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Week 324: Underlying Conditions

Portfolio Performance

Top 10 Holdings

See the end of the post for my full portfolio breakdown and the last four weeks of trades

Thoughts and Review

The late spring and early summer months were a trying time for my investments.

I haven’t written up my portfolio in a while.  Part of that was due to the summer, being away and not having the time to do my usual work.  But I also went through a 3 month period, from mid-May to mid-August, where I lost money and struggled with why. That dampened my spirits for putting pen to paper.

Losing money is hard enough, but it is harder when you have been generally right in your decisions.   I try, like the namesake of this blog, to analyze underlying conditions and let that determine my general bent on sectors and the market.  Where there is a bull market I like to be very long those stocks, and when there is a bear market I like to pull back significantly, retreat into cash, and go short where I can.

Throughout the spring and summer I found myself in a general bull market in US stocks, one that had made me a lot of money throughout the winter.  I was, quite rightly, very long US stocks.  The market kept going up, albeit in fits and starts.  But I began to lose money.  Now I didn’t lose money quickly.  In retrospect that may have been a better route as at least I would have been forced to discover my error.  But instead my losses slowly accumulated over the months of May and June.

What’s more, I did not see noticeably poor performance from any of the stocks I owned.  Sure my names weren’t breaking out to new highs, but my core positions at the time, the likes of Radcom, Silicom, Sientra, Combimatrix, Identiv and Vicor were not by any means breaking down (I leave out Radisys as it is a separate discussion).

It wasn’t until my portfolio was down about 6%, in the middle of June, that I woke up to the fact that something was wrong.  I scoured my list of stocks but found nothing worrisome with the names I held.  I knew that the Canadian dollar had been rising so that must have been having some effect but I had never really quantified my currency exposure.  I had always thought of currency as an afterthought, something that balances itself out in the end.

As I crunched through the numbers on my currency losses, I realized that while in the very long run my theory that currency balances itself out might be correct, in the short run a currency can make or break you.  The Canadian dollar was in the midst of unwinding 2 years of gains in two months.  Measuring my losses from the portfolio top in mid-May, I was 6% down, of which 5% came from currency.

It is here that I made my first big mistake. I was armed with the information I needed to act decisively.  I knew my problem: stocks were in a bull market, but clearly the US dollar was not, and I was, rather unwittingly, very long the US dollar.

So what did I do?  Something that, in retrospect, was absurd.  I made only a token effort towards the problem, taking only the excess US dollar cash in my portfolio and putting it into a Canadian currency ETF.  This effort, while directionally correct,  impacted about 15% of my US dollar holdings and thus did nothing to alleviate the problem.  I followed this up with an even more inexplicable move, even to me looking back on it now.  I put on index shorts to hedge my long positions.

Here I was with losses proving that I was wrong.  I had determined the source of those losses.  And what did I do?  I did something that was likely only to exacerbate them.

It really goes to show how wrong one’s logic can be when you are trying to cling to what you had. The reality, I think, is I didn’t want to do what was right.  What was right was to sell my US stocks.  Not because my US stocks were going down. They were not.  Not because the theses behind these positions was not sound.  They were.  But because I was losing money on those US stocks.

Unfortunately I could not wrap my head around this.  All I saw were good stocks with strong catalysts.  How could I sell my positions?  It’s a bull market!

I spent most of June compounding my problem with band-aid solutions that only dug me in deeper. I fell back on oil stocks as a Canadian dollar hedge.  This had saved me the last few times; in the past the Canadian dollar had risen because oil had risen, so I had gone long oil stocks and my losses on currency were more than compensated with my gains on E&Ps.  I was saved a lesson and left none the wiser to how impactful currency could be.

But this time around the currency was not rising because of oil.  My appraisal that I should be long oil stocks was based on the flawed logic that what works in the past must work again regardless of conditions.  That is rarely the case.  In June and July I bought and lost money on companies like Resolute Energy, US Silica and Select Sands, all the time continuing to hold onto US dollars and lose on them.

I also went long gold stocks on the similar thesis that if the US dollar is weak then one should be long gold.  In this case I was at least partially correct.  That is the right thing to do given conditions. But my conviction was misplaced. Rather than being long gold stocks because I thought gold stocks would go up, I was long gold stocks to hedge my US dollar positions.  You cannot think clearly about a position when you are in it for the wrong reasons even if a right reason to be in it exists.  Thus it was that in late July I actually sold a number of my gold stock positions. It was only a couple weeks later, finally being of a clear head (for reasons I will get to) that I bought them all back, for the right reasons this time, but unfortunately at somewhat higher prices.

