Business

Atlas Engineered Products designs, manufactures, and sells Floor Joists, Floor Trusses, Floor Panels, Roof trusses, and wall panels in Canada as well as offering project management and site assembly ancillary services. These joints and trusses are used to manufacture the building frames for single and multifamily residential real estate, and commercial and industrial real estate.

The company’s primary markets are Ontario, Manitoba, and British Columbia.

In 2015, Archer Petroleum Corp, an energy exploration company focused on Uranium, Oil, and Gas, began winding down business operations in the face of declining oil prices. Archer Petroleum maintained it public listing on the TSX Venture Exchange and began seeking a new business to acquire. In 2017, Archer Petroleum acquired Atlas Engineered Products in a reverse merger transaction and began trading on the TSX Venture Exchange under a new ticker ‘AEP’.

At the time of the acquisitions, Atlas Engineered Products was a manufacturer of trusses and engineered wood products in Central Vancouver Island, British Columbia.

Since being acquired by Archer Petroleum Corp, Atlas Engineered Products has executed on a number of acquisitions, both as a means of entering new geographical markets, but also entering new sectors.

A company going on an acquisition spree is likely to give investors some pause. However, there is a solid rationale for acquisitions in this space. First, most truss and joist manufacturers operate as local monopolies or duopolies in their geographic areas (this is expanded upon further in the competitive advantages section). The market for Truss and Joist manufacturers and distributors is highly fragmented. Despite Atlas Engineered Products Small Market Capitalization, it can still make acquisitions that are small relative to its size, due to the mom-and-pop nature of other truss distributors and potential succession issues when these owners decide to retire. There are significant post-acquisition opportunities for operational improvement. Higher asset utilization, implementation of better practices, and, perhaps most importantly, achieving better economies of scale (this is also expanded upon in the competitive advantages section). Once established in a geographic market, Atlas Engineered Products can then begin cross selling products to customers. As an example, floor truss and wall-panels are two complementary products. If a developer is breaking ground a new project, both products are necessary for a new building. It can be a convenience but also a cost saving measure for a customer to have both products delivered on the same route by one company with the specifications.

Insiders own 17.9% of the company through common shares, indirect holdings, options, and warrants. The two largest shareholders by far being the CEO and founder, Hadi Abassi, owning 11.1% of the company. In addition, Gianpaolo “Paul” Andreola owns 1.05% of the company and serves on the Board of Directors. Mr Andreola is a highly skilled and respected investor in Canadian small caps stocks and operates smallcapdiscoveries.com, a website focused on small cap investing.

Industry

I expect Atlas Engineered Products to benefit from two tailwinds in the coming years. First, the cost residential housing is extremely high in select markets in Canada, with Toronto and Vancouver both being in the top 15 most expensive cities in the world for housing. Residential housing has become so expensive that at the start of this year, the government, in an attempt to curb the increasing house prices, enacted a law restricting foreign ownership of residential properties for investments. As the prices of existing houses to rise, the incentive to build new housing increases. An increased demand for housing materials will flow through to Atlas Engineered Products.

In addition to the high cost of housing, Canada has one of the fastest growing populations in the developed world, growing at almost twice the pace of other G7 countries, thank to its immigration friendly policies. People moving to a new country require accommodation, and, as the population grows, the demand for new housing should grow as well. It is not just that the price of housing is high, but there is an acknowledged shortage of housing itself, with the Canada Mortgage and Housing Corporation estimating that 3.5 million new homes will need to be built by 2030.

With these macroeconomic tailwinds addressed, it is time to discuss the industry in a way that is more closely tied to Atlas Engineered Products. The manufacture and distribution of trusses and panels is a highly fragmented industry, with much of the industry being composed of Mom-and-Pop style vendors. There are strong local monopoly dynamics in the truss and panel distribution business. This means that Atlas Engineered Products can acquire other distributors and will not be in the position where it will be forced to compete against other, larger companies in the space in the coming years.

Once potential hazard is for Atlas Engineered Products is its performance is closely tied to the performance of the real estate industry in Canada as a whole. Significant debt is often used in the purchase of real estate by Real Estate Private Equity or manufacture by Developers, which makes it more sensitive to the economic cycle. Most of Atlas Engineered Products customers are developers who fall into the ‘opportunistic’ style of real estate investing. Opportunistic is the highest risk/highest return of real estate styles. The Central Bank of Canada has been raising interest rates in the face of higher than targeted inflation and housing prices have seen a slight decline as a result.

Competitive Advantages

Atlas Engineered Products benefits from two identifiable competitive advantages.

First, Atlas Engineered Truss companies enjoy a kind of local Monopoly. Trusses are large cumbersome objects and difficult to transport over long distances. A competitor that is not geographically close to Atlas Engineered Products would need to significantly undercut their prices in order to compensate for the cost of transporting trusses when trying to attract customers. Atlas Engineered Products does not have regulatory protection in preventing new competitors from starting new operations in the same geographic area, but if they do, there would likely be intense price wars, meaning it would not be lucrative for new entrants to compete against Atlas Engineered Products.

