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Week 193: On getting from here to there

Portfolio Performance

week-193-yoyperformance

week-193-Performance

See the end of the post for the current make up of my portfolio and the last four weeks of trades

Updates

This is a difficult investing environment.  Valuations are high and the market is choppy.  Even as I do my best to limit my exposure to the gyrations by keeping 25% of my portfolio in cash, reducing the size of all but my favorite ideas, and parking cash in dividend paying investments, I still find my stomach churning on days like some of those this week, as I found myself down 2% after Tuesday’s close.

Many stocks that might appear attractive in their own right are difficult to own in this environment.  It is a situation I find unpleasant. While I am still a relatively young man, in markets like these I find myself too old for this.

Like most Canadians I have two accounts.  I have an investment account, and an RRSP account.  Through most of the last 10 years, which constitutes the extent of my productive investing career, these accounts have seen similar allocations.  What I did in my investment account, I did in my RRSP.  However 4 months ago I changed this strategy.  I cleaned my RRSP out of anything speculative, anything small cap, and what I own now are primarily dividend paying companies and REITs.  And a lot of cash.

I just can’t justify the chase given the circumstance and intent of the account and where the market is right now.

In fact, I would expect that at some time in the next couple of years this blog is going to undergo a facelift. Its going to become the ‘how to make money on dividends and not lose your principle’ blog. That happens about 30% from now, so you can put a timeframe to that depending on the returns you think I can manage.

People write blogs like this for different reasons.  Some are looking to make a name for themselves by finding the next big zero or riding a name on the discard heap to the sun.  Others are hoping to parlay their knowledge into a career or at least a few mentions on network cable.  I’m in this for two reason. First, I actually enjoy writing. Second, I want to get to my goal and be done with it, and writing this blog speeds up that process.  How can I get from here to there in the shortest time possible?  That is my trajectory.  While the arrival time is getting close, I’m not quite there yet.

It is this purpose that allows me to exercise as little conviction to my ideas as I see fit.  I’m not interested in appearing consistent.  If an idea is not working I sell it.  If I read or learn something that changes my mind, I change it.  That may be even after I have said only a week before that I loved the idea like a son.   I learned soon after starting this blog that I would have to decide whether I wanted to be right and look good or make money. If I chose the former then I would have to either A. be perfect, or B. show a herculean ability stand by my convictions in the face of adversity and a willingness to stick things out for the long haul through inevitably lags in performance.  Well I’m certainly not A, and B is a little too risky given that A is not likely to be achieved.

Onto my chariots.

Oil Stocks

I took a position in Jones Energy, and I now have exposure to 3 North American E&Ps (with RMP Energy and Rock Energy being the other two).  I am likely too early; WTI continues to fall and the storage builds continue to mount.  But I have a good memory, and I know that trying to predict the stock price turn is not the same as predicting the turn in the underlying conditions.  Remember that things were not necessarily all that rosy in April of 2009 when the stock market decided enough was enough.  Besides, as I will point, this is only one side of a 3-way hedge.

Sometimes you have to lose a little money to make money, and that is the perspective I am taking with Jones Energy.  I will talk more specifically about why I chose Jones below, and give a little update into some of the work I have seen on RMP Energy, a second position of mine. But first a little perspective on oil and how I think about my positions.

At worst what I have here is a hedged bet.  I have my oil stocks one the one side and my airlines and tankers on the other.  At some point, one, or maybe two of these guys is going to be a winner.

The best case outcome is that I have 3 winning bets with staggered payoffs.  Here is how I think this plays out.

First, oil continues to be under pressure in the short-term.  This is already happening. Storage continues to rise, production grows, albeit at a slower pace.  The contango widens and once again the tanker stocks come into favor.  I do not believe that the tanker story is merely a storage story but the market does, so a short term move in these stocks depends on some negative developments on the oil price side and a positive move in the contango.  Tanker rates are already at elevated levels.  If rates move up during what should be the weaker spring season there will undoubtedly be calls that after a 6 year hiatus, the tide has finally come back in for the tankers.  As these stocks move back up, hopefully to their highs or beyond, winning bet #1 pays off.

Next, oil settles as it becomes clear that production has peaked and nobody is drilling any more.  The current narrative of collapse and fear is replaced by a narrative of the “new normal”.  The new normal narrative will be that low prices are here to stay.  This is what is going to set off the airlines.  They have been in a holding pattern since the beginning of the year, digesting some really large gains and wrestling with whether the boon in fuel costs is actually something that can be priced in for the long run.  Once the market decides it can be, they move up another leg and I get winner #2.

Finally for the last winning bet; the E&Ps.  Getting to here might be a shit-show or it might not.  The market is already starting to show signs that it discerns the survivors from the wreckage.  Of the three E&Ps I own, Rock Energy has no debt, RMP Energy has $115 million on a market capitalization of over $500 million (so very low debt), and Jones Energy, which does have a healthy amount of debt, has done such a good job hedging their production until the end of 2016 that by the time they realize spot prices most of their lessor hedged brethren will have already succumbed.  Rock and Jones have done secondaries.  These companies are in good shape.

I don’t think oil prices have to go back to $100 for stocks like these to rise.  At some point a legitimate new normal will assert itself and prices will go back to a $65 or $70 level where supply and demand are balanced.  Now I know there is a lot of talk that E&P’s are already pricing in $70 oil or $80 oil.  While I think this argument is being reserved for the larger entities, the EOG’s of the world, and not these smaller players who have actually taken a very hard fall, I also think this argument is flawed.  I simply ask you this: If some of these companies are pricing in $70 oil, are they also pricing in $70 oil service costs?

As I will explain below using Jones as the example, service costs are collapsing.  And that means $70 oil is no longer actually $70 oil.  $70 oil is maybe $85 oil when you look at in terms of margins, which is what matters.  And not operating margins, not the somewhat irrelevant costs that are used to put together all the break-even forecasts you hear about.  I’m talking about the half-cycle margins that include the primary cost associated with producing oil: drilling the well.  Those costs are coming down big.

The beauty of it is that $70 oil is still going to be $70 oil for the debt laden and high operating cost producers and so the cash flows of many will continue to be constrained.  But for the operators with the financial flexibility to drill and the land positions to achieve attractive returns, they will inherit this new earth.  And that is when my third bet pays off.

