Analyst: Matthias Eyford
All figures shown are in CAD.
AirBoss of America (OTCPK:ABSSF) is an Ontario based holding company, which, through its various wholly owned subsidiaries, engages in the procurement, development and sale of rubber-based products. AirBoss operates in three main product categories: rubber compounding, engineered products and automotive. With regards to operations, AirBoss primarily serves the transportation, defense, and resource industries in North America and Europe; they are the second largest in North America.
Market is underestimating AirBoss's capacity to adapt to Change and Diversify
Turbulence in raw material prices has caused AirBoss to suffer declining revenues over the last four quarters - a side effect of the cyclical rubber industry. However, we believe the market is not pricing in AirBoss's ability to adapt to new market conditions through endeavors such as diversifying its customer base and developing new products; its stock price is ultimately being undermined by macro conditions and does not speak to AirBoss's true intrinsic value. Paired with a strong balance sheet and a track record of financial diligence, we reckon AirBoss will adapt to these unstable macro conditions, and in turn develop a more resilient business model.
Valuation & Recommendation
Through comprehensive analysis using both the discounted cash flow model and comparable companies' model, we determined the estimated share price of AirBoss of America to be $15.17. Presently, the market values AirBoss of America shares at $12.84. Given AirBoss of America's current financial position and present economic conditions, we believe the market is undervaluing the price of its stock and recommend a buy rating. Based on our analysis, in our view, a target price of $15.17 more accurately reflects the value of AirBoss of America shares.
AirBoss of America Corp. operates within several subsidiaries throughout North America, of which they possess 100% ownership. These several subsidiaries can be categorized into three major realms:
AirBoss's main rubber compounding facility is located in Kitchener, Ontario, and has the capacity to supply over 250 million pounds of rubber per year (largest capacity is Hexpol Inc. with 1 billion,). Within its manufacturing of rubber-compounded products, AirBoss uses chemical formulae to create customized rubber formulations. AirBoss's key products serve many applications: mining, military, pipeline, infrastructure, automotive, cable and wire, and tire. AirBoss has the largest market share in the North American rubber compounding market. Their two main revenue streams are tolling and mixing. The majority of clients from Rubber Compounding come from the resource sector. Rubber Compounding has historically been the most significant revenue stream of AirBoss, but due to the decline in raw material prices, it has shrunk, as savings have been passed onto customers.
(Source: Company website)
AirBoss Engineered Products applies chemistry expertise to compound rubber-based products for solutions for the industrial and defense segments. Industrial applications include mining, oil and gas, automotive, while defense applications include military, first response and Chemical, Biological, Radiological and Nuclear gas masks (CBRN). Located in Vermont, in November 2015 AirBoss's Engineered Products division operations were transferred to Acton-Vale, Quebec. The Engineered Products find highly applicable functions in the economy. AirBoss's most recent subsidiary acquisition was of Immediate Response Technologies (IRT) in 2015.
(Source: Company website)
Located in Auburn Hills, Michigan, AirBoss automotive produces flexible moulded rubber products for the North American Automobile industry. These moulded rubber products include bushings, dampeners, boots and isolators, that serve as anti-vibration solutions to control and limit shock for automobiles, which enhance the customer's ride. AirBoss Automotive has established key customer relationships within the North American auto industry, and is a continued preferred supplier. Automotive revenues grew 14% in 2015.
(Source: SEC filings)
Research and Development
As a predominant growth strategy, AirBoss strongly emphasizes their commitment to product innovation and a sustainable competitive advantage. As depicted by the R&D spending graph, AirBoss's R&D expenditures show continual increase, as from 2012 to 2015 R&D spending increased by 48%. Most recently, AirBoss's Engineered Products division launched their renowned, NATO approved CBRN gas masks, suits, and footwear. These new products will allow them to grow their Defense segment and expand operations to NATO countries. Forward looking, management has recently expressed their intentions of developing healthcare related products for their Immediate Response Technologies Division . A sustainable commitment to R&D shows AirBoss's willingness to diversify their customer base and move away from cyclical and low margin industries. We believe AirBoss's funding towards R&D is being channelled effectively not only toward cost-cutting efficiencies, but also toward industries with substantial growth potential such as defense, healthcare and law enforcement; sectors which would diversify their customer base away from industrial rubber compounding customers, such as in mining or oil and gas, thus mitigating their susceptibility to volatile macro conditions.
