KeyStone’s Stock Talk Show Episode 261.
Great to chat with you again – I will kick off the show by reviewing a couple of Canadian M&A deals over the past week, including a bid for a company from our Canadian Focus BUY Portfolio, aerospace product manufacturer Héroux-Devtek Inc. (HRX:TSX), which has produced a 79% gain for clients. I will also review the bid for steel producer Stelco Holdings Inc. (STLC:TSX) and why Canadian companies, and in particular Canadian Small-Cap stocks, may be ripe for continued M&A activity.
In our YSOT segment, Brett answers a viewer question Valeura Energy (VLE:TSX), an oil and exploration, development and production company focused in Thailand and Turkey. While it faces a near-term challenge and geopolical risk is higher, the stock is up 100% over the past year, has a cash rich balance sheet and relatively reasonable valuations.
Finally, Aaron answers a viewer question on goeasy Ltd. (GSY:TSX), a company which clients should be very familiar with as it continues to be a stellar performer in our Canadian Income Stock Research. Goeasy’s shares have gained over 70% over the past year and Aaron will let you know whether we have a BUY, SELL or HOLD on the stock.
Let’s get to the show –my cohost, Mr. Aaron Dunn – and the killer B’s, Brett, and Brennan.
Canadian Market Mid- Small Cap M&A Ripe for M&A?
HRX:TSX & STLC:TSX Acquired in last 5-days.
Héroux-Devtek Inc. (HRX:TSX)
COMPANY DATA | |
Symbol | HRX:TSX |
Stock Price | $31.02 |
Market Cap | $1.043 Billion |
Yield | 0% |
Héroux-Devtek Inc. is a manufacturer of aerospace products and is the third largest landing gear manufacturer in the world. The company serves both commercial and defence sectors. HRXalso manufactures hydraulic systems, fluid filtration systems and electronic enclosures – operating across 15 locations in North America and Europe.
Strong Performance over the past year for clients up 106.6%
Transaction details.
Héroux-Devtek agrees to be acquired by Platinum Equity Advisors, LLC, a U.S.-based private equity firm, for $32.50 in cash per share a 28% premium to the closing share price on July 10, 2024, a 47% premium to the 90-day volume-weighted average, and a 79% gain from KeyStone’s original recommendation price.
Valuations.
Héroux-Devtek currently trades at a trailing P/E of 27 times, an EV/EBITDA of 14 times and a P/FFO of 13 times.
Forward looking: 22.69x 2024 expected EPS.
Conclusion:
Valuation is fair given the debt levels.
The current discount to tender price is ~4.8%, with an expected closing date before March 31, 2025.
KeyStone rating is shifted to Tender / SELL – take the 79% gains and recycle profits into new Focus BUY recommendations.
The next Canadian Stock to receive a takeover bid over the last week was:
Stelco Holdings Inc.
(STLC:TSX)
COMPANY DATA | |
Symbol | STLC:TSX |
Stock Price | $65.61 |
Market Cap | $3.60 Billion |
Yield | 3.08% |
Stelco Holding Inc. is one of Canada’s leading steel producers, operating out of two facilities: Lake Erie Works near Nanticoke, ON, and Hamilton Works in Hamilton, ON. The company’s rolling and finishing capabilities enable it to produce not only hot-rolled coil but also value-added steels such as coated and cold-rolled steel.
Transaction details.
Stelco entered into a definitive agreement to be acquired by Cleveland Cliffs (Cliffs) for $70.00/ share, consisting of $60.00/share of cash and 0.454 Cliffs shares. The takeout price is an 87% premium to Friday’s closing price and a 37% premium to Stelco’s pre-announcement 52-week high.
The agreement allows Stelco to terminate the transaction and accept a superior offer, subject to a customary right to match in favour of Cliffs and a termination fee of $100 million.
Cleveland-Cliffs Inc. (CLF:NYSE) – publicly traded largest flat-rolled steel producer in North America.
Valuations.
Based on current forecasts, the implied takeout multiple is 6.5x EBITDA and ~16 times EPS.
Fair value given the volatility in steel markets.
Conclusion.
Cliffs deal will likely proceed – Stelco has received shareholder support from Fairfax Financial (23.64% of the shares outstanding), Alan Kestembaum (15.77% of the shares outstanding), Lindsay Goldberg, and the executive team, who all control ~45% of the outstanding shares. Further, the transaction has received support from the United Steelworkers union.
Chance a superior bid that is not matched by Cliffs could materialize – holding until the “bid period” expires at the least is advisable.
With two takeover bids out there we are being asked if this activity will continue and if..
Canadian stocks are being targeted in M&A activity – and why
We have seen a pick up in activity in the Canadian market – Generally – M&A has been depress for several years after rates rose and capital become more expensive and harder to access – We do see Canadian companies being targeted, and it is likely a good strategy.