Why Jones?

So I bought Jones and I think they have a very good chance to be a big winner when we eventually come through this morass.  Reason #1 for my optimism is that Jones has a very good hedge book for 2015 and 2016:
hedges
Compare the above hedge positions to the company guidance below:

guidance

So to put everything in like terms, guidance is suggesting oil production of about 2,518MMbbl, natural gas production of about 21,000MMscf and NGL production of about 2,300MMbbl.  That means they have about 92% of oil production, 93% of natural gas production and 66% of NGL production hedged at decent prices for 2015.  The volumes hedged for 2016 are not far off that.

On their fourth quarter conference call Jones said that their drilling and completion costs are coming down substantially. Wells that used to cost them $3.8mm are down to $2.9mm.  They think that will come down to $2.6 million in short order.  That is a huge change that has moved the profitability curve down substantially.

While all operators are seeing costs come down, Jones is in enviable position being the major operator in the area – I think they have more leverage over their suppliers than some.

Unlike my other two E&P picks, Jones has debt.  They have also taken on more debt recently. At the beginning of February they sold $250mm of 9.5% senior unsecured notes due 2023 to the market.

Jones has also issued shares, but worth noting, the offerings were at substantially higher prices than what the stock is trading at today:

A. 4,761,905 shares at $10.50 to Magnetar Capital LLC and GSO Capital Partners LP
B. 7,500,000 shares at $10.25 via an underwriting with underwriter option for additional 1,125,000 shares

In total Jones has offered 13.4 million shares if underwriter option is exercised. It will raise a little over $130mm in proceeds from the offering.

As far as the operations go, things look solid.  The company is going ahead with three drilling rigs all focused on the Cleveland.  They’ve settled on a frac design and will be going back to an openhole completion with 33 stages.  This is expected to give them the oil uplift that had been the intent of all the experimentation that they did in 2014, but without a lot of added cost.  Production is going to fall as they cut back on drilling, but I think we are all past the point of worrying about what happens to production in the short term.  They didn’t have a lot to say about their Tanaka wells on the last conference call, but given the opportunity for additional lands that is likely to open up in the Cleveland, I’m not sure if the viability of the Tanaka is relevant any more.

Basically, I think Jones will weather the storm here. They have ample liquidity to increase their position in the Anadarko basin with cheap assets. You can pick up the shares at a 20% discount to the underwriting less than a month ago. The near term commodity price risk is greatly mitigated given the hedge book. The move down to $8, which unlike many of their peers is a significant new low, seems to me to be unjustified given all of these factors.

Reviewing RMP Energy

Since I the discussion revolves around  E&P’s in this post, I wanted to give a few thoughts on RMP Energy.  In the last couple of weeks I spent some time reading through and analyzing a recent report put out by Peters.  In the report Peters raised some concerns about the extent of Ante Creek play and the recent decline in Ante Creek production.  Production at Ante Creek is down to 8,300boe/d from around 10,200boe/d in the summer.  Peters lowered their target price on the stock.

To some extent their concerns are valid.   The Ante Creek wells drilled in the south aren’t as productive as those in the core 8 sections.  In the recent March presentation the company the company said as much, delineating between the core, the infill of that core, and regional development.

ror

With that said, I don’t know if I would worry too much about the production declines.  I think that it has more to do with facility capacity constraints than anything else.   The problem is that as the reservoir pressure declines the wells are producing a higher gas content.  Pretty typical behavior.

If you look at the numbers, at 10,200boe/d the volumes were 63% liquids, so gas production was about 22.6MMscfd.  At 8,300boe/d gas production is now up to 48%, or about 23.9MMscfd, so even as the overall production has declined, gas production has ticked higher.  And its started to hit the ceiling.  According to the March presentation the facilities at Ante Creek can only handle 24MMscfd at current gas plant capacity:

gascapacity

Fortunately more capacity should be online shortly, at which time we will see what production can really do.

Peters NAV in the report was $4.25. Its pretty easy to come up with a higher NAV than that and in fact some of the other analysts do, but lets go with this number for sake of comparison.  At the time of the report, at a $5 price, RMP was at a 20% premium to NAV.  This was at the upper end of the peer comparison below:

nav

At the current price, a little under $4, RMP trades at less than 90% of NAV which is pretty closely inline with their peers.  But should RMP really trade at the same level as LEG or DEE? Probably not. So I think the stock has probably come down too far.  I traded some RMP when it got into the $5’s, waited patiently for it to correct like this, and now I’ve jumped on it here sub-$4.

The other leg to the story is that RMP has had excellent initial results for the two Waskihagan wells drilled with their new slick water frac design.  You’ll note in the table above that the Waskihagan wells don’t have a great return with the oil based fracs.  RMP is testing out slick water based fracs and the first two have performed admirably so far.  Another poster on InvestorVillage posted a list of the top performing wells in the WCSB in December-January and the two water based frac wells from RMP made the list.

Fifth Street Asset Management

I tweeted this one out on Thursday.  Fifth Street Asset Management is a fairly small, recently IPO’d asset management company.  They manage a little over $6 billion in assets, with about 90% of those residing in two business development corporations (BDCs).

aumThe stock did an IPO in November at $17 per share.  Since that time it as sunk in price, for what I believe are two main reasons.  First, both of their BDC vehicles trade below book value, and the company has come out and said that they will not raise capital at their BDC’s below book.  This invites the assumption that growing assets under management (AUM) is off the table.  Second, the larger of the two BDC’s, Fifth Street Finance, put out some fairly crummy results in February, including a reduction of the dividend and news that the existing CEO, Leonard Tannenbaum, would be resigning to focus on Fifth Street Asset Management and their new hedge fund.

This feels to me like one of those stories where yeah, the news is bad, but chances are it is transitory and as it is digested and conditions improve the stock could quickly go from dog to darling.  While they are unable to expand their AUM via the BDC’s Fifth Street does have other options for growth.  The company recently closed on a $309 million CLO.   They are starting a hedge fund (which as I mentioned will also be run by Tannenbaum), are expanding into aircraft leasing, and starting a Japan focused fund.  So there are other ways to grow.  And while the BDC’s are below book right now things change.

