Badger Daylighting (TSX:BAD, BADFF) recently made an appearance on my GuruFocus screen for financially strong small-cap stocks with growing earnings. GuruFocus has the most comprehensive stock screener based on fundamentals. I previously reviewed the company LKQ Corp (LKQ) and found that it had already gone up nearly 1,200 percent in the past 10 years and now has a market cap of $8.36 billion. I analyzed the company’s 10-year financials at GuruFocus and created a screen to find companies similar to LKQ while it was still a small-cap stock. The screen has the following criteria:
Market Cap: Maximum of $1 billion
Financial Strength: Minimum of 8 out of 10
Profitability: Minimum of 8 out of 10
P/E (TTM): Maximum of 36
EPS Growth Rate 1Y: Minimum of 25 percent
It was interesting to see that the screen only resulted in 13 stocks as of today. It was run for stocks trading in the United States and Badger Daylighting showed up because it is trading in the U.S. on the pink sheets. The screen can also be used to scan stocks on the global exchanges through a Global Membership. The stock of this fast growing company peaked at $43.65 earlier this year in April and has been dropping since. From the start of 2012 to its recent peak, the stock was up nearly 700 percent as investors began catching onto this small-cap stock and sent the price far too high. Now the stock is at C$26.78 and just about at fair value according to the GuruFocus DCF calculator. It would be hard for this stock to stop on a dime and reverse trend so it is likely to continue to drop some more. Any further drop in the stock’s price is now more of a buying opportunity. (The large spike in January is a display error due to the 3-for-1 stock split.)
Company background
The Calgary-based company was founded in 1992. Badger provides nondestructive excavating services for contractors and facility owners in the utility and petroleum industries in Canada and the United States. Its main business is very simple: Its hydrovac trucks provide pressurized water to loosen the soil while its large vacuum unit removes the soil and debris. A video on its website showed a professional operator using the system to safely excavate gas utility lines in only five minutes. The units can be used to work in areas up to 50 feet deep and over 500 feet away horizontally. Case studies in Badger’s most recent investor presentation showed how the company provides a more efficient and less costly approach to traditional digging. A water main break example showed that water service was restored 60 percent faster and at a tenth of the cost of the traditional approach. A contractor was able to increase productivity in gas distribution upgrades by more than 800 percent by hiring Badger to dig service repair pits.
James Stone, portfolio manager of the Baron Energy and Resources Fund, gave the following comment in Baron Funds' (led by the guru, Ron Baron) first quarter report:
"We increased our position in Badger Daylighting Ltd. (TSX:BAD), a provider of custom-made trucks that use pressurized water and powerful vacuums to excavate in areas with buried pipes and cables. These “hydrovac” trucks are much safer than mechanical equipment and more efficient than manual digging. Hydrovac truck demand is growing rapidly, as oil and gas companies use them to build new wells and pipelines, and as utility companies increasingly use them to maintain underground infrastructure. Badger is meeting this demand by building more trucks and adding more service locations in the U.S. and Canada. With over 800 trucks and 110 locations, Badger is by far the largest provider of hydrovacs in North America, competing mostly against local mom-and-pops. This size advantage and the company’s manufacturing capabilities allow Badger to enjoy economies of scale and lower operating costs. Given the strong tailwinds of capital investment by the energy and utility industries, along with increasing safety pressures around accessing and maintaining existing infrastructure, we believe demand for Badger’s services should continue growing nicely."
Financial strength
One of the reasons why Badger appeared on the screen is its strong financial condition. It scores an 8/10 for financial strength. Although the company only has C$3.3 million in cash on its balance sheet and a much larger C$95.8 million in debt, it has enough operating income to cover its interest expense more than 36 times. The current assets are also enough to cover the current liabilities by 2.13 times. A negative is that the company issued more shares in 2012 and 2013 and shares outstanding increased from 32.4 million to 37.0 million. The company does not have a history of diluting shareholders, and the share count has remained flat for 2014. I would not expect any further dilution in the near future.
