ADF Group: Value or Value Trap

The search for cheap companies is Canada can be hard. The size of the Canadian market is much smaller than our neighbours to the south. Take out many gold mining, oil exploration and our huge banks, and the options become limited. We have a Venture exchange, but since I have room in my registered accounts, I only buy from the major American and Canadian exchanges. Sure, I could expand my circle of competence or accept a smaller return, but I will cross that bridge when I run out of ideas.

ADF group, ticker, came on my radar about 6 months ago. I have checked on it from time to time as I did some other research, but have recently taken a closer look.

Corporate Profile (from their website):

“From a blacksmith shop founded in 1956, ADF Group Inc. has become over the years a North American leader in the design and engineering of connections, fabrication and installation of complex steel superstructures, heavy steel built‐ups, as well as miscellaneous and architectural metalwork for the five principal segments of the non‐residential construction market, namely: office towers and high‐rises, commercial and recreational buildings, airport facilities, industrial complexes and transport infrastructures.

The Corporation operates a modern 58,530‐square‐metre (630,000‐square‐foot) fabrication plant in Canada and uses the latest technologies in its industry.

A pioneer in the development and implementation of innovative solutions, the Corporation is recognized for its engineering expertise and project management, its important fabrication capacity and its skills in the following specialized market niches: the fabrication of steel superstructures with a high level of architectural and geometric complexity, the fabrication of steel structures for the construction or refurbishment of nuclear power stations, and projects subject to fast‐track schedules.”

I will focus on the past 5 years for analysis, as the company had issues earlier in the decade and seems to have resolved them. Since the restructuring finished in 2007, the company focuses on profitability not revenue.

  • Diluted market cap of 66 million (at price of $1.90), about $0.15/share in net cash.
  • Trading at 78% of tangible book value.
  • Revenue per quarter is about half of what it was 8-10 quarters ago.
  • TTM EV/EBITDA of 5, 5yr Ave EV/EBITDA is at 4.
  • Taking out excess cash and normalizing operating earnings, P/E 7-8. Current P/E is 14.
  • P/operating FCF around 7.
  • Current backlog at 90 million, with around 15 months to feed the plant. Slight growth over last quarter but no new projects signed. Contract changes under negotiation.
  • Heavy insider ownership, at around 40%. The voting control in the hands of the Pashini family.
  • The compensation of the Pashini family seems high, and there are roadblocks in place to prevent getting rid of them (not saying someone should), but they did grant and maintain bonding to secure various loans with different lenders.
  • Major presence in New York City.
  • Management has a past that makes me nervous, from the AIF:
    • a) Mr. Jean Paschini was director of LBL Skysystems Corporation between August 7, 1997 and February 15, 2002. The year following Mr. Paschini’s resignation as director, this Corporation filed a Notice of Intention to make a proposal pursuant to the Bankruptcy and Insolvency Act, and received a cease trade order on its shares on the Toronto Stock Exchange, for default in filing its quarterly financial statements. Trading of the shares of LBL Skysystems Corporation was therefore suspended between November 14, 2002 and November 14, 2003, the date on which the shares of that Corporation were delisted from the Toronto Stock Exchange.
    • b) Mr. Jean Paschini, Mr. Pierre Paschini and Ms Marise Paschini were directors and executive officers of Owen Steel Corporation Inc., then a wholly‐owned subsidiary of the Corporation, from the latter part of 2001 to December 16, 2003. An interim receiver was nominated to hold the assets of this Corporation while they exercised these responsibilities. The shares of Owen Steel were then sold by the Corporation and pursuant to this transaction, the interim receiver was released.
    • c) Mr. Marc A. Benoît worked approximately 13 years for Société générale de financement du Québec (“SGF”). He left SGF on March 17, 2006. During the past six years of his mandate at SGF, namely from 2000 to 2006, he was manager of SGF’s metal and industrial sector. In that capacity, he was involved in more than 15 businesses, and was appointed director for nine of them. Over the years, two of these entities (namely Lavalum, s.e.c. and KPM Amérique du Nord, s.e.c.) filed for bankruptcy within the 12 months following Mr. Benoit’s resignation as director of these limited partnerships.
    • d) Between February 1999 and August 2, 2002, Louis Potvin was successively Vice‐President, Finance and President and Chief Operating Officer of LBL Skysystems Corporation. In the year following his resignation as executive officer, this Corporation filed a Notice of Intention to make a proposal pursuant to the Bankruptcy and Insolvency Act, and received a cease trade order on its shares on the Toronto Stock Exchange, for default in filing its quarterly financial statements. Trading of the shares of LBL Skysystems Corporation was therefore suspended between November 14, 2002 and November 14, 2003, the date on which the shares of that Corporation were delisted from the Toronto Stock Exchange.
    • Source: ADF Group Annual Information Form.