I think they can do $1+ earnings per share this year.  The company distributed 30c quarterly dividend in January.  On the conference call where they announced the dividend they warned that it would exceed 100% of income in the fourth quarter and possibly exceed 90% of net income for 2015.  As was picked up on by one of the analysts on the call this implied managements expectations of earnings, that they think $1.20 per share is reachable.

I think there is a reasonable chance that the concerns about the FSC subside, the company shows further evidence that they can raise capital outside of the BDCs, and the market begins to focus on the growth potential rather than the lack thereof.  And the stock comes back to its IPO price.

Patriot National

This is another recent IPO that I think has some upside if they can execute and the market gets comfortable with them.  The IPO price was $14 and I have bought the stock at a significant discount to that in the low $11’s.  The IPO prospectus can be viewed here.

Patriot handles the procurement and management (including claims management) of workers compensation insurance.  They basically sign a contract with a client for a set book of workers compensation business, then procure that business through affiliated insurance agents and manage it.  The contract will define the risk parameters, geography, premium size, etc that they want in their book.   Patriot’s system distributes the data to its agents who then look for opportunities to sell into it.   Patriot doesn’t take on any of the claims risk.

Patriot currently provides services to Guarantee Insurance, Zurich Insurance Group Ltd. and Scottsdale Insurance Company.  Scottsdale is a relatively new relationship that should continue to add reference premium growth during 2015.  They recently began a relationship with AIG, of who they will begin to provide services to in 2015 and expect to become one of their “primary insurance carrier clients over time”.

They are a small company compared to many of their peers.  with 26.4 million shares outstanding, the market capitalization sits at $290 million.  The company will likely do around  $23-$25 million of EBITDA in 2014, which doesn’t make them seem particularly cheap.  So the story here is growth and I think there is a good chance they can achieve that.

One of the interesting elements of the business model is that Patriot has quite good visibility into its future revenues, because the contracts are signed up front and then Patriot goes out and fills them.  I managed to get a hold of the BMO report on Patriot. Being the underwriter of the IPO, presumably BMO has a close line with management.  In the report, they expect reference premiums to grow from $375 million in 2014 to  over $500 million in 2015 as the relationships with AIG and Scottsdale mature.  That would be 30% growth.

In the company can put together that kind of growth the 14x EBITDA multiple would be justified. If you apply the multiple on the higher level of business, its easy to come up with a lot of upside from here.  Also worth noting, this is a low cash use business.  Maintenance capital is in the low single digits, and the company only has about $40 million of debt, so the vast majority of EBITDA falls down into free cash generation.

Anyways much like Fifth Street I think that Patriot is suffering from the post-IPO uncertainty.  No financials, no track record, no conference call, and the only information it buried deep in a prospectus that most people don’t want to bother with.  I think there is a decent chance they continue to execute on the business and grow reference premiums, and that the stock runs up into the high teens.

TC Transcontinental

TC Transcontinental is a pretty simple story.  They are the largest printer in Canada.  Their printing operation is diverse and includes flyers, packaging materials, newspapers, magazines and books.  Of those lines of business, the main driver of revenue is from retail flyers for customers such as Superstore and Canadian Tire.  Flyers and related services make up a little over 50% of their total revenue. In addition Transcontinental owns an array of local newspaper and magazine publications in Quebec.  They recently expanded into flexible packaging with the purchase of Capri.  The table below illustrates the primary customers in each of their segments.

customers

While the print operations are by no means a growth industry, the company has done well to stabilize revenues while improving EBIT from the business.  EBIT has shown continuous improvement for the last 5 years.

ebitOver the long-term, print remains a challenged business.  Maybe flat to a down couple percent a year.  Transcontinental is offsetting the declines by pushing growth from within their media segment (via a growing online presence) and through the expansion into flexible packaging.

The company has made a couple of acquisitions over the last year and a half to facilitate some growth.  First, in December 2013 they bought a number of Quebec local newspaper and magazine assets of Sun Media.  They paid $74 million for these assets, which generate annual EBITDA of about $20 million.  In April they entered into flexible packaging with the purchase of Capri for $133 million.  Capri generates EBITDA of about $17 million, and 75% of revenue comes from a 10 year contract with Schreiber Foods.

While neither of these acquisitions are revolutionary, I believe they are paying a reasonable price to grow and expand in new directions.  And they aren’t growing via debt.  Like United Online, the print business may not be a great growth business but it does generate a lot of cash.  And that is really what made me look twice at the company.  Transcontinental is really cheap on a free cash basis.  Based on the 2014 year (ended November), the stock trades at 5x the free cash generated.  In 2015 they have to start paying cash taxes again so multiple will jump to around 7x.  There are not a lot of companies left these days that trade at single digit free cash multiples.

So TC Transcontinental is inexpensive and has plenty of cash available for acquisitions  to offset declines or to further facilitate moves into other growth areas.  There are the pieces there for something to go right.

An update on United Online

United Online has been a reasonable winner for me so far, going from $12 and change to $17 since I bought it back in November.  I did some more work on United Online a couple of weeks ago and I thought I’d put it out there for anyone interested.

United Online is not my largest position.  I am not convinced of its prospects and to be honest I don’t even really understand the demand for its StayFriends and Classmates products.  Yet I think the stock has a reasonable chance of going higher.

United Online operates a number of legacy businesses that, while in decline, are producing an increasing amount of free cash flow as United attempts to milk them for the cash.  These businesses are:

  1. Social Networking Services – they operate the classmates.com, StayFriends.com and Trombi.com (France) brandssocialnetworking
  2. Loyalty Marketing – operate a loyalty marketing service called MyPoints.  MyPoints is an online shopping membership that provides discounts and rewards to usersmypoints
  3. Internet Access – operate the brands NetZero and Juno, providing dial-up and mobile broadband servicescomm

While these businesses are all declining, and they hardly exemplify the large moat stability that a value investor typically craves, they are generating more and more cash as United squeezes down the cost side.  In the fourth quarter free cash generation was $8 million.  In the last 9 months its been a little under $15 million.

I’ve listened the last few United Online conference calls and its clear that management understands the predicament they are in.  They know that the existing business lines are essentially in either a stasis or prolonged run-off and that they need to do something to generate growth.  To that end, United Online is in the process of rolling out three new products: a low cost cell phone, a cloud based shopping list app called List+, and a gift card management app called Swappable.  While I don’t really get the cell phone angle, both List+ and Swappable fit well with the existing MyPoints customer base. There is a decent SeekingAlpha article that describes the new products, but its only available for a couple more days.