As further evidence of this local monopoly dynamic, consider Atlas Engineered Products Windows segment, which was recently shuttered (pardon the pun). Windows, while fragile, are more easily transported over longer distances than roof or floor trusses. Windows did not benefit from local monopolies and had poor results before being shut down in 2021.

Atlas Engineered Products benefits from economies of scale in two ways. First, as it grows in size and continues to execute on its acquisition program, it can extract more favourable terms from its suppliers. Gross Margins have improved from 23.3% in 2018 to over 30% in its most recent Financial Year. This is partly attributable to a shifted focus on high margin, high value segments within Atlas Engineered Products but also a sign of Atlas Engineered Products’ strong negotiating position with suppliers.

Second, Atlas Engineered Products’ operating expenses can support additional revenue without need for additional operating expenses. Consider their results 2018 compared to 2021 and 2022. In 2018, Operating Expenses (excluding Depreciation and Amortization) represented 21.3% of revenue, compared to 9.1% in 2021 and 9.6% in 2022. Put another way, compared to 2018, $3.45m in additional operating expenses were able to support an increase in revenue of $50.3m. This is further evidenced when we look at Atlas Engineered Products’ upwards inflecting margins. In 2018, Atlas Engineered Products recorded an EBITDA margin of 3.4%, compared to 22.5% in 2022 and 20.2% in 2021.

As Atlas Engineered Products grows, they could, if needs be, undercut competitors in specific markets by relying on their superior size to offer lower prices.

Valuation

I estimate a 41.36% IRR if shares are purchased at their current price and held for five years using conservative assumptions. These assumptions are expanded upon below.

A link to the DCF and DCF notes in excel form can be found by clicking this link

The valuation is the most exciting aspect of the Atlas Engineered Products thesis. It is rare for investors to be able to purchase shares in a company that has grown revenue at a 3-year CAGR of 21.2%, has operating margins above 20% with the potential for continued improvement, and the ability to reinvest at attractive rates of return for the foreseeable future. It is rarer still for the company to be trading at a 4.5X EV/EBITDA (TTM)

Gross margin has expanded from 24.3% in 2019, to 32.1% in 2022. This is attributable to Atlas Engineered Products shutting down low value, non-core segments, such as Windows. I am doubtful there will be any significant Gross Margin improvement going forward. The model assumes a decline to 30% for the next two years, followed by an expansion to 32.5%, still below what Atlas Engineered Products recorded for 2022FY.

Operating expenses as a percentage of revenue declined from 22.4% in 2019 to 11.8% in 2022. This points to Atlas Engineered Products effectively scaling its operations. The model assumes that this figure will, in time, further decline to 9.8% in 2026. If the above assumptions can be met, along with Atlas Engineered recording $122.95m in revenue in 2026, Atlas Engineered products should be able to reach an operating margin of 22.7% in 2026.

I assume a significant portion of generated cash will be allocated to M&A. Most of Atlas Engineered Products historical growth has come from acquisitions, and with Atlas Engineered Products currently generating more cash than any time in its history, they are in a stronger position than ever to execute on M&A. Management makes limited disclosures, and I do not have a strong visibility on the M&A pipeline. In the event Atlas Engineered Products cannot ramp up their M&A spend, the cash can be returned to shareholders in the form of dividends or buybacks.

Risks

The biggest risk to Atlas Engineered Products is that it is closely tied to the performance of the real estate market in Canada. There has been a sharp rise in real estate prices in Canada in recent year. Real estate has historically been less volatile than equities but does have some unique risks associated with it.

First, leverage is used much more liberally in real estate than in equities. It is rare for a hedge fund to run above 130% gross exposure, and this is usually offset by short positions. On the other hand, real estate can involve only putting down 20% on a property, equivalent to 400% leverage. While real estate prices have been less volatile than equity prices, REITs have historically experienced more dramatic drawdowns than stocks.

Real estate tends to be less liquid than stocks. Whereas each individual stock in a company is fungible (with exceptions where there are dual-class structures), each building is different from each other, with different considerations in every scenario. A stock can be sold instantaneously, but selling a building is a lengthy and expensive process.

Furthermore, real estate indexes are not necessarily accurate representations of the underlying value of their assets. Real estate assets prices are typically only updated when sold, which can be years since their initial purchase. There may be a wide variance between what the owner of a property believes it is worth and what it can be sold for in the market.

Atlas Engineered Products is exposed, albeit indirectly, to all of the above risks through their customers. A severe downturn in real estate markets in Canada would have a material adverse effect on Atlas Engineered Products financial performance.

Atlas Engineered Products has a high degree of operating leverage, thanks to their economies of scale. This benefits Atlas Engineered Products while they are growing, but means that a slight decline in revenue can have an outsized effect on earnings. Even a slight cooling off in the real estate market in select areas may have a large impact on Atlas Engineered Products cash flow.