capitalize on the post-COVID recovery is North American Construction Group Ltd. (TSX—NOA), a heavy construction and mining services provider. “NOA is a compelling investment opportunity for value investors with a longer-term time horizon to own a wealth generating company which can be bought today near its tangible book value,” says Mr. Schilling, who underlines the company’s 26 per cent return on equity in 2019. “Although the oil market remains challenging, NOA has overcome adversity before and this downturn could result in a stronger, more diversified business.”
Elaborating on some of the adversity the company has overcome in the past, the analyst says, “NOA has a history of delivering solid results despite several headwinds faced over the last few years, such as wildfires, plant fires, commodity price declines, and production curtailments.”
Looking ahead, the analyst concedes that the company will probably face more turmoil before business actually improves.
“The collapse in oil will likely result in additional production curtailments and pricing concessions from NOA’s key customers, which could impact financial results while the oil market remains in a state of flux,” he says.
“With that being said, we believe that NOA is well-positioned for when this market normalizes due to the company’s manageable balance sheet, extensive backlog, and discounted valuation,” the analyst adds. North American’s net debt-to-EBITDA (earnings before interest, taxes, depreciation and amortization) ratio for the trailing 12 months preceding the end of May stood at 2.5 times, while the company boasts more than $100 million in available borrowing capacity. As of the end of 2020’s first quarter, its order backlog added up to roughly $1 billion.
Mr. Schilling predicts that the company will ramp up the pace of its diversification into new resources and geographies because of the oil price collapse. (North American Construction Group changed its name from North American Energy Partners in 2018, reflecting its shifting business focus.)
Diversification program succeeding
“The company has seen recent success from this initiative in coal, including five-year contracts in Texas and Wyoming. We expect further opportunities could arise in copper, iron ore, and gold,” says the analyst. “NOA is targeting 40 per cent of adjusted EBIT (earnings before interest and taxes) from outside the oil sands by 2022 and this downturn may result in achieving this goal ahead of this timeline.” Mr. Schilling adds, “North American has historically been punished from a valuation standpoint due to its oil exposure and customer concentration.” As such, greater diversification could translate to a better reception from investors.
In the meantime, long-term contracts with its clientele provide some assurance to investors as to North American’s ability to stay afloat, the analyst suggests.
“Although production volumes from the oil sands may fluctuate over the near term, NOA remains the low-cost provider of mining services in this market, which is becoming increasingly important as oil prices hit new lows. Pricing concessions from key customers can be expected, but we emphasize the value proposition NOA provides through its lower-cost solutions,” says Mr. Schilling.
This is an edited version of an article that was originally published for subscribers in the June 19, 2020, issue of Investor’s Digest of Canada. You can profit from the award-winning advice subscribers receive regularly in Investor’s Digest of Canada.
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