(Source: SEC filings)
History and Geographic Breakdown
Previously known as IATCO Industries, AirBoss of America's inception came about in 1989 with the amalgamation of Greenstrike Gold Corp. and Ontario Ltd. In 1998, AirBoss ventured into the industry of rubber compounding with the acquisition of International Technical Rubber Manufacturing. From there, AirBoss amalgamated several other businesses and formed a diversified holding company, that to this day, continues to expand its horizon across North America. Today its headquarters are in Newmarket, Ontario. AirBoss of America went public in 1999 on the Toronto Stock Exchange, and has since achieved a 260% overall return. AirBoss's flexible automotive products are manufactured in Malaysia; its defense products are manufactured in Bromont, Quebec. As for its rubber-compounding segment, AirBoss has locations in Kitchener, Ontario and Scotland Neck, North Carolina. In addition, AirBoss's research faculties exist in Kitchener, Ontario, Acton-Vale, Quebec, and Wake Forest, North Carolina.
(Source: Company Website)
Staple Products with an Economic Moat Create Stable Revenue Streams
As the North American rubber compounding industry is consolidated with high barriers to entry, few large players compete for large contracts. Barriers that characterize difficult entry into this industry are high capital requirements, asset specificity, key customer relationships and economies of scale. These natural barriers create an economic moat for AirBoss and give them considerable market power. Being the second largest rubber compounder in North America with a large network of wholly owned subsidiaries, AirBoss benefits immensely from economies of scale. What further solidifies AirBoss's business model and their revenue streams is their value proposition of producing 'need to have products' that find application in the economy regardless of trends and consumer preferences. However, due to the cyclical nature of Airboss's business model, Airboss is sensitive to economic trends and thus growth can sluggishly coincide with GDP. In spite of this, management has expressed strong emphasis on inorganic growth and product innovation. We believe AirBoss operates with a sizeable economic moat, thus providing assurance of future revenue streams.
Airboss's Defense products are the most propitious sign of organic growth as revenues from defense grew 53% from 2014 to 2015. As discussed later, defense spending is predicted to grow substantially over the coming years. Conversely, a particular realm of concern from investors over the past year has stemmed from a significant slowdown in their Rubber Compounding segment. In 2015 revenues from Rubber Compounding had fallen close to 21%. As their rubber-compounding segment represents a significant portion of revenue streams, revitalized strength in raw material prices complemented with a continually expanding automotive and defense industries, we believe, foreshadow rejuvenated future organic growth prospects for AirBoss.
Possession of a Strong Balance Sheet to Finance Inorganic Growth
As management has repeatedly emphasized, inorganic growth is not a dominant growth strategy, but crucial in times of sluggish activity due to cyclical nature of their business model. Fortunately, as indicated by historic financials, AirBoss has a proven record of maintaining a strong balance sheet with significant cash reserves and manageable debt; this will enable management to realistically pursue their strategic inorganic aims of customer base diversification and product innovation. We reckon the consistency of a healthy balance sheet is indicative of financial diligence amongst management, which provides assurance of future growth and financial stability.
The Macro Environment
Industry Overview and Outlook
(Source: IBIS World)
Through its three main operating segments, AirBoss is primarily exposed to the automotive, industrial, health and military markets. These markets are cyclical in nature and very responsive to economic trends. Thus organic growth typically tends to coincide with GDP growth. As AirBoss's management has emphasized, product innovation and inorganic growth are key to revenue growth. AirBoss's revenue streams also face significant exposure to global commodity prices. As of their most recent Q3, net sales dropped 14%; management attributed this to a "decline in volume and drop in raw material prices where savings were passed on to customers." In terms of Canadian market growth, for which AirBoss operates in, Canadian exports rose from 23 percent in 1990 to 45 percent in 2010, indicating healthy growth trends. In terms of revenue projections for the Canadian rubber industry, as depicted above, revenue is forecasted to grow annually at an average of 0.55% for the next 4 years.
The World Price of Rubber
(Source: IBIS World)
The declining price of rubber has been responsible for significantly constraining AirBoss's revenue over the preceding 4 quarters, particularly in their rubber-compounding segment. This is an example of the cyclical nature of their business, as macro external trends such as the price of rubber have remarkable effects on their revenues. In terms of supply, Southeast Asia provides almost all of the world's rubber; having supply concentrated entirely in one region does spell out the risk of market volatility in the price of rubber. The equilibrium price of rubber is largely determined by demand from emerging countries like China and India, or, on the supply side, the quality of rubber harvests. For example, the price of rubber spiked in late 2010 due to a supply shock caused by heavy rains in Thailand. With regards to future outlook, as depicted in the graph, analysts predict the price of rubber to annually rise 2.5%. This outlook rests on the assumption of moderate rubber consumption and sluggish growth from emerging markets. For AirBoss, the volatility depicted in the world price of rubber accurately reflects management's concerns over "volatile raw material prices", while also justifying their goal in innovating new products that would mitigate their exposure to it.