The Swappable app is a bit of a hot money area right now.  United is competing with another gift card app start-up so there is a gift card app star-up called Raise.   Raise raised $56mm from investors in January, which values them at a little under $1B.  They have “reported hundreds of thousands of customers had either bought or sold cards from around 3,000 brands via the site to date”.  While Raise hasn’t said how many users they have. They did say:

In addition, in 2014, the company sold over a million gift cards, and between November and the end of the year, Raise grew over 50% in revenue and other metrics. And user growth quadrupled.

Again according to media reports Raise “passed $10 million in monthly gross card sales several months ago and has been growing more than 10 percent a month since then”. The company takes a 15 percent cut when someone sells a gift card or store credit on their site.

From what I can tell, the Swappable app does pretty much the same thing that the Raise app does.  Moreover, United Online can leverage off of MyPoints.  From the recent conference call:

MyPoints already does millions of dollars of gift card revenue. It has primarily been desktop. It has been user, going to buy a gift card on MyPoints

So putting it all together, United Online has:

  1. A comparable product to Raise
  2. “An ecosystem in place with MyPoints and the other databases around the company”
  3. “9-plus million MyPoints members we can write and invite to this product”

With cash on the balance sheet exceeding $5.50 per share, United Online has an enterprise value of $160 million at $17.  So a lot less than Raise, even though they have a number of other irons in the fire, and an established means of generating capital to plow into the business.

So we will see.  But its enough of a story to keep me interested in the stock even as it has risen.

Gold Stocks

In continue to own small positions in Endeavour Mining, Argonaut Gold, Timmins Gold and Primero Mining. These positions are just a trade, premised on the supposition that we have once again gone too far to the downside, just as we went too quickly to the upside in January and before that went too far to the downside in December.  But even as I kept all of these positions small, they still led to gyrations in my portfolio, as they saw daily movements in the high single digit and low double digit percentage points.  More and more often it is occurring to me that owning gold stocks is not worth the trouble.

What I sold

Mart Resources

I bought Mart Resources at the trough of the last oil stock rout because of what I saw a lot of potentially positive news on the horizon.  The company was likely to release news about the purchase of the OML-18 block and show production gains after the commissioning of their new pipeline reduced the existing production bottleneck.

Unfortunately none of this is likely to materialize as the company has sold itself to its partner Midwestern for a paltry 80c per share.  This is a case study in why not to invest in a country like Nigeria.  Based on the publicly available information it is difficult to make a case for selling the company at this price.  This likely means that there is other non-public information that makes a sale of the company compelling, if not unavoidable.

One only has to look at the recent share price, which ticked down to 50c at one point, to illustrate the skepticism of the investor base about the legitimacy of the proceedings.  Quite honestly, at this point who really knows what is going on.  I sold my shares at a slight profit from my purchase but in relation to what I had expected, which was the opportunity to  sell these shares at $1+ within the year, it is a substantial disappointment.

magicJack and Radsys

I group both of these companies together because my motivation for selling was similar; a lack of conviction about their prospects.

In the case of magicJack, I keep coming back to the name as I compelled by its large cash position ($5 per share) and the potential for the company to behave in a manner similar to United Online, milking the legacy business for cash while developing new and perhaps complimentary businesses to facilitate growth.  Nevertheless management has disappointed once too often for me to hold my shares through earnings, particularly given that their largest retail vendor (Radioshack) went into bankruptcy during the quarter.   I will be listening closely to the conference call though, and could come back to the stock depending on what I hear.

I could be back into Radsys as well.  Honestly the problem with Radsys is really my problem.  I don’t understand the business that well.  The thesis is based on the 4G LTE products that Radsys offers and I just haven’t developed enough background on the offerings to feel confident holding the stock.  I’ll try to make time to learn a bit more and come back to the stock once I do.

Earthlink

I exited my position in Earthlink after the company announced fourth quarter results.  Its not that the results were particularly bad, its just that they also weren’t notably good, and its difficult for me to envision the catalyst that takes the stock materially higher in the near term.

The company announced flat revenue quarter over for the managed services business, and they really need this business to grow at a reasonable pace given that it is their only true growth driver.  And while they announced that they would be reviewing strategic alternatives for their fibre assets, they were vague about what might sold and for how much.  If the stock drops back to below $4 I will look at it again.

Transat

It was pointed out in the comment section of my last post that while Transat no longer appeared in my portfolio, I had not actually written about my sale.  This was an oversight on my part.  These updates get long and at times I miss transactions that I should mention.

To paraphrase my response to the comment, I sold the stock because I thought that the weak Canadian dollar was going to make the winter season (Q1 and Q2) difficult. When you run a business that has mid digit margins and the currency moves 10% in a few months, its difficult to respond fast enough.  Transat also unfortunately hedges much of its fuel so in the short term they are not going to benefit from the reduced jet fuel prices.  The winter routes also have a lot of added capacity from Air Canada this winter.

All of this came to pass when the company announced weak first quarter results.  Now I still really like Transat and I am looking to add my position back, but I’m not sure we are there yet.  The second quarter is likely to be just as weak as the first, and the Canadian dollar just keeps on falling.  The summer though will be stronger, they will benefit from the weaker Euro and the fuel hedges will begin to run-off.  At some point there is a buy here, but I haven’t jumped in yet.

Final Thoughts

Bad things tend to happen when the US dollar is this strong.

Portfolio Composition

Click here for the last four weeks of trades.

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Week 189: Playing the oil trade from all angles

Portfolio Performance

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week-189-Performance

See the end of the post for the current make up of my portfolio and the last four weeks of trades

Updates

One of the themes  over the last few months has been a shift in methodology towards taking what I can get.  Less have I been holding out for the big gain, and more have I been booking 10-20% gains when they materialize.

The change arises from my confidence, or lack thereof.  I know we are in a bull market and still at all-time highs but it doesn’t feel like that and so I remain somewhat cautious.   I’m just not comfortable waiting for upsides to play out in full.  So I take what I can get.

