VALUE: After Hours (S07 E21): Why TerraVest Is a Boring Business That Prints Cash

During their recent episode, Taylor, Carlisle, and Chris Waller discussed Why TerraVest Is a Boring Business That Prints Cash. Here’s an excerpt from the episode:

Chris: Yeah. Oh, I should have probably said at the beginning actually. I obviously own shares in XPEL and TerraVest. So, just full disclosure on that. TerraVest is a really interesting company. They are Canadian listed. Their business is in the US and Canada. They operate in a series of industrial niches. So, industries that seem very boring. Different types of storage tanks, propane tanks, fuel tanks and so on. The trailers and trucks that carry these different tanks.

I think a lot of investors for many years dismissed it, because those industries frankly aren’t very exciting. Many of them are very low growth. A few of them even declining industries. But the stock has actually performed really well. It’s compounded at about 35% per annum for a decade. The reason is because they have an excellent management team of four or five guys at the top who are all really competent, all have most of their net worth in the stock and have done a great job taking the cash from those businesses and acquiring other mom-and-pops.

And so, they’ve not tried to chase growth in some of these industries. They’ve been very clear that they’re going to take the cash out and they’re able to buy these mom-and-pops, because in a lot of these industries, there are only four or five companies in a specific niche. These are small industries where there’s only really a small number of acquirers, with TerraVest being the obvious one.

If you’re a mom-and-pop maker of propane tanks, you pay a lot more for steel than TerraVest does. So, TerraVest can acquire that company, use its scale to get a 10% to 20% discount on steel by cutting out the distributor and so on, and basically transform that business from a company they acquired at probably 10 times free cash flow to now 6 times free cash flow. And so, they’re able to generate a very good return through those acquisitions. They’ve just been doing that again and again, and been very return focused. That’s why they’ve generated such strong returns in an industry that doesn’t seem very exciting.

Tobias: So, talk us through the management team there. How long have they been there? They seem to be central to the story here.

Chris: Yeah. So, Dustin Haw, who is the CEO, I think only 45 still. He’s quite young. The whole team have basically been there for just over a decade now. So, Charles Pellerin, who’s the chairman, and then they’ve got Mitch Gilbert who’s the chief investment officer who leads a lot of the M&A initially. And then, they’ve got some division heads, some of whom have joined through these acquisitions.

They’re all very, very accomplished. I think Dustin, in particular, the CEO is the key. He’s someone who is both very knowledgeable as an operator. He really understands the engineering of these products. I think he has a PhD in physics or astrophysics. I think maybe Physics. Yeah. So, he really understands the engineering of this stuff. He really understands how to actually run the businesses, but he also understands how to deploy capital. I think it’s so rare to find someone who can do all of that.

Jake: Is that what’s wrong with the US right now, is our PhDs in astrophysics are doing M&A roll ups?

[laughter]

Chris: Yeah.

Jake: Oh, man.

Tobias: I think there should be more of you doing it.

Chris: Yeah. Yeah. So, he’s just so impressive. Every time I speak to him, I leave thinking I don’t own enough shares. He’s very impressive and someone with high integrity as well. If you look at the way he communicates and the way this company in general communicates, it’s not promotional at all. They don’t really have targets. In fact, they don’t do earnings calls. They don’t really have an investor relations website if you go on it. There’s not really anything there. So, they just have been really focused on executing for the last decade and just done a great job.

Jake: How do they finance the acquisitions?

Chris: So, they do use debt. They usually go up to about two times EBITDA. One thing I will say just to counter some of my points, is that in the last couple years or so as the stock has increased, well, really from $30 to now $160 in a couple of years, it’s been the first time it’s gone from a 10 times free cash flow stock to now 25 times, which is maybe still fair for a company, these qualities, but obviously different. So, they have started financing some of the acquisitions through equity.

Personally, I would probably prefer they didn’t do that. They would probably say they’re acquiring at multiples much cheaper than where their stock trades at, which is fair. But yeah, traditionally, they finance through debt and occasionally they issue equity to pay off some of that debt afterwards.

Tobias: If the stock’s done 35% a year for a decade now, how can it be undervalued? Talk to us about the valuation.

Chris: Yeah. So, I own a few shares still. I think at this point, it is close to fair value. I think that they can generate incremental returns on invested capital of about in the 15% to 18% range. And they typically reinvest basically all of their earnings. So, they can still, through acquisitions, probably grow in that 15% to 18% range. They’ve got an excellent record.

And so, what should a business of these qualities trade at, which still has a long runway to keep doing that? Obviously, some really successful serial acquirers traded a much higher multiple. I would say going back to our early conversation, I probably wouldn’t bank on any multiple increase at this price point.

25 times multiple is probably a reasonably fair multiple for this business. If it can still grow at 15% to 18%, then you still get that return going forward. But yeah, I definitely think it is obviously a lot more fairly valued now than it used to be. And the interesting thing will be as they get bigger and they have to move into more adjacent markets, can they still deliver these types of returns?

Tobias: That seems to be a problem for many of the serial acquirers. I just think about [chuckles] Constellation.

Jake: Constellation.

Tobias: Yeah.

Jake: Heico, TransDigm. Yeah.

Tobias: Constellation going outside VMS software. I think it’s not even software, right? It’s just anything at this point.

Chris: Yeah. They’ve done an amazing job obviously for many years. Obviously, I wouldn’t anchor on that, because that’s the exception. But it is possible. TerraVest management team are so strong and they’ve acquired essentially platforms now. So, they’ve brought in some bigger companies that are have some overlap with their existing industries, but are also in some more interesting ones. Those platforms are now acting as acquisition vehicles, a little bit like some of these serial acquirers. So, you can see they’re being very thoughtful about how they build it out.

But I do think it’s fair to say that they used to generate over 20% returns on capital, just getting discounts on steel and quite basic things. That is not going to continue forever. They still do those types of acquisitions. But by their nature of being small, mom-and-pops, they’re just less meaningful. So, we shouldn’t expect that level of return to just continue.

Jake: Is there may be an onshoring thesis that could be helpful there too? This might be a tailwind.

Chris: Possibly. All their manufacturing is in the US and Canada. So, they’ve reasonably insulated from that point of view. But to some extent, they’ve always been quite insulated because steel tanks are just heavy. So, the transportation cost is high. And so, they haven’t traditionally faced huge competition from China.

Tobias: Heavy and bulky.

Chris: Yeah. Yeah. So, a lot of those markets actually very local. So, even in just specific parts of Canada– Western Canada doesn’t always supply Eastern Canada and so on.

Jake: It’s like a gravel pit.

Chris: Yeah. Yeah, exactly.

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