Demand From Car and Automobile Industry
The performance of AirBoss's automotive segment directly coincides with North American auto production. Forward looking, analysts expect revenues from the auto-part manufacturing industry to rise at an annualized 7.4% in the future.
Inorganic Growth and Acquisitions
AirBoss does possess a strong balance sheet to finance acquisitions and diversify their subsidiary holdings. With little debt and a sizeable and continually growing cash balance, AirBoss remains in a good position to finance further inorganic growth. Management's emphasis on inorganic growth is a source of confidence for investors; they mainly look for acquisitions that would diversify its customer base. Most recently, with the announcement of their acquisition of Immediate Response Technologies, AirBoss's stock rose 21% over the course of the subsequent week indicating the enthusiasm among investors. Typically, AirBoss finances their subsidiary acquisitions with debt; given their low debt-to-equity ratio (0.24), we believe management is competent at identifying not only good acquisitions targets, like IRT and SunBoss Chemicals, but also acquisitions that do not burden themselves financially.
Stronger U.S. Defense and Infrastructure Spending
Now with a new Trump administration in the U.S., it is expected that defense spending will rise not only in the U.S., but also Canada, as other NATO nations will be pressured to do the same. Throughout his campaign, Donald Trump's rhetoric has suggested he aims to drastically increase defense spending and pressure NATO allies to do so as well. Estimates range from $500 billion to $1 trillion in spending increases. From this, AirBoss can expect to become more competitive within its Defense segment and contribute to boosting segmental revenues. Customers AirBoss serves through its defense segment include the U.S. Air Force, U.S. Coast Guard, U.S. Army, etc. Furthermore, the recent U.S. election has fuelled much investor optimism within AirBoss, as infrastructure spending will rise and industries such as coal mining will be revitalized.
(Source: Company website)
Diversification of Customer Base and Product Innovation
Due to changing industry conditions and the cyclical nature of the markets they operate in, management has expressed strategic endeavours that aim to diversify their customer base. Their most recent and avidly watched endeavours include the expansion of their defense segment with the development of CBRN clothing, and the acquisition and expansion of Immediate Response Technologies where they aim to develop healthcare products. These endeavours are a major confidence boost to investors, as for example when they acquired IRT trading volume skyrocketed and was complemented with much investor optimism.
So far in 2016, AirBoss's quarterly earnings reports have been significantly below investors expectations. As indicated by daily trading volume, earning reports tend to be a major catalyst of trading activity. Throughout the conference calls however, management has expressed their dissatisfaction with the results and laid out a strategic plan for future growth. This plan includes a diversification of their business model to become more resilient to macro conditions. As indicated by the historical income statement, AirBoss has seen revenue decline continually across all business segments. Management has attributed this decrease in segmental revenue to "customers leaving at a greater pace then the customers [they're] onboarding", and the decrease in the world price of rubber with "savings being passed onto customers".
Gren Schoch: Chairman and CEO
Mr. Gren Schoch has been Chairman and substantial individual shareholder of AirBoss since 1989. During his tenure, he took AirBoss public in 1999, and has been integral in AirBoss's growth as a company. In 2015 he was awarded a salary of $430,155 and stock options of $1,367,669. He is AirBoss's most significant individual investor with an equity stake of $54.21 million dollars. In addition to co-founding AirBoss of America, he also co-founded Latco Industries and has served as the Chairman of many other companies including Kensington Energy Ltd. (2001-2005) and Petromet Resources Ltd. (1997-2000). By trade he is a professional engineer. Over his tenure the stock has returned 260%.
Lisa Swartzman: President
After a management shakeup in 2014, Lisa Swartzman was promoted to president of AirBoss of America Corp. to oversee all of its operations and continue to help secure key customer relationships. Ms. Swartzman has strong experience in the Canadian capital markets industry, as she was the treasurer for Loblaw Companies and George Weston prior to joining AirBoss. In 2015, Ms. Swartzman received a salary of $249,294 and stock options of $1,410,426. Currently, Ms. Swartzman has an equity stake in the company of $1.25 million. Over her tenure the stock has returned 14.96%.
Daniel Gagnon: CFO
Daniel Gagnon is the most recent executive appointment made by Mr. Schoch, having been appointed on June 20th, 2016. The preceding CFO, Mrs. Wendy Ford, served since 2014, and was dismissed during a period of 'substantial transition". This refers to the declining revenues experienced by AirBoss due to turbulence in commodity markets. Prior to joining AirBoss of America, Mr. Gagnon was the CFO of Centric Health Corp. and Revera Inc. Currently, he possesses $256,000 worth of equity in AirBoss, equally as large as his stake in his prior job, Centric Health.
