Small Cap Stocks

In this post, I’ll take a look at ATS Automation (ATA.TO or ATSAF.PK ), a Canadian company that primarily specializes in providing automated manufacturing systems to various sectors, including the fast-growing alternative energy industry. In addition, the company also owns PhotoWatt France, a provider of photovoltaic solar modules and is a leader in the manufacture of refined metallurgical silicon (UMGSi) silicon cells and modules. UMGSi a lower grade of silicon that can be acquired more readily than polysilicon.

ATS Automation has been in restructuring mode since September 2007, when a group of shareholders successfully ousted past management and installed a whole new leadership team. Recently, the company’s fourth quarter fiscal 2008 financial results demonstrated significant financial improvements and a strong outlook for fiscal 2009, prompting me to take a closer look at the company. Although the stock has appreciated dramatically from its low earlier this year, I still believe that ATS Automation (ATA.TO – PinkSheets), has significant upside (100%) in the next one to three years.

Summary: Why Is ATS Automation (ATA.TO) a Potentially Attractive Speculation

The following criteria combine to imply that ATA. TO shares have low risk and attractive upside over the next one to two years:

• Depressed Price: Although the stock has appreciated dramatically from its low earlier this year, when there appears to have been some liquidity concerns, it is important to note that ATA.TO is still significantly lower than its high of nearly $18 back in April 2006 and is still well below prices that were reached over five years ago.

• Corporate Restructuring and Divestitures: Over the last six months or so, the company has significantly restructured its workforce and started to divest significant asset holdings, including an entire business division. Details can be found in the last MD&A report, here: http://www.atsautomation.com/profile/investors/pdf/ATS%202008%20Annual%20MD&A.pdf

• Attractive Industry Dynamics: As will be detailed further below, both of ATA.TO remaining operating subsidiaries have significant exposure to the high growth alternative energy sector.

• Improving Financials and Year-Over-Year Comparisons: As can be seen below, ATA.TO’s fiscal 2008 fourth quarter demonstrated significant profitability improvements and top-line growth prospects, implying that in the coming year the company’s financial reports should show significant improvements and growth.

• Low Valuation: As I’ll show below, despite the recent rebound in its shares, ATA.TO is still a cheap stock based on potential EBITDA assumptions. On an even more simplistic level, ATA.TO stock trades at an EV/Sales ratio of less than 1, despite improving profitability ratios and a strong sales outlook.

• Healthy Balance Sheet: ATA.TO has a net cash position and little debt.

• Seemingly Unknown to Most Alternative Energy Investors: Despite investor fascination with alternative energy plays, particularly the Chinese solar companies which I wrote negatively about in a previous post, I have seen little to no mention of ATA.TO as a solid alternative energy play in any popular media or top tier Wall Street analysts reports.

• Continued Good News Over The Next Year Creates Positive Feedback Loop Over the next year, I believe that ATA.TO will continue to report solid financial results and could in addition release exciting strategic news, including additional partnerships for PhotoWatt, the sale of the company’s discontinued operation, as well as additional alternative energy contracts for the company’s main ASG subsidiary. Combined all of these news items should help to create a positive feedback loop for the company and the stock.

Company Background

ATS Automation Tooling Systems Inc. (“ATS” or the “Company”) operates in two segments:

• Automation Systems Group (“ASG”) is an industry-leader in planning, designing, building, commissioning and servicing automated manufacturing and assembly systems – including repetitive equipment manufacturing and test solutions – in the worldwide market for healthcare, computer-electronics, automotive, energy and consumer products automation. Interestingly, the fastest growing segment of ASG is in the solar and nuclear manufacturing automation markets.

• Photowatt Technologies includes Photowatt France, a vertically-integrated manufacturer of ingots, wafers, solar cells and solar modules. Photowatt France has developed processes and technologies to manufacture solar cells from UMGSi silicon, a lower grade of silicon that can be acquired more readily than polysilicon. This is an important advantage since there is not enough polysilicon available to meet current industry demand and polysilicon is a primary raw material used by most solar manufacturers. As of March 31, 2008, Photowatt France had annual ingot, wafer, cell and module production capacity of approximately 60 megawatts (“MW”).

