Stock Talk Podcast Episode 285 Show Notes

You are listening to KeyStone’s Stock Talk Show – Episode 285

Great to chat with you again this week. I will kick off the show highlighting the tremendously strong Q3 FY 2025 numbers from Aritzia (ATZ:TSX), a company which should be no stranger to clients as it has been in our Canadian Small-Cap Focus Buy portfolio since 2020. With the fashion retailer shares up 110% over the past year, crushing the likes of Lululemon and Canada Goose in the Canadian retail landscape, we look at what is driving the growth. Aaron looks at the headline news of the week with Big U.S. tech plunging on Monday following news of a Chinese AI competitor – Nvidia shares were down over 17%. Aaron let’s you know if there are opportunities or if Monday’s rout may continue. In our YSOT segment, Brett answers a viewer question on DIRTT Environmental Systems (DRT:TSX), a modular interior construction company that specializes in sustainable building solutions. While the company’s shares are up significantly over the past year, the long-term share performance has been poor. Brett let’s you know what is driving the rebound and if it can continue. Last, and definitely least, Brennan answers a viewer question on ADF Group Inc. (DRX:TSX), a North American leader in the design and engineering of connections, fabrication, including the application of industrial coatings, and installation of complex steel structures, heavy steel built-ups, as well as in miscellaneous and architectural metals for the non-residential infrastructure sector. The stock is down well over 50% from its 2024 highs – after authoring a MONITOR report on the stock for clients, Brennan let’s you know his take on the business.

Poll question.

Steelmakers halting price quotes:
https://financialpost.com/commodities/mining/canada-mexico-steelmakers-refuse-new-us-orders

TD: Economics on Trade Balance
https://economics.td.com/ca-canada-us-trade-balance

Deutsche Bank on Tariff impact on US inflation – will likely use image
https://seekingalpha.com/news/4396909-with-25-tariffs-on-canada-mexico-looming-db-forecasts-effect-on-u_s_-inflation

YSOT Aritzia (ATZ:TSX)

Our Canadian small-cap clients should be no stranger to Aritzia as it has been in our Canadian Focus Buy Portfolio since the start of 2020 – the stock was recommended at $16.80.

I thought we could take a look at Aritzia’s share price over the past year compared to two of the other larger names in the Canadian fashion industry.

First, Aritzia has performed tremendously well – up 110% in one year.

The company has significantly outperformed the two more well-known names in:

Lulu Lemon and Canada Goose

Your question should be, what powering these strong gains in Aritzia – quite simply the company’s very strong latest quarterly number which bested analyst expectations, strong margin improvement from recent strategic investments and positive growth outlook –let’s start by taking a look at the last quarter.

Q3 FY 2025 Highlights.

Net revenue increased 11.5% to $728.7 million, with comparable sales growth of 6.6%..

 Powered by… US net revenue increasing 23.6% to $403.7 million, now comprising 55.4% of net revenue.

Gross profit margin increased 430 bps to 45.8% from 41.5%.

Adjusted EBITDA increased 48.7% to $136.4 million.

Net income increased 71.9% to $74.1 million or $0.63 per share, compared to $0.38 per share in Q3 FY 2024.

Strong balance sheet: Net Cash Position and Return of Capital: Aritzia has ~$207mm in net cash as at Q3/F25.

Financial Outlook – Guidance.

FY 2025 Guidance Raised: Management raised FY 2025 guidance due to a higher annual revenue outlook with its mid-point guide increased by ~4% to $2.68 B (prior $2.57 B).

Key margin metrics unchanged, implying FY 2025 EPS of $1.80-$1.90 (consensus was $1.73).

FY 2027 Guidance: Management reiterated its F2027 key guidance metrics that implies EPS of ~$3.50.

Tariffs?

Exposure to Tariffs: 

On the company’s most recent earnings call management spoke to the issue of tariffs being contemplated by President Elect Trump for goods manufactured in China and sold in the U.S. The company stated that they have been proactive in diversifying manufacturing base in recent years, with the “great majority” of its products now being manufactured outside of China.

Management did convey that they estimate the impact from a 10% tariff to be ~30bps to its EBITDA margin prior to implementing any mitigating actions such as offsetting price increases. This should be something that does not significantly impact results, but is worth monitoring.

Additionally, we note that a weaker Canadian dollar can hurt the Canadian operating margins.

Conclusion

Q3 FY 2025 result were very strong in terms of revenue, margin, and EPS growth.

Marks the true impact of the company’s strategic turnaround and the foundation to capitalize on a material growth runway in the U.S. is in place.

The company’s solid growth outlook is driven by strong product resonation, an acceleration of store openings, and eCommerce penetration. Combined with cost initiatives/leverage Aritzia is positioned for attractive EPS/FCF growth.

Valuations are currently premium.