From the latest conference call:

  • Receivable at 24 million, but most contracts are with government institutions. Has received 8 million since the end of July.
  • Order changes are being negotiated with a client.
  • Management thinks next year will mark the year when the construction turns around and ADF signs more contracts.
  • There will be some contractual changes to the backlog in the next quarter.
  • Put a bid on a facility to make their push into the nuclear market by putting a bid on a lot in Western Canada. They have the appropriate certification to begin nuclear work. Facility can be up and running by next year, but will need extra financing.
  • New CFO looks experienced and should help the company navigate the challenging business environment.

Notes on customer concentration

  • Year ending Jan 2010 – 70% from 2 clients
  • Year ending Jan 2009 – 63% from 2 clients
  • Year ending Jan 2008 – 82% from 3 clients
  • Year ending Jan 2007 – 63% from 2 clients
  • This company will always have higher than normal customer concentration. The majority of work is done out of one plant in Quebec, and the size of the builds are huge. One project can take months to complete. That’s why one new contract addition will drive up backlog dramatically. A positive is that no customers have left, at least to my knowledge. The decrease in backlog is mostly from the completion of projects.

Count the Cash

  • Even though margins have been stable, the company has not been producing cash. Closer look at the cash flow statement and balance sheet shows that the accounts receivable have been rising. They are rising in absolute numbers from just over 11 million in 2008 to over 24 million today. And they are rising relative to revenue and as a percent on total assets. Running up the CCC (cash conversion cycle) from 30 days to 130 days (ttm), is something to be concerned with. Most of the time I can digest a rising CCC in a slower economy if it is mostly revenue related, and not a function of higher inventory and accounts receivable. A write-down in receivables will take away the discount to book value very quickly.
  • The FCF (including working capital) peaked in 2008 and has been negative for a while now. Though I don’t usually include changes in working capital in my valuations, YOU MUST PAY ATTENTION TO CHANGES IN IT. Working capital can be volatile and some of the investment is for the future. I will make adjustments if I feel working capital is too low and will need to be expanded to take on additional capacity. The company said that they expect cap-ex to be around 2 million, mostly for maintenance. Depreciation and amortization (ballpark maintenance cap-ex) has been over 3 million annually for the last 2 years. My numbers will use 2.8 million for maintenace capital expenditures (property, equipment, and intangibles).
  • Another thing that makes me nervous is the accrual method of accounting; revenue is recognized on the % of completion method. This can lead to wild swings in revenue and margins, as evidenced in most companies other than ADF. I am not smart enough to know if management is manipulating earnings, but errors in assumptions can be made whether intentional or not. I know that compensation is down across the board.


Given the lack of certainty,I am currently passing on ADF group. I have no idea what the stock will do over the next little while. I will try to do some more work to better understand this company and management. The focus on profitability is a big positive. The backlog will keep the lights on for at least 12 months, giving the economy time to recover. The customer concentration and some management concerns are enough reason for me to be cautious. I would put fair value around $4 but am not confident that will be attainable. If I see some new contracts or the receivable situation heading in the right direction for a couple of quarters, I would reconsider my “fence-sitting” position. I don’t have an issue paying more that the current price if a favourable outcome seems more likely.



Latest conference call

Q2 2011

Latest Annual Report

Latest Shareholder Presentation


Filed under Company Analysis

2 responses to “ADF Group: Value or Value Trap

  1. Matt

    Have there been any changes with respect to your opinion on ADF Group?
    I was searching for information on the company and ended up reading your helpful analysis.

    It appears that the company’s financial position is now even stronger with $0.63 per share or almost half of its share price in net cash. The receivables situation is similar with 126 days of sales outstanding, however because of the cash position there may be enough margin of safety at the current price to withstand a substantial write-down. I doubt this will happen since the WTC project is well funded. It seems like WTC is 90% of its business right now. Backlog is decreasing with less than 12 months of work left now.

    • I still don’t own any.
      I have a tough time with these types of companies. There seems to be a fair bit of companies with high net cash, decent business but a lack of a catalyst. ADF is doing the right thing from what I see. As you mentioned the receivables are coming down, but I don’t know how much of that was due to the nature of their contracts. Also having only one plant and such large contracts, you will see high customer concentration and ADF may be at the mercy of their customers from time to time.
      For now I am still staying away. Having so much of the voting control in the hands of the family makes me uneasy. It takes away the potential of an activist and I think there are companies that offer similar upside with less uncertainty.

      Hope this helps.

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