Friday, April 9, 2021

ADF Group Update

Shares of ADF Group (DRX.CA) are down some 20% over the last two days, thanks to a disappointing quarterly update, on a number of fronts:

  • They managed to turn a profit only by booking gains in PPP loans they took that they expect to be forgiven
  • They warned of lower margins in coming quarters due to pricing pressures

  • The lack of profits combined with the warning on margins suggests the great backlog they built over the last year was in large part priced to win with the intention to stay busy, i.e. without a lot of profit built in. Investors may be ratcheting down their near-term profit expectations, with good reason, leading to a drop in the share price.

    But this may represent an opportunity. DRX trades at barely over half of its tangible book value of about $3 per share, with almost no net debt. Eventually, pricing will return to this industry as it's starved of capital.

    Revenues were depressed in the quarter due to production scheduling issues; it's likely the company is still profitable, and with a backlog of $436 million (compared to annual revenue of $172 million) there is plenty of revenue certainty.

    So you've got a safely-capitalized company in an industry that's not going away that is trading at a huge discount to its assets due to short-term profitability issues. It looks like an opportunity for someone. Not for me though, because I already own enough having bought during the panic last year.

    Disclosure: Author has a long position in shares of DRX


    Jonas said...

    Hi Saj,

    Would be interesting if you could elaborate on the industry being starved of capital.

    (also a shareholder since a few years back).


    Saj Karsan said...

    Hi Jonas,

    Nothing specific. Just thinking from the point of view of ADF and its competitors who see the discount to book, as it has persisted for some time, as they consider whether to add or reduce capacity.

    Joe said...

    Hi Saj,

    What is your DRX.CA price target? It seems to be trading at 2/3 of book value already. Thanks!

    Saj Karsan said...

    Hi Joe, I don't really have any price targets. I think this business is probably worth something around its tangible book value.