The company scores a near perfect 9/10 for Profitability & Growth and is outperforming the industry on all profitability measures. EPS growth has slowed down in comparison with the company’s historical standards, but is still at a high 24.10 percent.
The metrics to look for to monitor Badger’s growth and efficiency are its revenue per truck and the number of truck builds per week. The revenue per truck was reported as C$34,600 for 2013, up 5.2 percent over 2012’s revenue per truck of C$32,900. The number of hydrovac units increased 25.6 percent to 791 units in 2013 from 630 units in 2012. Five years ago, the number units was only 407 hydrovacs. The company is reducing its build from 5 trucks per week to 4 trucks per week. Four trucks per week still amounts to another 200 trucks per year, a 25 percent increase from 2013. The company states that the builds have a 4-year payback period and an economic life of 10 years. The return on capital is a high 20.36 percent.
Management
Badger has had the same chairman/CEO duo in control since 2001, providing stability at the top. George W. Mason is the chairman and has plenty of connections in energy. He is the chairman of Mako Hydrocarbons, Fortaleza Energy, Poplar Creek Resources and CriticalControl Solutions. He is also a board member of Teekay GP and Teekay LNG Partners, and was previously the president and CEO of TransCanada Pipelines.
Tor Wilson joined the company in 2000 and has been the CEO since 2001. Prior to joining Badger, Wilson was the senior vice president and COO of Timberjack Inc, an international equipment manufacturer and distributor that was purchased by John Deere in 2000. The stability at the top will help the company maintain its high Business Predictability ranking of 4/5.
Valuation
Before the stock’s big move to the upside, it was undervalued in relation to its earnings and growth rate. The stock overcorrected to the upside, and it will likely overcorrect to the downside. The stock closed at C$26.86 on Sept.18, and is down 38 percent from its closing high of $43.25 on April 2. The GuruFocus DCF Calculator shows that the stock is now fairly valued at its current price. The exact price given by the DCF Calculator is C$26.50. It is likely to drop more from here with its heavy downward momentum. Any further move to the downside adds to its margin of safety.
Risks
A large risk is that Badger might not be able to keep up with demand and properly handle its growth. The latest quarterly report stated that EBITDA margins in the U.S. dropped to 27 percent from 31 percent due to increased costs and investment required for growth, mainly associated with recruiting and training employees. Later in the report, the company commented, “The U.S. economy has improved which will create more work opportunities for Badger. However, this improvement has made it harder to recruit the required people to handle the work.”
It sounds like a good problem to have that the company could have a hard time finding enough qualified employees to keep up with demand, but that could potentially cause the company to grow slower than expected. The plan for the build of new trucks has been reduced to 4 per week as opposed to 5 per week. The stated reason was to allow the U.S. to focus on improving revenue per truck and to continue to build the organization required to grow the business.
Outlook
There is plenty of opportunity for Badger to capitalize on its U.S. business while continuing to grow in Canada. The U.S. revenues have accelerated in the past five years and just passed the revenues from Canada in 2013.
With the U.S. population being nearly 10 times as large as Canada, there is plenty more room for growth. The industry is highly fragmented and Badger is the leader. Its economies of scale and in-house design, research/development and manufacturing give it a large competitive advantage. The stock is now fairly priced, but the price has plenty of downward momentum. Any further drop will from here will be an increase in the margin of safety.
Using the tools available at GuruFocus, I was able to analyze a 10-bagger company such as LKQ to find its characteristics before the stock price took off to the upside. The 10-year financials are available on one page along with interactive charts to show trends in each item of the financial statements. From there, I was able to take those characteristics and search for similar companies in the All-In-One Screener. I saved the screener so I can periodically check to see if any new companies appear on the list. Badger Daylighting was one of the most recent additions to the screen results. There are plenty of different categories to screen for to help find the next investing opportunity. There are also pre-set screens such as the Buffett-Munger Screener, Peter Lynch Screen, and the Ben Graham Net-Net. Give it a try to see what investment opportunities you can uncover.
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