As I say it was at the beginning of August that I finally was struck by what I must do.  I’m not sure what led me to the conclusion but I think an element of deep disgust played a part.  I had just seen my biggest position, Combimatrix, get taken over for a significant premium. My portfolio took a big jump, which took down my losses from my mid-May peak from -10% (over 8% due to currency!) to -7.5%.  But then in the ensuing days I saw those gains begin to disappear.  Part of this happened because Radisys laid an egg in their quarterly results, but part of it was just a continuation of more of the same.  Currency losses, losses on index short hedges, some losses on my remaining oil stocks, and the ups and downs of the rest of my portfolio.

I simply could not handle the thought of my portfolio going back to where it was before Combimatrix had been acquired. I was sick of losing money on currency.  And I was reminded by the notion that you never see conditions clearly when you are staked too far to one side.  So I sold.

When I say I sold, I really mean I sold.  I took my retirement account to 90% cash.  I took my investment account to 75% cash.  There were only a couple of positions I left untouched.  And I took the dollars I received back to Canadian dollars.

I continued to struggle through much of August, but those struggles took on a new bent.  I was no longer dealing with portfolio fluctuations of 1%.  The amounts were measured at a mere fraction of that.   This breathing room afforded me by not losing money began to allow me to look elsewhere for ideas.

I don’t know if there is an old saying that ‘you can’t start making money until you stop losing it’, but if there isn’t there should be. When you are losing money, the first thing you need to do is to stop losing it.  Only then can you take a step back and appraise the situation with some objectivity.  Only then can you recover the mental energy, which until that time you had been expending justifying losses and coping with frustration, and put it towards the productive endeavor of finding a new idea.

In August, as my portfolio fluctuated only to a small degree but still with a slight downward slant, I mentally recuperated. And slowly new ideas started to come to me.  It became clear that I was right about gold, and in particular about very cheap gold stocks like Grand Colombia and Jaguar Mining, so I went long these names and others.  I realized that being short the US market was a fools errand, and closed out each and every one of those positions.  I saw that maybe this is the start of another commodities bull run, and began to look for metals and mining stocks that I could take advantage of.  I found stocks like Aehr Test Systems and Lakeland Industries, and took the time to renew my conviction in existing names like Air Canada, Vicor, Empire Industries and CUI Global.

Since September it has started to come together.  I saw the China news on electric vehicles and piled into related names.  Not all have been winners; while I have won so far with Albemarle, Volvo, Bearing Lithium and Almonty Industries, I have been flat on Leading Edge Materials and lost on my (recently sold) Lithium X and Largo Resources positions.  Overall the basket has led to gains.  I’ve also been investigating some other ways of benefiting from the EV shift.  It looks like rare earth elements and graphite might be two of the best ways to play the idea, and I have added to my position in Leading Edge Materials (which has a hidden asset by way of a REE deposit at the level of feasibility study) to this end.  Likewise nickel, which is not often talked about with electric vehicles and has been pummeled by high stock piles, has much to gain from electric vehicles and could see a resurgence over the next couple of years.  I’m looking closely at Sherritt for nickel exposure and took a small position there so far.

I saw that oil fundamentals were improving and got back into a few oil names, albeit only tentatively at first.  Such is the case that once you are burned on a trade, as I was when I incorrectly got into oil stocks in June and July for the wrong reasons, you are hesitant to return even when the right reasons present themselves.  Thus it has taken me a while, but over the last couple of weeks I have added positions in Canadian service companies Cathedral Energy and Essential Energy, and E&Ps Gear Energy, InPlay Oil and even a small position in my old favorite Bellatrix.  A company called Yangarra Resources has had success in a new lower zone of the Cardium, and I see InPlay and Bellatrix as potential beneficiaries.  These newer names go along with Blue Ridge Mountain Resources, Silverbow, and Zargon, all of which I held through the first half slump in oil.

I even saw the Canadian dollar putting in the top, and converted back some currency to US dollars a couple of weeks ago.

Most importantly, got back to my bread and butter.  Finding under the radar fliers with big risk but even bigger reward.  I have always said it is the 5-bagger that makes my returns.  If I don’t get them, then I am an average investor at best.

I found Mission Ready Services, which hasn’t worked yet but I think is worth waiting for.  I found some other Canadian names that I think have real upside if things play out right (in addition to the above mentioned metals an oil names, I added a position in Imaflex). Most profitably, I was introduced to Helios and Matheson after reading an article from Mark Gomes.