Here is the performance of the major North American Exchanges over the past 5-years. The laggard is the Toronto Stock Exchange – if we include the TSX Venture, it would be an even bigger laggard.
If we look over the last year – a similar scenario unfolds with the TSX being the poorest performer.
Generally, valuations are more attractive on the TSX and it appears some larger US companies are taking advantage of this – we expect it to continue.
Valuations:
The S&P TSX (Canadian market) is trading at a PE ratio of 21.8x .
The S&P 500 P/E Ratio is at a current level of 27.45x.
A number of clients reached out in our Weekly Chat session and via email in the wake of the HRX premium takeover inquiring as to what stock or stocks we believed could be the next company acquired from our Buy recommendation lists.
For decades we have experienced great exit points from stocks our clients and KeyStone itself have invested in – we have seen this over the past year with H20 Innovations and Héroux-Devtek and expect the trend to continue through 2024.
One other item you may have noticed was the second laggard of the 5 exchanged listed over the past 5-years was the Russell 2000 often considered a larger US small-cap index. The valuation gap between large and small-cap stocks remains at 20 years highs in favour or small-caps.
We believe a number of solid small cap stocks are primed for takeover bids.
Predicting which stocks will be acquired is a fools game – look for a profile of good businesses, with solid revenue and profitability growth and reasonable valuations.
We see potential M&A activity in Specialty Canadian Pharma, Aerospace and Defence, Software, gold and energy segments – so a broad range.
It is something we expect to continue to report on through 2024 and into 2025.
YSOT Valeura Energy (VLE:TSX)
1)
Valeura Energy symbol VLE on the TSX, is an oil and exploration, development and production company focused in Thailand and Turkey. Currently, the production is offshore based in Thailand after the company sold its shallow conventional gas business in Turkey in 2021. The company underwent a major transformation in 2022 shifting its focus to Thailand. The company operates in 4 off-shore oil fields in Thailand.
2)
The stock is trading up 100% over the past year at $4.20 a share with a $450 million market cap.
3)
Looking at the operations in the Gulf of Thailand. The Manora and Jasmine fields are mid-life while the Nong Yao and Wassana fields are actively undergoing expansion and exploration.
The company has 37.9 million, in proven and probable reserves.
Combined, the fields are expected to produce approximately 23 thousand barrels daily in 2024. During Q2 the company produced 21.1 thousand barrels per day.
The company is expecting a 50% production bump for the Nong Yao field, providing a significant portion of the organic growth for 2024 exiting the year at approximately 11 thousand barrels per day.
I will note as well the Wassana mobile offshore production unit, has been found to have a crack, which puts the current production at 17 thousand barrels per day at this time. The crack may be superficial which means no risk to structural integrity and a shorter turnaround to production if it is structural repairs need to occur. The company expects to know the severity by the end of July.
4)
For 2024,
The company is expecting production of 21.5 to 24.5 thousand barrels per day, 13% year-over-year.
The company’s benchmark oil is Brent, but during the last quarter, it is notable that the company actually received a premium of $2.7 over Brent.
The current guidance implies a netback of $45.0 per barrel after expected royalties of 13%, operating expenditure of $220 million, and flat general and admin of roughly $25 million. Putting the annual net back at approximately $378 million.
5)
Looking at the preliminary results for Q2 2024,
Oil production was 21.1 thousand barrels per day, at a realized price of $87.7 per barrel resulting in revenue of $164 million.
The company closed out the quarter with $145 million in net cash after having a combined outlay of $109 million for taxes, the purchase of the Nong Yao Floating Storage and Offloading Vessal, and its final contingent consideration for the acquisition of KrisEnergy.
At $145 million US or $199 million Canadian with no debt past leases, the cash is roughly 44% of the market cap. So cash rich to say the least.
6)
Switching to valuation looking at external analyst expectations, the company is trading at only 0.2 times EV/EBITDA. Quite cheap to say the least due to the high cash balance and expected strength in EBITDA given the current oil price.
7)
However, the company does have some key risks.
The Manora and Jasmine oil fields are mid-life and production has been trending down for multiple years, the company can extend the economic life with infill wells, but ultimately other production sources need to be found to keep the same level.
Near term the company is also seeing lower production due to the Wassana crack, which if it is structural will lower cash flow for the year.
Of course, this is on top of the commodity risk with oil.
8)
Concluding,
If you are an oil bull, Valeura appears to be appealing due to its strong financial position which is further supported by the strong cash flows expected if oil prices remain steady or higher. The company is trading at an overall discount. While we would never invest for the expectation of a takeover the combination of valuation and production growth expected in 2024 creates the potential for the company to be acquired.
So overall I would say if you want to speculate on Oil Veleura can be a method to do so.