Our last note on Colabor Group (GCL.TO; $1.01) predicted that “if the company can stop revenues from falling, and in fact start to grow them again, EBITDA (earnings before interest, taxes, depreciation and amortization) should expand. Can they? We think so.“
Results for the second quarter were released last week and bore out the above thesis. For the first time in several quarters, if not years, revenues grew, albeit only slightly. EBITDA, meanwhile, surged by 37%. Not many companies see that kind of year-over-year earnings increase, making old Colabor look more like a growth story.
As mentioned in a previous note the company had sold its Décarie Meats division for $20 millionduring the quarter, which was applied to debt repayment and which improved the stock price significantly. The more recent earnings report led to signifiant trading volume but not a big move in the stock price, as some investor took profits (the stock is up more than 100% in a year) and others stepped up to take a first position. I bought more stock, because I believe we’re in the early innings of a classic and highly profitable turnaround. Companies at the beginning of a solid turnaround plan generally see their stock prices rise for a few years before the easy money is made.
Let’s have a closer look at the financial mechanics of the quarter. Unfortunately, for competitive reasons, the company has opted to stop publishing the schematic margin analysis that I have published for you in the past. Nonetheless, by closely reading the MD&A and notes to the financials statements I’ve been able to reconstruct it:
This is a very good result with a big percentage increase in EBITDA, on small increase in revenues. Cost discipline was very good, contributing most of the gain in earnings. Gross margin, however, fell slightly for the second quarter in a row. This is likely a result of product mix (some items have lower margins than others) and possibly a result of the sale of Décarie. I have written the company to enquire. For now I’m not concerned because cost control is dominating the P&L and there’s more of that to come. Still, at some point the company must increase revenues and gross margins in order to increase value.
Can it? Yes. Management mentioned on the earnings call that it had exited some low-margin contracts. This focus on profitability over revenue is a hallmark of a solid turnaround story. They also spoke to revamping their private-label offering, which you can expect to see bear fruit early in 2020. Private label usually drives gross margin improvement.
Elsewhere, it appears Quebec is doing much better, while Ontario struggles still. One of the directors told me earlier this year that the big problem in Ontario is a contract with a big customer (I believe it’s Cara) that’s not very profitable, if profitable at all. CEO Lionel Ettedgui mentioned on the call that the company has renegotiated some contracts, and walked away from others. He also said he was in negotiations with a “big” Ontario client and hoped to have a new, improved deal in place by end of year. That could really move the stock price.
On a more positive note, EBITDA margin was 2.7%, versus 1.9% last year. This is the critical yardstick. WIth revenues stabilizing, and assuming an annualized rate of $1.2 billion, and assuming EBTIDA margin can get to 4%, this yields a $2.85 stock price (I use a 8x EV/EBITDA multiple, which is the standard in this industry).
Although revenues might dip in the coming quarters as the company gets rid of low-margin business, I do think over that longer term sales will grow, and that EBITDA margin can be higher, possibly 5% or maybe more. At that level, and with $1.5 billion of sales, the stock price could go to $5, illustrating the sensitivity of this investment to small changes in outcome. This won’t happen overnight, but gradually over two to three years.
Other notes: The company appears to have gotten a very good price for Décarie Meats. When asked about other possible asset sales, Mr. Ettedgui said if he gets another attractive offer he’d consider it but he prefers to continue to improve EBITDA to pay off more debt, which he believes is still too high.
I’ll leave you with a heartening quote from him: “When I joined the company I was a bit shocked about the industry and I found out that the level of execution was really too low compared to other industries. So we decided to change the culture of the company and the go-to-market [strategy]. And so far we’re quite successful. Very far from where we want to grow but I’m quite optimistic that we will be able to deliver better execution further over the next quarters.”