I don’t completely understand the reason why, but good things do not come to you when you are mired in a mess of doing things that are wrong.  It is only when you stop doing what is wrong that other options, some of which may be right, will begin to present themselves.

I also don’t know which of what I am doing now will turn out to be right, and what will turn out to be wrong.  I will monitor all my positions closely and try to keep a tighter leash than I have been.  What I do know is that I will not continue to be wrong in the same way I was through the months of May to August.  And that is a big step in the right direction right there.

Portfolio Composition

Click here for the last eight (!!) weeks of trades.  Note that in the process of writing this update I realized I do not have a position in Gear Energy or Essential Energy in the practice portfolio.  I have owned Gear for over a month and Essential for a few weeks.  This happens from time to time.  I miss adding a stock I talk about and own in my real portfolio.  I added them Monday but they are not reflected below.

Note as well that I can’t convert currency in the practice account.  I know I could use FXC but in the past I haven’t, I have just let the currency effects have their way with the practice portfolio. Thus you won’t see the currency conversions that I talked about making in my actual portfolio.  I may change this strategy the next time the Canadian dollar looks bottomy but as I am inclined to be long US dollars at this point, I’m leaving my allocations where they are for now.

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Catching a moonshot with Helios and Matheson

Every once in a while I get one right at just the right time. It doesn’t happen often, but it certainly is nice when it does.  Such has been the case with Helios and Matheson.

I owe this idea to Mark Gomes.  His article led me to the story.

Before I start this post, let me just say I am pained to write about a stock that has gone up so much.  I don’t intend this to be an endorsement of the stock at this level, particularly in the short run, as it could as easily drop as rise 10% or more today (I see the stock is down almost 15% in pre-market on this news, which doesn’t seem all that bearish to me at first glance).  Nevertheless my thought process in this particular case is worth recording and that is what the intent of this blog really is, so here it goes.

I’m not going to step through the story in this post.  There are plenty of other places where that has already been done, both in Mark’s article and this one here.  There is also a good two part series interview with the CEO of MoviePass on the Forbes website (part 1 and part 2).

After learning about the story, I spent all of Monday delving into it.  With some trepidation I bought stock in the $3.50’s and then watched the price rise and then fall back to below where I bought it at the end of the day.

On Monday evening I spent a significant amount of time deliberating about my position.  There were at least a couple of times where I was on the verge of selling my shares first thing Tuesday morning.

Why such anxiety?  Because it is not an easy story to accept at face value.  The business model, essentially selling unlimited monthly passes for movie tickets (the only limit being one purchase a day) is, at least on the surface, a wildly unprofitable proposition.  Every time a customer goes to a second movie, MoviePass loses money on that sub.

This is why, and not without good reason, the company is derided on twitter by most of those with a serious take.  Its very easy to conclude that MoviePass is destined for bankruptcy.  I made a single tweet about the company today (I was afraid if I made more my inbox would see a deluge of nastiness) and the first response I got was ‘it’s called a Ponzi scheme’.

I don’t believe that a Ponzi scheme is quite the right parallel even if things do go awry, but I admit I have no crystal ball to say that all will end well with MoviePass.  Nevertheless I held more than half of my shares today, even as the stock rose some 60% (I admit I did sell some shares, you just have to after that kind of day).

But why did I hold most of what I owned?  Well some of it was momentum, the low float, the past fluctuations in the stock (it rose to $17 last summer, albeit with a much lower share count), but those reasons alone aren’t enough.  There are always circumstantial reasons to stick around.   What gave me the conviction to stick to the stock, to not sell at the open, or when it was up 10% or 20% on the day, was a shift in how I started to think about the stock on Monday night.

Those with harsh criticism of MoviePass are thinking of it as an established business.  It can’t be profitable right now; they are paying full price for tickets and every additional theater goer adds losses to the bottom  line.  The losses are going to accumulate and the company is destined for bankruptcy.  That is the chorus.  That is also how I was thinking about the stock when I was ready to cash out Monday evening.

But what if we start thinking about MoviePass like a start-up.  An early stage start-up doesn’t worry about monetizing.  They worry about disruption, growth and capturing market.  I’m no VC, and maybe this is just me being naive, but it seems like the thesis with many start-ups is that by the time they are ready to monetize, they expect to be big enough that options will present themselves that are not identifiable just yet.  And sometimes that logic is correct.

