Stay away from DIRTT stock, Industrial Alliance says

Long-term optimism should be mixed with shorter-term pessimism on prefab interiors company DIRTT Environmental Solutions (DIRTT Environmental Solutions Stock Quote, Chart, News TSX:DRT), according to Industrial Alliance Securities analyst Neil Linsdell, who delivered a quarterly preview of the stock on Tuesday.

Linsdell is leaving his rating at “Sell” and his target price at C$5.75, representing a 12-month return of negative 2.7 per cent at the time of publication.

Calgary-based DIRTT (which stands for Doing It Right This Time) uses proprietary software to design, manufacture and install customized interior environments. The company recently debuted on the Nasdaq Global Select Market, yet DRT has been having trouble this year, with the stock plunging from a high of C$9.30 per share on April 25 to sub-C$6.00 territory, where it has been languishing for the past couple of months.

Earlier in March, management released 2019 guidance which called for five to ten per cent growth for the year, a surprise drop from the ten to 20 per cent growth rate the company had delivered in recent years. But even that got corrected downwards in September to flat growth for the year, with management citing project delays, the loss of expected revenue from some contract cancellations and deferrals and a tile warping issue that took longer than expected to address.

“While we are optimistic about the longer-term potential for DIRTT’s offerings, we see reductions in short-term guidance and further manufacturing optimization efforts still tempering enthusiasm until DIRTT demonstrates sustained growth and profitability improvements…”

It all adds up to a gloomy picture over the next while, according to Linsdell.

“While we are optimistic about the longer-term potential for DIRTT’s offerings, we see reductions in short-term guidance and further manufacturing optimization efforts still tempering enthusiasm until DIRTT demonstrates sustained growth and profitability improvements. We don’t expect to see any substantial results from these efforts until some time in 2020,” he said.

“With a mostly changed, and beefed up, senior management team, DIRTT has been finalizing restructuring efforts and establishing a plan for sustainable growth, improved profitability, and cash generation,” Linsdell added.

“We anticipate more insight into efficiency improvements, capacity additions and a more focused sales and marketing strategy, towards scaling operations to support growth initiatives. We expect this plan to be touched on with the Q3 results and to be presented in-depth during the November 12 Analyst Day in NYC,” he said.

Ahead of DRT’s third quarter results due on November 7, Linsdell is expecting an 8.0 per cent year-over-year decline in revenue from $73.9 million to $68.0 million. On adjusted EBITDA, the analyst is expecting $6.6 million, a 9.7-per-cent margin, in comparison to last year’s Q3 EBITDA of $13.1 million. For the fiscal year, Linsdell is now calling for a decline of 2.8 per cent in revenue to $266.9 million and a 45-per-cent decline in adjusted EBITDA from $42.9 million to $23.4 million. (All figures in US dollars unless where noted otherwise.)

The analyst’s C$5.75 target comes from applying an 8x EV/EBITDA multiple on his forward NTM forecast, 12 months out (Q3/20-Q2/21). Linsdell explains that his rating remains a “Sell” even though the target implies only a downside of 2.7 per cent because of his expectations for weak third quarter results.