YSOT DIRTT Environmental Solutions (DRT:TSX)

1. DIRTT Environmental Systems symbol DRT on the TSX, is a modular interior construction company that specializes in sustainable building solutions. In addition to prefabricated physical products like various walls and doors, the company also offers its proprietary design integration software or ICE. The company operates in both Canada and the US, with the lion’s share of revenue coming from the US.
2. The stock is trading at $1.18 a share and a $228 million market cap after a strong performance over the last year rising 107%.
3. However, zooming out the stock performance has not been so bright. With the stock trading well off its all-time high set in 2019 of about $7.60.
4. So why has the stock performed so well over the past year, is a turnaround occurring? Pulling a chart from the company’s Q3 presentation as it shows the significant financial change. Gross margins have improved dramatically with non-GAAP gross margin at 40.7% up all the way from 17.7% in Q1 2022, this is a similar level to 2019 and prior. The improvement was driven largely by cost reduction measures that the company has taken over the last 2 years. The company closed a couple of facilities as well as lowered its headcount by about a quarter between 2019 and 2023.  This has been reflected across the business this has allowed the company to move into overall profitability, with the last quarter marking 4 a year of consecutive GAAP profitability.
5. Moving onto the most recent financials for q3 2024 the figures are in US dollars. Revenue fell by 12% to $43.4 million due to four large projects occurring in Q3 2023 that did not recur.
   GAAP gross profit margin improved to 38.% from 34.4%, but gross profit fell slightly to $16.8 million from $17.1 million due to the lower revenue, so improved margin but lower revenue base.
   Adjusted EBITDA fell to $4.1 million from $5.3 million as EBITDA margin did fall to 9.4% from $10.6% due to a lower gross profit as well as higher operating expenses, so the business had reduced operating leverage during the quarter despite the improvement in gross margins.
   Net income came in at  $7.1 million or $0.3 per share a big improvement from a loss of $6.3 million and $0.05 per share. This is due to a gain on extinguishment of convertible debt as Dirtt bought back $32.5 million of face value debentures during the quarter.  Without the gain, the company would have been in a slight net loss position which does take away from that consecutive GAAP profitability I mentioned before.
6. Shifting to the balance sheet, the company is in a net debt including leases of $31.7 million, without leases Dirtt is in an ever so slight net debt position but nothing meaningful. The level of debt was significantly reduced as the company repurchased outstanding debentures this was funded not by external cash flows but by issuing shares through a rights offering at $0.35 a share, so the balance sheet improved at the cost of increasing share count by about 62%. The trailing net debt & leases to EBITDA is at 2.2 times. Which is on the higher end but is driven largely by leases and the company does seem at least structurally sound now after repurchasing the debentures. Additionally, off the balance sheet, the company does have significant tax loss carryforwards in both the US and Canada so the company will unlikely to make tax payments in the coming years.
7. Looking forward, for 2024 the company is guiding $165 to $175 million in revenue and $12 to $15 million adjusted EBITDA. For 2025 the company is guiding $194 to $209 million in revenue and $18 to $25 million in adjusted EBITDA. Off the midpoints, 2025 revenue is expected to grow by 18.5% and adjusted EBITDA by 59%. Dirtts 12-month pipeline at the end of Q3 sits at $255 million, pipeline is the number of projects being pursued from quality leads so some will of course fall out that’s why we are seeing a difference between pipeline and guidance.
8. On a valuation basis using the company’s guided midpoint EBITDA for 2025 the shares are trading at an EV-to-adjusted EBITDA of about 9 times, so not overtly cheap nor absurdly expensive at the current level, given it is a recovery story at the current time but may have upside if the company can execute on growing revenue at the current margin profile.
9. Concluding,
   Dirtt has had a rough couple of years but has rebounded in 2024, the company restructured its balance sheet making the debt level manageable, and the margins have recovered, but now we need to see can grow from top to bottom line to support any appreciation in the stock.  To do this the company will need to navigate the risks that come along with the construction industry including the cyclical nature, material inflation which previously impaired the company, and supply chain management which could have elevated risk with the current tariff talk. Overall though we will continue to Monitor Dirtt Environmental Solutions for it to execute on its transformation.

YSOT ADF Group Inc. (DRX:TSX)

Price: $8.90

Market Cap: $159.M

Yield: 0.44%YSOT from Mario via email – “Good afternoon. It is always a pleasure to listen to your podcast on my ride home from Toronto. My question is on the small cap DRX. I bought a substantial amount in 2022 and became about 20% of my portfolio as of the beginning of 2024. Then the price went down, but I couldn’t find any major reason for it and bought more at end of 2024. I believe in holding stocks for the long run and let the winners go. It continues to loose momentum so far. I would appreciate your opinion.”

Description:

ADF Group Inc. is a North American leader in the design and engineering of connections, fabrication, including the application of industrial coatings, and installation of complex steel structures, heavy steel built-ups, as well as in miscellaneous and architectural metals for the non-residential infrastructure sector.

As of Q3 2025 Management noted that its Canadian facility in Montreal is at 70-75% capacity and its U.S. Facility in Great Falls is at 65-70% capacity. The Fabrication shop in Canada can do approximately 100-120 tonnes per year while the U.S. Fabrication shop produces approximately 25-35 tonnes per year.

Slide 2

The stock has had a strong run since the beginning of 2023, up 330% driven by strong financial results – and as Mario indicated, the stock has since become a large weighting in his portfolio due to the gains. Now, the last time we covered the stock on the podcast was in October 2024, and we actually wrote up a MONITOR report for clients in our most recent Canadian Cash Rich, Profitable, Small-Cap Research Report released in late December.

