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The following segment was excerpted from this fund letter.
Terravest (TSX:TVK:CA, OTCPK:TRRVF) is a C$1.3bn market capitalization company based in Alberta, Canada, rolling up storage tank (propane, fuel, water) and boiler/furnace companies, run by a well-incentivized management team focused on good capital allocation. Terravest trades at a reasonable mid-teens free cash flow valuation, unlike many well-known serial acquirers.
The storage tank industry is surprisingly profitable, offering high returns on capital and proving to be a better business than one might have expected. Terravest operates four divisions:
- Compressed gas equipment (e.g., LPG and propane tanks), essential for rural home and commercial heating and agriculture (crop drying, etc.). 30% of sales and 24% of EBITDA at 16% margins.
- HVAC (industrial, commercial, and residential fuel tanks, wastewater tanks, furnaces, and boilers). 29% of sales, 30% of EBITDA at 20% margins.
- Processing equipment (wellhead procession equipment) near natural gas and biogas production facilities. 18% of sales and 13% of EBITDA at 14% margins.
Service (water management) servicing and close to LNG producers. 24% of sales, 33% of EBITDA at 27% margins.
The company has a strong history of growth through acquisitions. It currently operates 25 businesses and has made 20 acquisitions since 2013. Terravest typically uses debt to fund acquisitions, primarily of mom-and-pop companies, bought at an average 5.5x FCF multiple, then uses the cash flows of the acquired businesses to pay down debt.
Following the acquisition, Terravest focuses on increasing profits by driving revenues through price increases and reducing costs, resulting in an effective post-acquisition multiple decrease from 5.5x to 4.1x. Terravest has generated a 21% average annual ROIC since 2013 and an EBITDA growth of 28% annually over the same period. Terravest operates a scalable, decentralized business model with centralized capital allocation and empowered operating company managers.
An example of improved unit economics is as follows. On a 60k gallon tank, Terravest improves gross margins from 20% to 34%. Terravest has a significant advantage with steel costs; it can buy in enough volume to directly source steel from mills, saving up to 15% on the price of steel, which constitutes 55% of the cost of goods sold. Terravest also has the working capital to buy steel in bulk and stock it in inventory, a financial capability smaller companies lack. As a result, Terravest can build customer orders in 10-14 weeks compared to 20-26 weeks for smaller companies, allowing it to charge a 5-10% premium. Finally, it saves 5-10% on labor costs.
There is some risk to cyclicality, given exposure to energy markets. Additionally, there is a perception that the propane markets are in terminal decline, being the target of environmental regulators. However, much of the propane is used for residential and commercial heating in rural areas with no good gas pipeline infrastructure. Therefore, Terravest’s delivery tanks are “critical infrastructure.” According to the EIA, propane consumption in the US has been stable for 20 years. With boilers in the HVAC business, Terravest mainly operates older style standard efficiency cast iron boilers, which are at risk of being regulated out of existence by continually updated environmental regulations. While true, this again is a slow decline. Demand for boilers is driven by new construction, where the patchwork of differing state and city regulations will likely take time to seriously dent revenues and replacement cycles, where the incremental cost to a homeowner to upgrade existing piping to accommodate a newer style boiler increases switching costs.
In the meantime, the company can continue deploying its cash flow at high rates into attractive adjacent end markets such as biogas, LNG hydrogen markets, and chemical tanks, many of which have a significant overlap in equipment as its petroleum markets. Terravest has a long runway for growth from a large pool of potential acquisitions and a strong operator/capital allocator team with a CIO with a strong track record and a CEO who is only in his early 40s. Finally, management is highly aligned, owns approximately 25% of the company, takes reasonable compensation, and is set to make themselves generational wealth if they continue to compound the business (as they have for the last decade).
Terravest is a smaller, less well-known company with a minimal investor relations presence. The price recently ran up as several value investors published well-thought-out write-ups online. I initiated a starter position, intending to invest more in the future.
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