MoviePass has went from 16,000 subscribers to 400,000 subscribers in a month.  It is undoubtedly going to be much higher in another month.  While I don’t know exactly how they can monetize their subscriber base, I do think that their options (and leverage) increases as their base grows.  Maybe they will be able to leverage their size against the bigger chains.  Maybe the early adopting chains will show such growth that the larger chains will relent.  Maybe ancillary revenues at theaters will increase to a point where it’s a win/win for all.  Maybe they can leverage their data analytics, identifying preferences of card holders and promoting features based on those tastes.

To take a “for instance”, long before I was introduced to Helios and Matheson or MoviePass I read a piece that talked about how important concessions were to the theater business.  The article explained how much money movie theaters made from concessions.  Prices are high and margins are big.  A big part of the business model depends on filling as many seats as possible.  Yet theaters are often far from full.  MoviePass is tailor made to address this problem.  MoviePass is monetizing otherwise empty seats in a way at least somewhat analogous to how the original model for Airbnb monetized empty beds, or how Uber monetized empty cars.

I think its worth noting that there was a NY Post article this morning saying that while AMC has expressed hostility towards the MoviePass model (as they are reeling after being just about to launch their own subscription package), “Regal and Cinemark have taken a wait-and-see approach to the $10 plan.”

Helios and Matheson paid $27 million for a 51% ownership in MoviePass back in mid August.  There is a clause in the agreement they signed with MoviePass that preserves their 51% ownership, even in the event of further issuance of shares.  As I mentioned, at the time of the transaction MoviePass had 16,000 subscribers.  So Helios and Matheson paid $2,500 per subscriber.

Is that valuation realistic?  If it is, then you can do the math on 400,000 subscribers.  If its not, and it seems a little steep to me, then what should a subscriber be worth?  I guess if you think the company will do nothing but lose money then its an easy answer and that number is pretty much $0.  But if you think they are going to be able to monetize their base, then it’s a worthwhile question.

After the run up to a little under $6, Helios and Matheson has a market capitalization of about $75 million including the dilution of the convertible notes and warrants they offered as funding for the MoviePass transaction.

At that price, the current subscriber base, which again increased about a bazillion percent in the last month, is being valued at $375 per subscriber.  If (when!) MoviePass doubles that subscriber base, its $185 per subscriber.  The company thinks they can get to 2 million subscribers. If that happens then we are at less than $75.

Those numbers do not seem out of line to me.  Particularly when the options available for monetization are likely increasing as this base grows.

I know I am going to get a lot of feedback on this post.  And I am going to be told how stupid my reasoning is.  So let me remind the reader that one of the tenants that I try to keep is to hold both sides of the argument in my head at all times, and not to commit to either side fully.  This is never more the case then it is here.  I see both sides.  I understand that the optimistic view of MoviePass might be wrong.  And I’m willing to change my perspective.  If I didn’t own the stock already I would be pained to buy it here, but that is mostly a factor of knowing my own psychology and that I would be whipsawed out on a correction.  However already holding the stock, I am willing to give it some rope as I do see a path.  Maybe its blurry but its there, and the market is telling me that path is being cleared.  So I will stick with it for now.

Getting on the EV Bandwagon

I have taken small positions in a number of EV related mining stocks.  As I tweeted on the weekend, the catalyst to these additions were comments out of China about accelerating the move to electric vehicles.

 

 

In this post I’m going to briefly go through the positions I’ve taken.  In a later post I will talk in a bit more detail about the one position (well two actually) that I think is the most interesting to talk about (the two companies, which soon will be one, are called Bearing Lithium and Li3 Energy).  Note that I bought many of these positions earlier in the week, and some have run significantly higher since then.  While I’m still holding all of them, they are in some cases less attractive now then they were earlier in the week, at least in the short term.

Albemarle (ALM) – They are the easiest way to play Lithium.  They are a large producer.  They are also expensive, trading at over 15x EBITDA.  But I didn’t think I was going to get them any cheaper given the news from China.

Lithium X (LIX) – They have 20 % ownership in a deposit in Argentina.   The deposit seems to have reasonably good Lithium concentration (500 mg/L).  They are in the process of a feasibility study.  The deposit is right in the middle of a Lithium corridor, with mines from SQM, Albemarle and Oro cobre.  They also have a 20% ownership in Pure Energy Metals, which has a lithium deposit in Nevada.  They have a $200 million market capitalization.  Here is the company presentation.