Sticking with the Airlines for now

This business of scalping, for lack of a better term, worked quite effectively with Hawaiian Holdings.  Leading up to Hawaiian Holdings earnings report on January 29th I held a fairly large position.   But believing that caution is the better part of valor, I reduced that position to its shadow in the days leading up to the earnings release.   The stock was subsequently pummeled after reporting lower guidance than anticipated.  While I still took some lumps, it was not nearly to the degree it would have been and I was left to decide where to go from here.

After much review I decided to add back, at least part way.   Here’s what I think.  The stock was hit because their revenue per average seat mile (RASM) is being squeezed on a couple of fronts.  First, on their Asian destinations fuel surcharges are shrinking down to nothing because of the drop in the price of oil.  Second, the strength in the US dollar is hurting their competitiveness to book flights from Asia; naturally the majority of Hawaiian’s customers on their Asian routes are traveling from these destinations and flying to the US: Hawaiian’s US dollar cost structure is hurting them here.  Third, the company said that North American capacity would be at a record high this year, with capacity growth peaking in the first half and this would put some downward pressure on prices.

The bottom line of all of this is a year over year total RASM decline of 3.5%-5.5% in the first quarter (including 3% that is attributable to currency and fuel surcharges).  I think that the market looked at that and said, whoa that’s a lot of headwinds for a stock that is up some 100%+ in the last year, and promptly sold it off.

While it’s a fair assessment, they are a lot less of a concern now that the stock is down some 30% in the last few weeks.   What is easily overlooked is that all of the negatives are more than made up for by the drop in jet fuel prices.  Using the company’s 2015 fuel guidance I calculate that the savings will be $230-$240 million for the entire year.  That is over $4 per share.

If the experts are right and oil prices are going to stay in the $50-$60 range for 2015 I simply do not see how a company like Hawaiian Holdings, or for that matter the other airline stock I continue to own, Air Canada, will continue to trade at such low PE multiples.  I have based this discussion on Hawaiian but I could have made similar arguments with Air Canada, with the primary differences being different events leading to a perceived earnings miss (in Air Canada’s case it was employee benefits, adjustments to pension assumptions and a lower Canadian dollar) and that the stock has quickly gained back its losses.  But Air Canada, like Hawaiian, will see gains from the lower price of jet fuel that far exceed any currency or revenue headwinds they encounter.

Getting back to Hawaiian, using the company’s guidance leads to earnings of about $2.75 per share.  Do they really deserve a mid-single digit multiple in a market where the average multiple of an S&P stock is somewhere north of 20?  I feel like the upside potential is, as they say, asymmetric to the downside risk.

The downside risk, of course, is that the price of oil rises  significantly.  While this is something to keep a close eye on, particularly with disruptions in Libya and Iraq, I feel well hedged by the oil stocks I own in my portfolio.  My positions in RMP Energy, Mart Resources, and my recently taken position in Rock Energy will all do very well if the price of oil spikes.  And as always, if things start to go south, I plan to exit my positions quickly to limit my losses.  But I don’t think I will have to.  I think this is probably at least a somewhat new paradigm for oil, which means its also a new paradigm for the airlines, something that even with the run up in the fourth quarter last year I don’t think the market has fully appreciated.

New Position: Willdan

I got the idea for Willdan from a couple of SeekingAlpha articles that outlined the investment case for the company (here and here).

Willdan provides consulting services.  They separate their business into four segments: engineering services (Willdan Engineering), energy efficiency services (Willdan Energy Solutions), public finance services (Willdan Financial Services) and homeland security services (Willdan Homeland Solutions).  Of these, the energy and engineering services make up the bulk of the revenue.

revenue_breakdownTo get a sense of the sort of consulting Willdan performs, its worth taking a closer look at a few of their contracts.  In 2009 Consolidated Edison awarded Willdan with one of if not the largest contract, $67 million to perform the role of “program implementation contractor” for an energy efficiency program directed at small businesses.  The contract was extended in August of last year.  Willdan’s role as contractor includes:

providing outreach to small businesses, completing on-site energy efficiency surveys, implementing energy-saving projects, and partnering with the community and local businesses.

As another example, Willdan provides engineering services to the city of Elk Grove California. After a bit of investigation I found that the services Willdan provides are things such a road construction and repair, drainage construction, lighting design and maintenance and traffic engineering.  Basically all the civil engineering tasks that one would associate with maintaining a city.

So this gives you an idea of what Willdan does.  Its probably not a bad business, not terribly reliant on the economy, but not really much of a moat beyond the skills of the individuals you employ who do the work for your customers.

Willdan is a small company, trading at a market capitalization of about $100 million.  When I first stepped through their historical results, Willdan looked somewhat interesting to me but I could have easily passed.  But what caught my attention were two recent acquisitions for $21.2 million. Both of these businesses are complimentary; typically Willdan provides energy audits and consulting but does not perform the engineering services for energy efficiency projects; these companies will expand that offering to the latter.  The businesses also expand Willdan outside of their core areas of California and New York and into the Pacific Northwest and Midwest.

So Willdan benefits on two fornts: they can expand their energy services auditing into new territory, and can market the engineering services of the new businesses within their own operating regions, presumably for energy efficiency audits they already have under contract.

On the conference call to discuss the acquisitions management said they paid 4.3x EBITDA for the guaranteed portion of the acquisition price.  The acquisition structure is tiered, by which Willdan pays 60% of the price (about $12.7 million) up front, with the balance contingent on the performance of the acquired businesses.  In particular each business has to grow operating earnings by 25% to obtain the full payment. It seems to me like a great structure for Willdan.

The acquisition price implies that businesses are generating about $3 million of EBITDA in the trailing twelve months.  Before the acquisitions Willdan said they could grow their top line organically by 15% in 2015.  Below is a rough estimate of earnings per share assuming that Willdan achieves their top line growth, maintains their existing margins, and that the acquired businesses perform sufficiently to achieve the full acquisition price.

earningsIts not unreasonable to assume that a company with $1.30 earnings and a growth profile over the last few years would be given a multiple of greater than 10x.

This is a small company and small position for me, and not one I am likely to add to.  I think there is a decent chance I will make a few bucks on it as it has a run to $17 or $18 or if I’m lucky even $20.