Commodity Cycles and Prices Risk
The procurement side of AirBoss's operations are specifically prone to fluctuations in commodity cycles. As it has occurred in 2008 and 2011, the global supply of synthesized rubber at times cannot keep up with demand, and can thus cause unforeseen hindrances in AirBoss's profitability. As AirBoss does not purchase raw materials through long-term supply contracts, but buys them on a purchase order basis, short-term volatility in raw material markets can induce price fluctuations, which affect AirBoss's cost of goods sold sporadically. Volatility in raw material markets are indirectly affected by swings in the price of oil and currency fluctuations. The recent decreases in raw material prices are a contributing factor to shrinking revenues.
Key Customer Dependency and Contract Risk
AirBoss's future success will depend on its ability to drive quarterly strong revenues and secure key customer contracts. However, buyer concentration is a ubiquitous threat to AirBoss, as in 2015 one contractor comprised 8% of sales and the next 5 largest customers represented 32% of sales. Diversifying its customer to mitigate its threat of buyer concentration will be crucial to solidify its revenue streams. However, as AirBoss indicates they are well aware of this risk, we believe AirBoss's strategic aim of customer diversification will mitigate their exposure away from key customer dependency.
Foreign Exchange Rate and Foreign Revenues Risks
As sales from the United States and other countries represented 74% and 7% respectively at the end of fiscal 2015, the foreign exchange symbolizes a significant risk. Fluctuations in exchange rates affect both AirBoss's revenues and expenses. Also, in light of currency risk, the fact that over 80% of Airboss's revenue streams come from foreign countries represents a risk of slowing domestic growth, and an increased reliance on foreign growth, particularly the US.
AirBoss's management has made it clear that inorganic growth will be a significant focus of revenue growth, as the company seeks to expand its defense and IRT segments. Inherent risks associated with this inorganic growth strategy are inaccurately valuing an acquisition, failure to integrate subsidiaries within its business model and unanticipated costs and risks.
Despite strong barriers to entry, AirBoss's revenue streams are contingent on their ability to secure customer contracts and offer competitive pricing. AirBoss is the second largest rubber compounder in North America based on capacity. AirBoss's ability to remain competitive will depend on their ability to offer industry competitive pricing and innovative by diversifying their product.
Shareholder Base, Liquidity, Market Depth
Currently AirBoss has 23m shares outstanding and is listed on the Toronto Stock Exchange. As AirBoss only has a market capitalization of only $305.9 million, it is understandable why the stock is not widely held by institutional investors and thus predominantly held by individual investors (48%). The largest individual stakeholder is the Chairman and CEO Gren Schoch, who has a $54.21 million stake in the company. Some large institutional positions include BMO Asset Management, with a position of 645,400 shares, and Didner & Gerge Fonder AB with a position of 710,000 shares. As the largest individual shareholder is the CEO with a 20% equity stake, investors are given confidence from his commitment to the company.
Trading Volume and Liquidity
AirBoss of America's stock has an average daily trading volume of 42,432 shares. Since the stock has low institutional ownership and is predominantly held by individual and insider investors, the stock is relatively illiquid. Its short interest as a percentage of float is 2.87%.
Discounted Cash Flow Analysis
A discounted cash flow model provides an intrinsic valuation of the company by predicting future free cash flows and discounting them back to present value using a calculated discount rate. After forecasting future free cash flows and discounting them using a WACC percentage of 6.14%, we found our implied shared price to be $16.68.
In terms of our assumptions for projecting future free cash flows, we assumed margins would stay relatively constant, and we did so by using the average of the past 4 historical fiscal years. However, because AirBoss's product innovation strategy and their rising R&D spending, we assumed an upward trending R&D margin growing at 0.2% per year. Also, in consideration of historical trends, we conservatively assumed COGS margin shrinking at 0.5%. With regards to dividend growth, based on historicals and our revenue projections, we estimated $0.01 growth per year. Due to the sporadic pattern of AirBoss's acquisitions, we did not assume acquisitions, but rather a modest $7m in capital expenditures per year. For a long-term perpetuity growth rate, we assumed it to coincide with GDP at 2%, as the company is cyclical and its growth tends to coincide with GDP. Finally, our income tax rate was calculated as an average of past historicals as 25% and held constant.
