Monday, September 27, 2010

ADF Group

ADF Group (DRX) designs and builds steel structures for the non-residential market. This company operates in a very cyclical industry, as it is reliant on a construction industry that is in no mood to build as a result of the recession. But market pessimism has pushed this stock to a price to book value of just 0.66, despite the fact that it has remained profitable throughout this downturn!

ADF had some rough years following the last recession in 2001, as its capital structure was far too aggressive (i.e. it had too much debt). As we've discussed in the past, cyclical companies should not carry a lot of debt. Since then, ADF has added some equity and reduced its debt, resulting in its current net cash position (cash minus debt) of $10 million.

Subtracting the net cash position from the company's market cap suggests the market is valuing the company's remaining assets at $50 million. But this is a company that has earned operating income of $57 million in just the last four years. Yes, the next couple of years will be slow, as the market for steel structures is not exactly booming. But the company is in no danger of going bust. When the industry returns to normal, ADF is in a position to return to growth.

There are a couple of caveats worth noting, however. The shareholders who control the company don't have a financial stake commensurate with their controlling stake. This results in misaligned incentives, as discussed here. Also, the level of customer concentration is high, with two customers making up more than two thirds of the company's business of late. High customer concentration adds to a company's risk level.

Undoubtedly, investors are afforded the opportunity to buy this company's assets on the cheap. However, it is not known when the market for this company's services and products will turn positive. But the company has a financial position (more cash than it does debt) that will allow it to outlast this downturn, potentially rewarding long-term investors in the process.

Disclosure: None


Anonymous said...

no one has made any comments yet..It really seems like this stock is ''under the radar'' haha

Anonymous said...

Definitely a sleeping value play.

This ad has been up for some time now, I screen shot it every now and again for my own records.

If I were in the east end of Canada, I would do physical scuttlebutt. Since I am not, I go with virtual scuttlebutt.

Also, don't skip over the large amount (relative to their market cap) of in the money currency contracts they hold.

Anonymous said...

Agree, this is an interesting case. I hold some shares not many but am unsure of whether to add more until they've received new orders or not. If I recall correctly they said they were bidding on a substantial amount of orders earlier this year, but nothing seems to have substantiated yet. You do have strong protection on the downside from the asset base however, and it will be interesting to see if they can grow their nuclear construction business.

Anonymous said...

Well Anon, lets hope you added more in Dec. I've been adding and adding over the past year. I'm the same Anon in post #2 and would encourage other interested ADF investors, or potential investors, to monitor activity on the ADF HR page, which is still showing many jobs to fill. Also look at Canadian Insider and note big volume spikes (will show on Google Finance or Yahoo) then reconcile with filings Canadian Insider. It's back up over $2/share and will go much much higher as business picks up, Western Canada expansions are completed and in the money USD currency hedges are utilized. In this Anon's opinion, EPS will shoot up over the next few quarters.

Anonymous said...

A revenue lock-up so big even Mr Market noticed:

Even with conservative margin assumptions, the expected profit from this deal alone is a very substantial amount with respect to ADF's market cap over the last little while.

And they still have stuff going on out west.

And they should start cashing in on the currency forwards.

Hey Karsan, your blog needs to deal with updates and recent comments better. Many value situations take month or years to develop but they tend to fall off the map after the initial spotting.

Anonymous said...

ADF Group's financial position is now even stronger with $0.62 per share or half of its share price in net cash.

In this business it's impossible not to have high customer concentration. It seems like the World Trade Center is 90% of its business right now and for the next 10 months at least.

It is very positive that management has articulated their objective to focus on profit rather than revenue and only accept orders from financially solid customers.

With regard to the recent post on EPS manipulation, these guys have a great opportunity to do it in every quarter since they recognize revenue based on percentage of completion but aren't doing it. The last two quarters have been rounded down from 0.023 to 0.02.