One new Energy Position: Rock Energy

As I mentioned in my last update, I had been in and out of Penn West a couple of times during the first month of the year.  I held Penn West for perhaps the last time a couple weeks ago when I bought the shares for a little under $2 (Canadian) and sold them at $2.60.  Regretfully I sold much too soon, the stock kept roaring all the way up to $3.30. But consistent with my theme this month and with the thesis I presented in my last update, the nature of my purchase was a short term scalp and to stray from the nature of my intent would have been little better than a blind gamble.

But having some conviction that oil prices have hit bottom, and as I mentioned already, having an eye on the production shut-ins in Libya and Iraq, I did peruse the energy universe for other names that I might want to take a position in.  I am by no means convinced that oil prices have bottomed, we may have, may not have.  Thus I was looking for companies that could weather a continuing storm but still pose a decent upside to a stabilization in price.

A lot of the stocks I looked at had gone too far too fast; reviewing Baytex, Suncor, the larger Canadian names, and they all seemed to be already pricing in an oil recovery.  Ditto for smaller names like DeeThree Energy, which I should have been looking at $2 ago.  Others, like Penn West and Lightstream, certainly have a lot of upside if a truly bullish scenario develops, but they run too much risk of a big drop on some bad news event driven by lenders getting skittish.  I don’t want to have to worry about that.

I settled on Rock Energy, a name I used to own at prices not far off what I bought it for now. Here are the reasons I like Rock:

  • Their debt is nearly non-existent at $20 million as of the end of third quarter and now, after a recent $13.2 million bought deal (done at $2.32 per share) debt is even lower.  There is no question that this company survives.
  • Rock revised their 2015 guidance and cut capital expenditures to the bone, to $25 million for the year, down from their original guidance of $90 million.
  • At an average price $40 USD WCS, with a US/CAD exchange rate of 1.25, they will generate $35 million of cash flow for the year, more than covering capital expenditures.
  • At this low level of capital expenditures the company would exit the year at somewhere in the neighbourhood of 4,600 boe/d. That values them at $28,000 per flowing boe upon exit.

The sensitivity analysis I did below shows how the company will cover its capital expenditures even at current WCS prices and illustrates the upside to an increasing oil price.

earnings-forecast

Rock will rise when the price of oil rises.  If the price of oil does not rise, Rock will flounder, but I doubt it will crash much further.

Hammond Manufacturing

I’ve been on the look-out for Canadian manufacturers that stand to benefit from the dramatic fall in the Canadian dollar. I haven’t had a lot of luck.  There aren’t a lot of manufacturers left in Canada, and most of the big one’s move dramatically in November, anticipating the move, and I wasn’t quite so quick to the trigger.

However I did find one overlooked name a couple weeks ago.  Hammond Manufacturing.  Hammond is engaged in the heavily moated business of electronic enclosure manufacturing.  I’m kidding of course, but when your business is one of commodity manufacturing there is little more that could be asked for than for a 20% currency devaluation to bring down your unit costs.

Hammond is a pretty simple story so I’ll keep this short.  The company manufacturers electronics enclosures, so racks, cabinets, wire troughs and a few more technically complicated items like air conditioners and heat exchangers.  They manufacture these products in Canada (Guelph) and thus they incur their costs in the Canadian dollars.  That means their costs have declined significantly of late, and that puts them at a competitive advantage.  The company is expanding production to meet the increased demand brought on by what is likely increasing market share.

The stock is also cheap.  Looking back at the trailing twelve months, at the current price the stock is at 6x free cash flow.  That free cash flow is going to decline in the upcoming quarters as the company looks to expand their business which means an increased level of capital expenditures.  I think there is a reasonable chance that capital translates into meaningful growth, and in turn, a higher stock price.

The Tanker Trade – DHT Holdings

I have remained patient with my position in Frontline even as it sank significantly from my original purchase.  When the stock hit $2.90 I reluctantly reduced because it had crossed my 20% loss threshold.  I held onto the rest as it sank further and subsequently added back as it recovered.  The thesis still seems intact and my position sizing is not so big as to make me uncomfortable with the wait for it to play out.  In addition to Frontline I continue to own Nordic American Tankers (which I mistakenly referred to as Navios Marine Acquisition Corp in my last update).

I added another name to the trade a week ago: DHT Holdings.  DHT is a bit safer way to play the thesis, insofar as any of these stocks can be considered safe.  Their ships are newer, they have a number of new builds scheduled for delivery over the next two years, they do not have the debt overhang, and with ~60% of their ships on the spot market they still stand to benefit from improved rates.

DHT has 14 VLCC tankers and another4 Suezmax tankers.  There are another 6 VLCC new builds that will be delivered over the next two years.  When I look at DHT’s earning performance at rates even slightly below today’s level, I am left to conclude there is significant upside in the stock if the thesis does play out as I expect.

forecast

A couple of weeks ago I posted Teekay Tankers monthly update video onto twitter.  It is available here.  In the video it was noted that supply growth over the next year or two for the three classes of ships used for crude transport (VLCC, Suezmax and Aframax) is non-existent. Meanwhile demand is expected to increase, including further pressure given the fall in the price of oil, and a number of VLCC tankers are being taken off the market for 1 or 2 years for storage.  I think that what we have seen over the past month is a short attack on the tanker stocks from those that believe we are seeing a repeat of last year; a brief spike in rates that will soon be followed by a collapse down to marginal levels.  What I think the shorts are failing to realize is that the dynamic is quite different then last year.  Indeed as we move through February you are not seeing significant weakness in rates and as a consequence the tanker stocks are being to firm up again.  I suspect (and am anticipating) that this is the precursor for another move up.

Scaling back on US names

I sold out of a number of positions in the last month, most of them for reasonable gains.  Included on this list was Engility Holdings, Rosetta Stone, CGI Group, Electromed and ePlus.  Each is an excellent illustration of the scalper trade in action.

Of the group, I most reluctantly sold out of CGI Group.  I think there is a decent chance it continues to trade higher.  But I also note that they are predicting somewhat weaker results in the first half of the year, followed by strength in the second half, they may experience some currency headwinds with the Canadian dollar falling, because they trade in the US and its not clear to me whether it is the Canadian or US ticker that determines the price they may also face share price headwinds if the Canadian dollar rises, and they simply aren’t as cheap as they were when I bought them 20% lower.  But really, my primary reason for selling the stock is because when I bought it I assessed that there was an easy 20% of upside but that my outlook was cloudy after that. I’ve gotten that first 20%, so to hold on without a change in thesis feels like a bit of a gamble.