International Lithium (ILC) – This one is a bit of a flyer.  Well, they are all flyers but this one more than the others.  They have a 20% ownership in a deposit in Australia as well as some early stage properties in Canada and Ireland.  The lithium concentrate grade of the Australian deposit is low but the size is decent.  Ganfeng Lithium, which is a lithium manufacturer in China, owns 17% of the company.  TNR Gold owns 15% and management owns 14%.  They have an $11 million market capitalization.  Here is the company presentation.

Largo Resources (LGO) – They have a Vanadium mine. Vanadium prices have taken off recently, the latest numbers I can get has prices pushing $11/lbs, after averaging under $6/lbs in the second quarter and even less earlier in the year.  The stock has moved a ton, and has moved another 20% since I bought.  But if you run the numbers at $11/lbs Vanadium its still only at about 6x cash flow.  Vanadium prices have spiked even higher in the past.  I saw one chart that briefly put them over $20/lbs.

Leading Edge Materials (LEM) – I have always enjoyed listening to Jim Dines and he has been on the lithium/rare earth band wagon for some time.  So when I started looking for rare earth stocks I went straight to google and typed in his name.  Leading Edge is his recommendation.  They have a graphite mine and processing facility in Sweden that appears to be nearing production of battery grade graphite.  Graphite makes up 40% of a EV battery by mass.  They have prospects for lithium and cobalt in Sweden/Finland.  They also have a rare earth elements project in Sweden that they released news on today that appears encouraging.  Leading Edge has a $65 million market capitalization.  Their company presentation is here.

Bearing Lithium (BRZ) and Li3 (LEIG) – These two companies will soon be one, as Bearing is in the process of taking over Li3. Li3 has been cash strapped but owns 17.7% interest in a lithium deposit in Chile.  I think of all the positions I’ve taken, I am the most excited about this one, as they appear very cheap compared to other juniors but I haven’t found a good reason for why, other than that Li3 has languished on the OTC and is cash strapped.  I’m going to write this one up in more detail.  If you want a heads-up on that, check out my recent Stockhouse posts on their bullboard.

Why I was willing to add to Mission Ready Services

Yesterday and today have been busy.  I got smacked on Empire Industries and on Blue Ridge Mountain, but also piled into a number of lithium, vanadium and graphite names that has helped claw some of those dollars back.  I will write about those names another time.  Today I was also working on a second post on Mission Ready Services and I wanted to get that out before anything else.

I wrote about Mission Ready Services on Friday.  Over the weekend and yesterday I spent a lot of time researching the company.  The basic question I wanted to answer was whether the company, and its recent news release, are legitimate?

I may yet be proven wrong about this, but so far I do not see anything to make me think it isn’t.

To recap, the news released last week had the following points:

  • Agreement is with a US based contracting party
  • Agreement is for purchases to a large foreign military.
  • Minimum Purchases as per agreement are (USD): Year 1 (2018), $50MM; Year 2 (2019), $50MM; Year 3 (2020), $100MM; Year 4 (2021), $100MM; Year 5 (2022), $100MM.
  • Advance Payments: Distributor agrees to pay Mission Ready (the “Manufacturer”) a down payment equal to forty percent (40%) of the purchase order amount within 10-days of submitting the purchase order.
  • Exclusivity: Manufacturer appoints Distributor, on an exclusive basis, as its sole distributor for the defined territory.

So its huge if it’s the real deal.

As I have dug into Mission Ready, I have actually been quite surprised with the strength of the company’s product.  Here is what I found.

In 2011 a company called Protect the Force (PTF) partnered with the U.S. Army Natick Soldier Research, Development and Engineering Center (NSRDEC) in an attempt to develop a better body armor.  This was in response to soldiers complaining about the bulk and discomfort of existing body armor options.

Together PTF and NSRDEC came up with a new body armor called the Ballistic Combat Shirt.  This article talks is detail about the ballistic combat shirt, describing the creative design that was a departure from existing body armors available, how it benefits soldiers, and some of the awards that it has won.  It references Robert DiLalla, who led the team on the NSRDEC side that partnered with PTF to develop the body armor as well at PTF themselves.

There doesn’t seem to be too much question that the Ballistic Combat Shirt (which Mission Ready has called Flex9Armor for their own product distribution) is better than its predecessors.  DiLalla comments that its “35% lighter, form-fitting and more comfortable”, and reduces the soldier’s thermal burden compared to the Interceptor Body Armor system.  Soldier acceptance has been terrific:

“The Soldiers have spoken loud and clear with more than 90 percent user acceptance in multiple user evaluations,” said DiLalla. “Typically, as we assess new body armor components, we’d consider 60 percent a successful number. So we were quiet surprised…”

There is also a video on Youtube of the armor being tested.