Quantative Background Statistics (as of 3/31/2008 – All numbers in Canadian):

• Share Price:

High Share: April 2006 about $18.00
Low Share Price: December 2007 at about $4

• Shares Outstanding: 70.5 million

• Current Share Price as of this report: $7.40 (Canadian)

• Market Cap: $525 million

• Cash: $57 million

• Debt: $29 million

Envoy Research Note: The balance sheet could change dramatically over the coming year due to various divestitures as well as access to credit lines. Effective June 2008, a 17-month credit agreement was signed providing credit facilities of up to $85 million.

• Enterprise Value: $500 million

• 2008 Sales: $664 million (ASG: $465 million and PhotoWatt: $199 million)

Envoy Note: ASG: Fiscal 2008 Order Bookings were $531 million, 20% higher than the previous year, driven primarily by strong Order Bookings in healthcare and energy sectors. Order Backlog of $232 million at March 31, 2008 was 25% higher than at March 31, 2007 primarily reflecting higher Order Bookings throughout fiscal 2008 compared to fiscal 2007.

• 2008 EBITDA By Segment:

• ASG Fiscal 2008: Excluding severance costs fiscal 2008 EBITDA was $20.0 million (actual operating earnings were $12 million or 3% of sales), compared to EBITDA of $21.3 million in fiscal 2007

• ASG Fiscal Fourth Quarter 2008: Excluding severance costs, fiscal 2008 fourth quarter EBITDA was approximately $7 million compared to $1 million EBITDA the year before.

Note: In 2005, which appeared to have been ASG’s best year in recent history, the company reported operating earnings of $38 million or about 7% of sales on revenue of $547 million. So in theory, assuming the company continued to reduce costs and improve profitability, ASG could achieve 7% operating margins, implying Operating Earnings of approximately $47 million and EBITDA potential of approximately $55 million.

• PhotoWatt Fiscal 2008: Excluding certain one-time gains 2008 EBITDA was $6.0 million, compared to EBITDA of $29 million in fiscal 2007

• PhotoWatt Fiscal Fourth Quarter 2008: fiscal 2008 fourth quarter EBITDA was approximately $7 million compared to $6 million EBITDA the year before.

Envoy Note: Lower profitability in fiscal 2008 primarily reflected the launch of UMGSi products. UMGSi products were sold at up to a 10% discount compared to polysilicon products, and produced lower cell efficiency resulting in fewer watts to sell at a given level of production. In addition, Photowatt France initially experienced high scrap rates and reduced throughput as it ramped UMGSi production. However, in the fourth quarter of fiscal 2008 UMGSi cell efficiency improved, selling price differentials decreased and throughput and scrap rates for UMGSi products achieved more acceptable levels. Overall it would appear that with despite lower operating profits from UMGSi modules, it would seem that with increased sales PhotoWatt absolute EBITDA dollar value could easily equal $30 million per year.

• Capital Expenditures:

Cap-Ex 2008: $21 million – $4 million for ASG and $17 million for PhotoWatt

Envoy Note: What is clear from these cap-ex numbers is that despite the need for significant cap-ex at PhotoWatt to expand operations, ATA.TO’s ASG business can generate enough positive free cash-flow (EBITDA – Cap Ex) from operations to support that business, as well as the ASG business.

Summary Quantative Analysis/Valuation:

Overall the numbers, in a somewhat simplistic manner (which is all that is really needed for stock analysis) above seem indicate that the current valuation of ATS does not take into consideration the value of at least of its subsidiaries.

From one perspective, it would seem reasonable to price ASG at 10X potential EBITDA or about $550 million, implying that the current share price assigns zero value to the PhotoWatt business. From another angle, one can argue that PhotoWatt could be worth about 2X revenue (as many other solar suppliers are worth) or about $400 million, implying that ASG is valued at a mere 2X EBITDA.

In sum, my guess is that based on the operating potential here one could easily justify a price tag of $13 to $15 for ATS or about $800 to $1 billion in Enterprise Value (10X EBITDA for ASG and 2X Revenue for PhotoWatt, about 15X potential EBITDA of $30 million).

What Went Wrong and What Has Changed?

There was so much that was wrong at the old ATA and so many new changes are in the process of being implemented that it is difficult to addresses all of these issues in one post. More importantly, the company has already neatly outlined all of the past problems and current resolutions in its annual MD&A report. I, therefore, recommend that interested investors read at least the first five pages of this report for a quick summary of What Went Wrong at ATA.TO and What Has Changed. You can click here to download the MD&A report.

What Are the Major Risks To ATA.TO?