We forecasted AirBoss's revenue as a sum of their 3 segmental revenues, as it provided greater scrutiny in driving their revenue. For their rubber-compounding segment, we assumed that it had reached the nadir of its decline in 2016, and - with revitalized strength in AirBoss's ability to operate under these commodity conditions - forecasted an upward trend of 5% per year, as it will gradually restore profitability. As for its automotive segment, most growth will come from North American automotive spending. We do not see tremendous organic nor inorganic prospects for this segment, thus we took a conservative approach and held a 2% growth rate constant. Based on our analysis, we concluded that most growth would be derived from its Engineered Products (EP) division (which includes IRT and Defense). Because of innovative growth initiatives, we forecasted EP segmental growth to be 3% per year. Holistically, we forecast total revenue to grow at a rate of roughly 2% per year.
Depreciation and Amortization
Depreciation and amortization have been forecasted from historical values of property, plant and equipment. Due to the stable nature of rubber manufacturing, we do not see their physical capital being obsolete any time soon, thus - in accordance to historical - we used an estimated useful life of 24 years to forecast depreciation.
Weighted Average Cost of Capital
In determining the weighted average cost of capital, to calculate weights, we used the market value of equity and the book value of debt. Using this method, we received a debt weighting of 20.1%. Next, we utilized an equity market risk premium of 5%, along with a beta of 1.2 from Bloomberg. In determining the risk-free rate, we used a rate of 1.081% from 5-year Canadian treasury bills. We calculated the weighted average cost of capital to be 6.14%.
Discounted Cash Flow Analysis Summary
By utilizing our discounted cash flow model with the assumptions outlined above, we were able to produce an implied share price of $16.68. We believe this speaks to the true intrinsic value of AirBoss of America.
Comparable Company Analysis
Many of AirBoss's Canadian competitors are privately owned. However, our comparable company analysis provides an accurate snapshot of competitors who actively vie with AirBoss for contracts throughout their various subsidiaries. Also the comparable company analysis endeavours to provide a comparison between AirBoss and other companies who are exposed to the same economic headwinds and operate under a comparable business model. This contrast essentially produces an industry benchmark to more accurately analyze their financials in comparison to their peers.
Bridgestone Corporation is a multi-national auto parts manufacturer based in Fukuoka, Japan. In addition to actively competing with AirBoss within the automotive industry, through its diversified products division, Bridgestone also engages in the development and sale of products with industrial applications. Their diversified products division includes the manufacturing of products such as conveyor belts and rubber tracks. They are the largest manufacturer of tire and rubber parts in the world.
Cooper Standard Holdings
Cooper Standard Holdings is a Michigan based rubber manufacturer that primarily serves the automotive industry. Their anti-vibration rubber products face direct competition from AirBoss's automotive segment.
Parker Hannifin is an Ontario based motion and control technology manufacturer that operates in the commercial, industrial and aerospace markets. Parker Hannifin competes with AirBoss's Engineered Products division.
Hexpol is an international rubber compounding company based in Sweden with operations in Europe, Asia and North America. Its Rubber Compounding and Engineered Products segments actively vie with AirBoss in North American and European markets.
Weighted Target Price
By weighting the output used from the two multiples (EV/EBITDA and P/E) used in our comparable company valuation evenly (50%), we receive a final implied share price of $11.67, compared to the current share price of $12.84. This implied share price provides a snapshot of companies exposed to the same economic headwinds as AirBoss. To produce a target price, we placed a 70% weighting on our discounted cash flow valuation and 30% weighting on our comparable company analysis because we believe a DCF valuation exemplifies the neglected intrinsic value of the company. By applying this weighting we received an implied target price of $15.17, representing an upside of 18%.
An Undervalued and Well Positioned Company
AirBoss is well positioned in an industry with formidable natural barriers to entry, which provide the company with security. Furthermore, the very nature of AirBoss's products are "need to have" and make them a staple good and solidify their presence. To counter threats posed on organic growth by the cyclical rubber market, AirBoss is well diversified through its subsidiaries, and possesses a healthy balance sheet to finance further inorganic growth and weather itself through economic turmoil. In addition, they have a consistent record of investing in R&D to maintain a competitive advantage among peers, and emphasize their commitment to strategic growth. Future growth prospects for AirBoss are contingent on their ability to manufacture products that possess a performance advantage and their aptitude to locate and operate in niche markets through the diversification of their customer base (like currently seen in their IRT endeavours). Having translated our outlined qualitative analysis into quantitative assumptions, we believe that current macro conditions and catalysts undermine the true intrinsic value of the company. With our implied weighted target price of $15.17, we are confident to place a buy rating on the company.
Appendix 1: Pro Forma Income Statement
Appendix 2: Pro Forma Cash Flow Statement
Appendix 3: Pro Forma Balance Sheet
Appendix 4: Discounted Cash Flow Analysis
Appendix 5: Comparable Company Analysis
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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