In 2012 Mission Ready merged with PTF, and along with them, acquired their development activities.

In May 2015 the development of the new armor was complete and Mission Ready said the US Army Contracting Command was soliciting bids for the Ballistic combat shirt.  PTF bid on the contract.  The company sounded quite optimistic in the press release.  However it was not to be.   In July 2015 they issued another press release saying that they had not won the contract with the US government.  They met all technical requirements but did not have the lowest price (there is a table below that will show the pricing breakdown).

Being the co-developer of the product, this must have stung.  In response PTF filed a protest.  The outcome of the protest was sustained, as described in a December 2015 news release.

“We recommend that the Army either: (1) reasonably re-evaluate the proposals in accordance with the RFP as written, and make new source selection decisions; or (2) re-examine the RFP’s minimum requirements and evaluation criteria, to determine whether they accurately and unambiguously reflect the agency’s needs, and, if appropriate, amend the RFP, re-open discussions, obtain and evaluate revised proposals, and make new source selection decisions.

The GAO decision on the protest also outlined the original bidders on the BCS.

But nothing much has come of it since.  According to this article, the new armor is being rolled out to the US military in 2019.   PTF isn’t supplying the initial order of the product.  After the December news release articulating that they had won their protest, there was nothing further on the matter.  I think a company called Short Bark Industries (second from the top in the table above) won the bid.  I note this article, which describes the suppliers that Short Bark is using to fulfill its order of BCS, and these government contracts (a government contract for $8.86mm, here for another $15mm, and another for $6mm).  Its worth noting that these contracts are for orders until June 2019 and all orders have been obligated, which means they are filled.  Its also worth noting that, at least from what I can tell, Short Bark is in bankruptcy proceedings right now.

But Mission Ready has kept rights to distribute the armor elsewhere.  The patent on the ballistic combat shirt lists them and the US government as assignees, though I am not sure whether that means Mission Ready actually holds the patent, or whether the patent belongs solely to NSRDEC.  In November 2015 Mission Ready signed an agreement with NSRDEC that gives them exclusive rights to market the Flex9Armor to governments outside of the United States and to other organizations within the United States.

In February of 2016, Mission Ready announced the launch of their version of the Ballistic Combat Shirt, called Flex9Armor.  The armor retails for $500-$600 USD (its worth noting that sometime in the last couple weeks a change was made whereby the retail armor can no longer be ordered on the website).  As described in the news release:

Co-developed with the US Army Natick Soldier Research and Engineering Center and launched by Protect the Force Inc., the Flex9Armor tactical solution is ideal for breaching operations, tight spaces, first-responder protection, and training exercises.  While the Flex9Armor is designed specifically for physically demanding conditions, the low-profile ‘exoskeleton’ design maintains comfort and full functionality for greater articulation in the shoulder and deltoid region.

Since that time not too much has happened in the way of contracts.  Mission Ready has added other products to its portfolio (they acquired a company called ForceOne, announced a small contract for Riot shield covers, and established relationships with the government on a couple of other product developments such as a safety vest for sailors) but revenue from any of the products has been lacking.  Until, of course, the recent news.

The order is so big, it seems most likely that is is from the US government.  The “foreign military” in the news release throws me off that trail, but it is a Canadian listed company, so maybe the US counts as foreign?  Edward Vranic wrote something up last week speculating as much.  As I pointed out, the winner of the previous contract with the US government, Short Bark, appears to be in bankruptcy, which seems coincidental.  But I see nothing about a new tender by the government as of yet, and there is nothing yet in the government contract list.

In some potentially related scuttle that I have to warn you I can’t confirm, there have been some comments on Stockhouse about a 10 year Egyptian contract that they are near finalizing.   Its a bit of hearsay because the presentation that discussed this has been modified.  There was apparently an early version of the August presentation that said they are “finalizing teaming agreement in EagleShield International/Tactical Elite Systems in Egpyt for a 10 year deal that Protect the Force would supply body armor for Egyptian military and later law enforcement”.

In the revised version of the presentation (with the reference to Egypt deleted), on slide 25 it says more generically that “Multiple foreign military and law enforcement opportunities identified since the beginning of 2017– Initial shipments expected to commence in Q4 2017”, which is still a pretty bullish statement.  The same slide also says that Mission Ready is “partnering with ADS Prime Vendor on Air Force Carrier and Armor project” (this one hasn’t been deleted).