Slide 3

Now looking at the recent quarter of Q3 2025 ended Oct 31, 2024.

• Revenue declined 2.7% to $80.0 million from $82.1 million in Q3 2024.
• The gross margin for Q3 2025 was 30.4%, compared to 24.4% margin for the same period in 2024. The improvement in margins is largely attributable to a better absorption of fixed costs, in line with the increase in fabrication volume, the continued favorable impact of the investments in automation at ADF’s plant in Canada, and a favorable mix of projects. In fact, since the beginning of the current fiscal year, the mix of products in fabrication was particularly favorable given the increase in automated fabrication which is higher margin.
• Adjusted EBITDA was $24.0 million or 30% margin, up 35% from the same period in 2024.
• Net income rose to $16.4 million or $0.55 per share in Q3 2025, up 47% from a gain of $11.2 million or $0.34 per share for the same period last year.
• The balance sheet is in a net cash position of $19.1M and equates to a net cash per share balance of approximately $0.64 per share.

Slide 4

Now lets look a little longer term at how the business has performed.

YTD we have seen record margins with gross margin of 32% and net margin of 18%.

But keep in mind, ADF group is a contract driven business, and over the long run margins have been cyclical which management equates the recent margin expansion to 1/3 automation investments coming online at its Canadian facility, 1/3 absorption of fixed costs given higher volume, and 1/3 from project pricing benefits. So margins are certainly at a historical high over the past decade….

ADF Group’s order backlog totaled $330 million as of October 31, 2024, compared with $339 million on the same date a year earlier and $510.9 million on January 31, 2024. On average backlog is comprised of 45-50% for fabrication hours, 35-40% for installation, and the balance is for raw materials 10-20%. Therefore, backlog is not overly sensitive to the price of steel.

Slide 5

The company does not provide guidance, but, it is of management’s opinion that they still see 3-4 years left of growth in an “atypical” business cycle. They also voiced that margins were heightened in FY2025 and will likely come down in FY2026. Growth in revenue is anticipated but Gross Margin dollars are expected to remain flat year over year (given margin % headwinds).

Since the company became profitable in FY2021 the company has maintained an average PE multiple of approximately 6 times.

And now looking at the current trailing valuations, ADF is trading at about 4.6x times trailing accounting Earnings, which is below its 5-year average of 6x. The company trades with an EV/EBITDA multiple of 2.8 times and a price-to-CFO multiple of 3.1x.

Slide 6

And here, I essentially just want to tease that for clients I went through a scenario for FY2026, hypothesizing an expected growth rate in revenue and a net income margin to provide clients with what we believe fair value to be if the stock can continue to trade at its average PE multiple of 6x…. but this is exclusive to clients in that report which was released in December.

Slide 7

So to conclude here on ADF Group:

•  ADF Group has performed well over the past 5 years, growing backlog to $330 million in FY2025 from $200 million in FY2019 and expanded gross and net margins from 8% and (0.5%), respectively, to 24% and 11%, in FY2024.
•  Over the FY2025 YTD period (Q3 2024 – Q1 2024) gross and net margins expanded even further to 32% and 18%, driven by better absorption of fixed costs (increase in fabrication volume), the continued favorable impact of investments in automation at ADF’s plant in Canada, and a favorable mix of projects given the increase in automated fabrication at its Canadian facility which is higher margin.
•  Cyclically, ADF is exposed to the non-residential construction industry with a typical business cycle lasting 5-6 years followed by a couple years of slow down. And during an up-cycle, ADF’s margins have typically performed well.
•  Management indicates strength in demand persists with further upside to the current cycle (3-4 years) – driven by Infrastructure spending in the U.S., lower interest rates, and reshoring of manufacturing – but looking forward to FY2026, margins are expected to come down given the favorable factors experienced in FY2025.
•  On top of the cyclical risk, a majority of ADF’s revenue comes from the US (>85%), therefore U.S. & Canadian trade relations – such as tariffs imposed on Canadian goods – can impact the company’s demand and profit margins. With president elect Trump threatening a 25% tariff across all Canadian goods when he takes office in January, this could materially impact ADF’s operations as it ships Fabricated Steel products to the US from its Canadian facility. Management believes that potential steel tariffs will likely focus on raw imported steel rather than fabricated steel imports. But there remains risk that potential steel tariffs could materially impact the business. And in the near-term management is seeing some downward pressure on pricing and slower project decision making as clients wait for more clarity.
•  In the near-term the business does not need capital for expanding capacity and will likely focus on paying down debt and returning capital to shareholders through dividends and share repurchases.
•  There is an investment case for ADF as it possesses a healthy cash rich balance sheet, backlog remains elevated, and the business remains relatively cheap in relation to its earnings and Adjusted EBITDA. However, risk is heightened in the face of near-term tariff uncertainties, tough comparable margins the business will need to lap in FY2026, and the risk of potentially investing in the later stages of a what management has called an “atypical cycle”. AS SUCH WE CONTINUE TO MONITOR.

DISCLOSURE.