I was pleased with the results from ePlus but surprised that the stock took off to the extent it did after earnings.  Shares were up nearly 15% at one point.  Much like CGI Group, ePlus is coming up on weaker seasonality in the next two quarters.  Also much like CGI Group, the discount I saw originally has been eaten up with the 20% gain in the share price.  Were I convinced we were in a bull market I may have held out for another leg up.  I’m not so sure though, so I just took my profits and walked away.

I spent a lot of time thinking about Rosetta Stone.  You can read my comments on a couple of short articles that were posted on Seeking Alpha.  I finally sold out of the stock for about a 10% gain and with some reservations about whether I am doing the right thing.  I still don’t really buy the short argument.  But I also didn’t feel confident enough about the business to hold the stock through its fourth quarter results.  I think the fourth quarter is going to be good; seasonally it is the best quarter by far. I’m less sure about guidance.

My actual 2014 portfolio performance

As I have noted before, I write this blog based on the performance of a tracking practice portfolio that is made available from RBC.  This portfolio is intended to mimic the general trend of my most risky investment portfolio.  However the practice portfolio has some limitations, in particular that you can’t short stocks in it and you can buy and sell options.  Every year I try to give a quick update on my actual portfolio performance as comparison.  In this last year the gap between the real portfolio and the one I track here was a bit bigger than usual, and mostly for a single reason: Pacific Ethanol.  In my actual portfolio, when given the fat pitch that was ethanol back in the early months of 2014, I not only loaded up on Pacific Ethanol stock but on options as well, with the result being very large gains on the calls.  Thus below, you can see the discrepancy between my more speculative account, where the options were bought, and the more restricted retirement account where you can only buy stock.  I had a pretty good year in my retirement account, but my investment account flourished particularly well thanks in large part to our good friend Pixie.

actuals

Portfolio Composition

Click here for the last four weeks of trades.  Note that the name change of Yellow Media to Yellow Pages removed that ticker from the practice account so there are a couple of transactions there to add back the 1,000 shares that disappeared.

week-189

Week 185 Just your run-of-the-mill Portfolio Update

Portfolio Performance

week-185-yoyperformance

week-185-Performance

See the end of the post for the current make up of my portfolio and the last four weeks of trades

I don’t have any general comments to make so I am going to get right into my portfolio updates for the last month.

The Tanker trade

The biggest moves in my portfolio have tended to take place in the first couple months of the year .  In 2013 it was YRC Worldwide.  In 2014 it was Pacific Ethanol.  I’m hoping that this year its the tanker stocks.

Of course the tanker stocks have already had significant moves.  I have been adding positions at prices that are much higher than they were a couple of months ago.  But to use Pacific Ethanol as an analogy, the move from $2 to $4 was only the first act.  I’m not sure if these stocks will put on the show that Pacific Ethanol did, but I am hopeful there is  a second act in the cards. Read more

Week 181 Doing ok but not loving this market

Portfolio Performance

week-181-yoyperformance

week-181-Performance

See the end of the post for the current make up of my portfolio and the last twelve weeks of trades (its been a while since I did a full update).

The last few weeks have been a rollercoaster.  It was less than a week ago, on Tuesday night, that  I was deliberating whether I should be making dramatic cuts to my exposure the next morning.  By the market close Friday my portfolio was back to the post October peak.

The gyrations have not been due to particular volatility in the stocks I own.  Over the last month I have basically been tracking the market, doing a little bit better but not much.  Its just that the market is going up and down like a yo-yo.

While I am happy to have gained back the losses I took over the past couple of weeks, this whole dynamic makes me uneasy.  Too many extremes for my liking.  In my investment account, which is where most of my risk is and the one I track here (its also by far the most fun one to write about) I’ve taken down some exposure over the last few days by reducing some positions that seem to be the most prone to gyrations in this market.  Stocks like Ocwen, Nationstar, Aercap and the like (note that I wrote this over the weekend and had reduced my servicing positions before the Ocwen settlement today.  Today I sold Ocwen entirely at the open, being a little surprised that it was trading at $19+, bought back some Nationstar at a little over $28 later in the day and then bought back a bit of a position in Ocwen at the end of the day on hope of a short term bounce). Read more

Week 177: Perspective

Five weeks ago I wrote that I was walking away for a while.  And so I did that.  It didn’t last as long as I had anticipated.

At the time I had taken my portfolio to about 60% cash and I had a number of shorts that helped hedge out the exposure from my remaining longs.  In early October I had basically stepped away because I had made some mistakes and lost confidence in my decisions.  It had started with the mistake of not looking closely at the oil supply/demand dynamic, which was compounded by the mistake of selling the wrong stuff when the bet began to go wrong.  As I lost money on a few oil and gas holdings, rather than reducing those positions I reduced other positions, presumably with the intent of reducing my overall risk.  Unfortunately this isn’t really what I was doing.  What I was actually doing was selling what was working while holding onto what wasn’t.  A cardinal mistake.

The consequence was that I saw my portfolio dip 12% from its peak by the second week in October.  More frustrating was that as stocks recovered in late October, I watched as some of the names I had sold near their bottom, in particular Air Canada, Aercap, and Overstock, recover their losses and were on their way back up.

I wrote my last post on a Friday afternoon after the market had closed.  Over that weekend I was virtually unencumbered by the markets.  My portfolio was cash, my blog was on hiatus, I had nothing to prevent me from thinking clearly. I don’t remember exactly when the moment came, but at some point that weekend I had a realization.

For those who have followed this blog over the past few years, you will remember that in December of last year I made a very large bet on New Residential.  The stock had gotten hit down to below $6 at the time.  I thought this was rather ridiculous and so I bought the stock.  I bought a lot of the stock.  I made it a 25% position in my portfolio.

In a narrow sense, the trade worked out.  By the end of December the stock had jumped close to $7 and I sold the position for a tidy profit.  But in the broader sense, it was an abject failure. Read more

Week 173: Done for now

Two weeks ago I made the following tweets describing my latest and last investment decision:

finaltweets

I meant to get around to writing a post acknowledging the same sentiments but I never did until now.  Since that time I have watched the market go down a lot and then come all the way back up.  I haven’t done much of anything during the whole see-saw.