The bottom line for me is that if the distribution agreement is legitimate the stock is significantly undervalued.  A contract that delivers $500 million over 5 years is clearly worth more than a $25 million market capitalization.  While I can’t be positive that the distribution agreement will lead to those kind of revenues, there are plenty of signs that it could.  I was however wrong when I implied on Friday that this was binding, it’s not.  It’s a distribution agreement, so what really matters is the first purchase order from that supplier and the subsequent funds from that order (40% of which are required to be delivered 10 days after the PO).

I added some to my position yesterday.   The product is there without a doubt.  The design team they have at Protect the Force is technically sound, has developed other products for the military, and received awards for their work.  The CEO, Jeff Schwartz, has a background in manufacturing and so that gives me some comfort (there is a Youtube video of both Schwartz and CTO Francisco Martinez talking about the company here).  Nevertheless I still have questions about manufacturing in those quantities (the distribution agreement implies quantities exceeding 100,000 per year), but they were in the running when bidding on the vest manufacturng a few years ago, and their bid was described as technically acceptable, so I would expect there is a plan for manufacturing.  Most important, I still want to see a PO.

I can’t say with 100% certainty that things will go forward as hoped, but there are enough signs that I’m willing to scale up my bet a bit.

Taking a Moonshot on Mission Ready Services

This is a tiny micro-cap on the TSX Ventures.  I just came across the stock this morning.  They have a $35 million market capitalization at current levels.  Just yesterday they announced a huge contract with a foreign military for their Flex9Armor and No-Contact Tactical Shield Covers.  The contract is for $50 million USD in the first two years, followed by $100 million USD for subsequent years.

I might be wrong, but the agreement looks more legitimate than some you see announced from small venture plays.  This isn’t an memorandum of understanding (MOU) or letter of intent (LOI) from what I can tell.  I have found those sort of agreements are often not carried out in the end.

Nevertheless, I can’t be positive if the contract is legitimate.  But it appears to be.  What due diligence I have been able to do in the last few hours suggests the company has legitimate products.  Earlier this year they announced a contract with the US Navy to develop Electrician’s Impact Safety vests.  That the company has had successful bids with the US defense industry gives me at least some comfort in the current contracts legitimacy.

Buying the stock here means I am adding after what has already been a large run.  It may be exhausting itself and I may have caught a short-term top, hard to say.  My thought adding here is that A. you never know where these things exhaust themselves and B. if the contract gets executed then I am still getting shares for well under the $50 million to $100 million revenue run rate of the deal.

As always, I am taking a small position only, as this quite obviously might not pan out.

Adding Gold Names

I decided to add more gold names yesterday as it looks to me like gold is breaking out.  I finally got a move out of some of my existing positions.  Americas Silver has jumped from $3.80 to $5.80, Gran Colombia Gold has moved from $1.40 to $1.60 and Klondex Gold has broken out of its $4 choke hold and is trading at $4.35.

First, I decided to add to both my existing positions in Gran Colombia and Klondex.  Gran Colombia had very good news on Monday, announcing that their mine strike had ended.  The stock, at $1.60, has hardly participated in the gold move, and is one of the cheapest gold stocks out there and less than 4x free cash flow.  The hair remains but the settled mining dispute removes some of it,  and I have to think it goes higher.

Klondex is my largest gold position and I added to it yesterday.  My add here was simply that it appears to have broken out from the $4 level (Canadian).  I’ve written about Klondex in the past.  Its been under pressure for months from an unusual GDXJ rebalancing that caused a lot of forced selling from the fund and follow-ons.  I note that there was a 25,000 share purchase by one of their directors on Thursday.

I added two new positions.  First, I added Wesdome.  Wesdome operates two mines at its Wawa complex in Canada and also has two advanced stage projects in Canada.   They have a $320 million market capitalization and $22 million of cash and no debt.  Guidance for the year is 55,000 oz.  I ran a quick comparison of gold companies looking at their enterprise value per ounce produced.  This is super simplistic of course, it doesn’t account for costs, reserves or development projects that are generally big determiners of value. Nevertheless, when I look at Wesdome it compares favorably (at $5,500/oz) to other miners.  There are cheaper one’s out there (for example Gran Colombia and Jaguar Mining, which I will talk about in a minute), but these generally have a lot of hair.  I don’t see much hair on Wesdome.

Jaguar, which I also added, comes out even cheaper, with an enterprise value of less than $1,000 per ounce.  But it has lots of hair.  I actually owned Jaguar years ago.  It has a new management team, a lot more shares, but essentially the same mining complexes.

