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DRX: Increasing Target Price on Improved Outlook

What you need to know:
• We are revisiting the assumptions in our model for ADF following strong industry data and positive conversations with management.
• We are increasing our revenue and profitability estimates from Q4 onward to reflect the more bullish outlook.
• We have increased our target multiple to 6.5x FY25 EBITDA (previously 6.0x), leading to a new $13.00/share target price (previously $10.00/share).
• Watch our recently published management interview here.

We are revisiting our model assumptions on ADF Group (DRX:TSX, ADFJF:OTC) following strong industry data and an improved outlook from management. Non-residential construction spending continues to grow in the U.S., posting 20% YoY growth in December while Canada posted 16% YoY growth in non-residential construction permits in October. Pairing this with a more bullish outlook from management in our conversations, we believe this infrastructure spending cycle will continue ramping into FY25 and beyond, leading to increased estimates for ADF. Furthermore, there was a comparable transaction in the U.S. at 7.5x EBIT, resulting in increasing our target multiple. We are maintaining our BUY rating and increasing our target to $13.00/share (previously $10.00/share).

Precedent Transaction
On January 9th, fellow steel fabrication firm, Capital Steel Service was acquired by Hill & Smith PLC (HILS:LSE, $2.6B mkt cap), a provider of infrastructure products and services. Capital Steel Service is based out of New Jersey and provides custom fabrication and steel services out of its 50,000 SF facility. The initial consideration for the acquisition was $6.25M with a total consideration including earnouts of $7.45M. For the year ending August 2023, Capital Steel Service posted $8.1M in revenue and $1M in EBIT, translating to 7.5x EBIT. Applying this multiple onto ADF’s FY25E EBIT of $61M would imply a target price of $14.00/share (48% upside).

Industry Data
Non-residential construction spending trends have continued to be strong across North America, providing leading indicators for ADF’s backlog and revenue. In December, U.S. non-residential construction spending increased 20% YoY to $1.2T, following 21% YoY in November and 23% YoY in October (Figure 1). In Canada, Non-residential construction permits reached 4.1M in October, increasing 16% YoY. Furthermore, the architectural billings index has started to improve, hitting levels of 46.2 in January compared to lows of 44.3 in October (50 is the baseline). As such, there is good justification that we are still in the early/middle innings of the infrastructure spending cycle and that ADF is not currently over-earning.

Model Updates
Combining the factors above with our conversations with management, we are increasing the projections in our model (Figure 3). For Q4, we are now expecting $77.1M in revenue (+50% YoY, previously $72.5M) and $13.6M in adjusted EBITDA (+132% YoY, 18% margin, previously $10.5M).

ADF’s backlog currently stands at $573M after its latest contract announcement (see our note here). Management has previously outlined that >80% of the backlog should be completed in the next 15 months, or $458M in revenue. Subtracting our Q4 estimate of $77.1M, revenue for FY25 should be around $381M, assuming ADF does not take on any new contracts. Continuing to take a conservative stance, we are now assuming $361M in FY25 sales (+13% YoY, previously $351M). As for margins, we are now expecting 18% EBITDA margins in FY25, up from 16%; this is still fairly conservative as ADF posted 22% margins last quarter.