And that is because I think I’m done.  I have a lot of cash, a few positions and no plans to chase anything up or even add to anything as it comes down.  Maybe when the Fed (or perhaps the ECB) decides to get back into the game I will change my mind. But for now I don’t really have a strong inclination to do anything.  So I’m going to walk away while I’m ahead.  Maybe there will be a better set-up in the future.  But until then…

Good-bye.

Betting some more on BXE

My portfolio had a tough week and has had a weak September.  As it goes when I show weakness, I am quick to clean house and start anew.  This week I jettisoned a number of names (including Sherritt, Mart, Straight Path Communications and Aercap), made a number of positions much smaller (including Overstock, IDT, Transat, Sanderson Farms, and Supercom) and raised a bunch of cash.  When the dust settled I had 10 positions remaining of significant size.

One of those positions is Bellatrix, of which, in the midst of oil and gas carnage everywhere, I bucked the trend and added to this week.  This after I had mentioned in a tweet a couple weeks ago that a recent add would be the last one.

Well I lied.  With the stock dropping to the mid-$6’s I decided to revisit the whole idea, and after doing so, I added fairly aggressively.  I do not make this decision lightly; as I have written before, once I have a full position I rarely add to it if it starts losing money.  There’s just too much chance that I am wrong.  At the time of the tweet Bellatrix was a 4% position for me.  Its now the largest position in my portfolio at 12%.  My average cost base is down to around $7.17.

Why was I willing to add so significantly?  Because the work I did helped reassure me that my original idea is most likely correct; that the company is suffering from a short to medium term processing bottleneck that should be alleviated by the commissioning of their own plant in mid-2015.

Most of my work focused around a production/decline model that would help give me a better idea of how production should trend under various drilling scenarios and capacity constraints.

My model is simplified, but not too simplified. I think that oil and gas models are some of the most difficult to make.  The inputs require estimates of decline rates, which changes over the life of each of the wells in the field, drilling schedules, which are impacted by weather, rig and processing availability, and in the case of the Western Sedimentary Basin, by spring break-up.  There are so many difficult to determine parts that I think it is better that one not try to confuse precision with accuracy.

Read more

Week 168: Cutting my gains

Portfolio Performance

week-168-Performance

 

See the end of the post for the current make up of my portfolio and the last four weeks of trades.

Recent Developments

I don’t know if the chart of performance really does justice to the volatility my portfolio has had over the last couple of weeks.  It feels like much more of a roller coaster than that little blip in the trend that you see on the screen.

I sold out of the rest of Pacific Ethanol and Rex American Resources in the first half of this week.  I hemmed and hawed through the weekend, even briefly added to my position to Pacific Ethanol on Monday (at the same time I was reducing my position in Rex American), but the volatility of the stocks, the declining price of ethanol, and specific to Pacific Ethanol, my uncertainty with respect to their corn basis (I concluded tentatively it is actually quite a bit higher than Q2) led me to capitulate on many of my shares on Tuesday.  I followed that up by selling the rest on Wednesday in the minutes that followed a very bearish EIA inventory report (+800,000bbl!). I tweeted on my sales at the time.

My caution turned out to be fortuitous as the stocks continued to fall the rest of the week.  I was even able to catch a few dollars of profit on the way down; always remembering the old classic to which this blog takes its namesake, I took the lesson that if a stock is to be sold it is likely just as well sold short, and so I took a small short position in Rex American and a few $18 puts on Pacific Ethanol.  The puts were sold Friday and my short position has been cut more than in half, so these were merely short term trades taking advantage of a clearly bearish dynamic. Read more

Adventures in Ethanol

Over the last week I have played some parts of the ethanol yo-yo well and other parts not so well. Let me review.

On the well side, I significantly reduced my extremely over-sized position in Pacific Ethanol (25% of my portfolio at its peak) at prices of about $23 per share.  On the not-so-well side, I added/subtracted and then added back my position in Rex Energy on continuously declining prices and held on to a still not insignificant percentage of Pacific Ethanol (about 5% position) through the declines of Thursday and Friday.  What is yest to be determine is that I added back some of Pacific Ethanol at $20.15 on Thursday. While I sold half of that on Friday morning for a bit of a profit, I held the other half through the decline on Friday and now sit with those shares at a lower price than I had purchased them for.

How this all ends remains to be seen.  This blog is not intended to be an account of my infallibility. Unlike many others on the blogosphere and on twitter, I have no omniscient insight into what can be absolutely stated as a good or bad decision.  Thus it is that you rarely see me laying out the ridicule, condescension or my favorite, the passive-aggressive rhetoric, that seems to be so prevalent in these mediums.  I can only wish for such certitude.  Unfortunately my world is far too gray to not feel empathetic for those who hold a different opinion than mine.

The beauty and horror of the ethanol stock is that it only takes a small difference of opinion to lead to a drastically different conclusion.  To take an example that I tweeted earlier tonight, in my model I get a $1 quarterly earning swing by adjusting the ethanol price by 20 cents – from $2.05 to $1.85 per gallon (note I originally had written 80c but I hadn’t been making an apples to apples comparison in my model).  A similar point could be made about Pacific Ethanol.  The significance of course is that 20 cents is about the swing that ethanol prices took in the last week. Read more

Week 163: Knowing when you are not at an advantage

Portfolio Performance

week-163-yoyperformance

week-163-Performance

See the end of the post for the current make up of my portfolio and the last four weeks of trades.

Recent Developments

Note that this update is as of Friday, August 15th.  I have been a few days delinquent in getting it out.

I have strayed from my bread my butter of late, away from the tiny micro-caps that pass everyone else by and into the world of still small but not so obscure caps.  These are stocks like Air Canada, AerCap and Bellatrix among others, still far from being large caps, but big enough to receive the attention of analysts and funds.

I am not so sure of my own advantage with these stocks. I may be overstepping my own abilities to think that I can see something here the market is not.  I am under no misconceptions about my research. There is simply no way that I, as an individual investor with a couple of hours of free time every day, can match the depth and scope of the research that the institutions have. Read more

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