We came across a bullish Forterra Inc. (FRTA) thesis on ValueInvestorsClub by Woodrow. VIC is one of our favorite sites to follow because the ideas are usually posted by aspiring analysts who are trying to find holes in their own thinking. We find the ideas presented on the site well thought out and definitely worth checking. Click here for the full article. Below we summarized the FRTA bullish thesis:
FRTA is a leading manufacturer of water pipe, and storm water filtration (drainage) products. The water segment primarily covers water ductile iron pipe and associated fittings for water utilities, and hence is a non-cyclical vertical with stable volumes. The drainage business makes storm water drainage systems, manholes and reinforced concrete pipes, therefore somewhat cyclical in nature. FRTA is evolving within a transforming industry.
A clear market leader in the water segment, and the largest name in the drainage segment with 67% higher revenues than its closest competitor, FRTA failed to register meaningful business and profits. A close scrutiny of the two main profitability factors– cost and pricing revealed the former somewhat exhausted while the latter having a lot of room for expansion. This is when Karl Watson took over as the CEO in mid-2019 marking a major turning point for FRTA. Watson successfully restructured the pricing strategy and tightened the cost structure.
On the pricing front, Watson implemented a smart strategy of semi-annual price increase with a two months advance notice thereby helping avoid disruptions to customers business, while allowing ample time for the company to implement the new pricing. A 12% price increase in its water business in 1H2020, largely unnoticed by the Street, saw the company achieve a 94% increase in the segment EBITDA.
The drainage business, however, still has potential for double-digit EBITDA over the next several years, but also has the challenge of a being a localized business with limited coverage area.
FRTA will implement some long term cost restructuring plans, which should further aid the bottom line over the years. One major cost is labor, where productivity factor plays a major role in the overall cost of manufacturing. In the drainage business, for instance, labor component can run up to 30-35% of the overall cost to manufacture the product. The company is currently investing in the technology to further improve the cost structure. The strong combination of logical pricing and cost improvements should yield higher margin for both segments, especially the drainage business stands good chance of earning 25% EBITDA over the next several years with a steady 4% price increase.
An accelerated EBITDA growth and higher fee cash flow will enable the FRTA to rapidly deleverage its balance sheet. As equity investors slept, FRTA’s deleveraging momentum has caught the attention of credit ratings agencies. S&P and Moody’s have upgraded their rating on the company. The analyst believes FRTA deserves to trade at a 10.2x EV/EBITDA around $35.