Jaguar has a market capitalization of $90 million, $20 million of debt and $20 million of cash.

Apart from being really beat down, and very cheap (at least on a superficial basis), Jaguar actually seems like they had gotten their shit together up until the last quarter.  They had consistent production from both their Turmalina, Pilar, and Roca Grande mines.  But production slumped at Turmalina in the first quarter, causing the shares to slide.

The share drop was potentially accelerated by Resolute Funds, which sold 30 million shares over the quarter.  I found this article, which speculates on the impact of the Resolute Funds liquidation.

My bet with Jaguar is that in a rising gold price environment, many past transgressions will be forgotten.  It is also that maybe the second quarter does not portend the future. Jaguar kept guidance in the second quarter, and they had been producing consistently at Turmalina for the past 6 quarters.

Adding a new position in Imaflex, Selling Psychemedics

I added a new position in a company called Imaflex this week. Imaflex trades on the Canadian market.  They produce polyethylene films for packaging, garbage bags and, most recently, agricultural products.  I’ll do a more detailed write-up but for now the thesis is:

  1. this is a small company ($65 million market capitalization)
  2. they just reported strong growth (32% year over year revenue growth in the second quarter)
  3. they are ramping up a new product called Shine N’ Ripe that uses a thin film wrap around plants to increase sunlight and deter insects
  4. that product is gaining traction, having generated $2.1 million of orders in the second quarter on top of $3.3 million in the first quarter, and is driving growth

The company trades at a fairly reasonable valuation of 14x free cash flow based on the trailing twelve month numbers.  Focusing on more recent history, they trade at only 8x free cash flow if you annualize the last quarter results.  This is a small position for me so far, at 0.5%.

Its also in Canada, which means I don’t have to worry about currency, the bane of my existence the last few months.

Selling Psychemedics

A second trade, after much consideration, was to sell Psychemedics.  As the stock rose back to the $21 level I decided I did not have the conviction to wait and see if it would go back into the teens.

Psychemedics didn’t have the best quarter in Q2.  The main culprit was gross margins, which declined from 52% in the first quarter to 48% in the second quarter.  In the last two quarters of 2016, the company had gross margins of 59%.  Historically, margins have been around 50%.

Unfortunately Psychemedics doesn’t give a conference call so we are left with only what they have written to understand the significance of the decline.

What the company said in the second quarter press release was:

In the past quarter, we have made a number of strategic decisions and are implementing a number of strategic initiatives that we believe are in the best long-term interests of the company. Our market share remains strong and we have taken further strategic actions to solidify and strengthen our long-term position in the market. In addition, we now have established a wholly-owned subsidiary in Brazil and have brought on a Country Manager, a Brazilian national to manage our business in Brazil and work with our distributor. We believe in the long-term attractiveness of this market and are willing to make short-term investments and sacrifices.

In the 10-Q they said that “the decrease in margin was attributable to a mix of business, the inclusion of Brazil sales taxes and additional depreciation from equipment placed in service.”

I have been worried that Psychemedics had lost market share in Brazil to a competitor, Omega, that had just started operating in Brazil 3 months ago.  Omega stated on their website that they have achieved 25% market share in Brazil in the first 3 months of operations there.

But after talking to management I got the impression that Omega’s press release may have been optimistic and that while they are now a competitor in Brazil, they have not scaled to the degree they are suggesting.  There was a lawsuit between Omega and (indirectly) Psychemedics earlier this year.  There is clearly no love lost between the two companies.

Still, the rising costs/shrinking margins bother me, particularly given the valuation.  I am uncomfortable that Psychemedics is trading at over 10x EBITDA when they are having trouble maintaining margins and there is some uncertain level of increased competition in the Brazil market.   And I can’t help but look at the long-term stock chart and note that it wasn’t that long ago that the stock traded at $10.  It shouldn’t trade at $10 again, but a motivated seller in a crappy market and I think $15 is not impossible.

On the other hand its entirely possible that the market looks past the second quarter, the stock continues to trade at this level for a while, and then we get an upside surprise in the third quarter and its back to the mid-$20’s.  I’ll accept the risk I miss out on that.  If I had a bit more confidence, ie. if I hadn’t just been smacked down by an incessantly strong Canadian dollar, I might be more willing to take the risk.  But given the strength in the Canadian dollar, and my suspicion that the US dollar weakness is not a temporary event, if I am going to own a US stock, it needs to be a lopsided bet. Psychemedics doesn’t feel like that right now, so I’m out.