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If it’s true…

So first of all, my blog is private again.

Second of all, Mission Ready is moving a little this morning because this was posted on the Federal Procurement Data System.  The second one down is a $US200 million contract award.

In typical Mission Ready and TSX Venture fashion, there has been no confirmation, no press release and no halt of the stock.

If this is what it appears to be, it is quite significant to Mission Ready.  Consider that this is a ~CAD$35 million company, give or take.  Even assuming a 10% margin on these dollars, they represent a significant influx of cash.

Is it true?  Or is there some sort of gotcha that is not evident?  It would be nice to know with a bit more certainty.

Week 432: Where My (tenuous) Conviction Lies

Portfolio Performance

Thoughts and Review

Writing about the broad market makes me uneasy.  I fully admit I do not have any edge to it.

Yet I necessarily have to take a position on the broad market, and this blog is about why I make the decisions I do.  So regardless of whether my point of view is naïve or uneducated, I still need to describe it.  If only for my own posterity.

With that disclaimer, I want to briefly explain why I continue to be cautious on the market even as we approach new highs.

First, caution is different than being bearish.  I am not bearish right now.  I’m still long many stocks.  My longs are roughly double the value of my index shorts.

I am probably not enough of an expert about the macro-drivers of the market to be truly bearish on it at this time.  Its too ambiguous to me.

Instead I stick to my knitting – I go long individual companies that I can definitively say I am bullish of.   At times, depending on my level of trepidation in the market, I hedge the overall exposure to varying degrees. The bigger the hedge, the more cautious.

Right now, I’m more hedged than usual.

Consider the charts of the following stocks:

When I look at the three sectors that underlie these six charts (SaaS, pot stocks, oils), I don’t see much in common.

Debt issuance is a priority for oil companies.  Stock issuance for pot stocks. Most of the SaaS names are self-sufficient.  None of the sectors these companies operate in have much in the way of overlapping fundamentals.

The only thing I see in common is A. the chart pattern.  The charts are all miserable, and B. these are the sort of stocks that are driven more by speculation than most.

Of course, I am cherry picking sectors that are under-performing.  I could take the charts of Texas Instruments, Taiwan Semiconductor or even Apple and paint an entirely different picture about the market as a whole.

But that is kind of the point.  It is my suspicion that these poorly performing, uncorrelated sectors are signs that liquidity is a little more scarce than it typically is, but not necessarily scarce enough to a worry the whole market just yet.   We are left with rolling bear markets in some sectors, while the overall market holds up.

I have been railing on about tightening liquidity and worrisome economic signs for some time now.

Maybe I shouldn’t.  I certainly don’t understand all the machinations.  But there are a few general principles I have learned, and that I will continue to stick by so long as they work more often than they don’t.

My first five years of investing were from 2004 to 2008.  During that time my Dad was a BMO client and as such I was a faithful listener and reader of their head strategist – Donald Coxe.

Coxe put out a monthly publication called Basic Points and did weekly calls each Friday.

Donald Coxe was quite a good strategist.  He wasn’t perfect of course, and some of his views have turned out to be wrong, but many were right and he caught a number of very good investing trends.

One of Coxe’s favorite metrics to gauge the state of the financial system was the TED spread.  This was the difference between interest rates on three-month futures contracts for U.S. Treasuries and Eurodollars with identical expiration months.

Coxe followed this spread with interest, and when it rose unusually high, he said it was a time to exercise caution in the market.

He did not pretend to understand all the dynamics that may be moving the spread.  In fact, he often admitted it was an opaque market.

What he did know was this – that the spread was correlated to liquidity, and when liquidity was less abundant bad things were more likely to happen than if liquidity was loose.

What bad things?  Who knows!  It was and is (I think) kind of futile to try to predict what might be the lynch pin.  You just look silly most often.

The lesson here is more about the concept and less the particular indicator.  The TED spread doesn’t seem to work like it once did and I am not entirely sure if there is a single indicator that has taken its place.

Nevertheless, there are some signs the last few months that suggest liquidity is less abundant that it was 6 or 9 months ago.

One of the signs are these rolling bear markets that are hitting sectors that you might consider speculative.  In my experience rolling bear markets in such sectors can preclude downturns in the index as a whole.

We saw something of the sort in 2015.  In August of 2015 I wrote:

When I raise the question of whether we are in a bear market, its simply because even though the US averages hover a couple of percent below recent highs, the movement of individual stocks seems to more closely resemble what I remember from the early stages of 2008 and the summer of 2011.

The move down in the index didn’t occur until late 2015 – early 2016.

In all honesty, it doesn’t feel quite as bad now as it did in mid-2015.  So we are likely further away from a move of the averages, if it happens at all.  Nevertheless, the chance that something like this may occur again has been my caution since the late spring.

There are reasons to believe my caution will turn out to be wrong.  Some have talked about signs that the economies of Europe and China are bottoming.  There is maybe some sort of trade deal in the works between China and the United States.  The Fed is loosening in one way or another. So is the ECB.  The weekly leading indicators in the United States have been trending up of late.

Nevertheless, I still think I am more comfortable taking a cautious bent.  When I look at the performance from the funds letters I have read, I see some numbers that, while very good so far this year, showed -15%, -20% or even -25% in the fourth quarter last year.  I would not handle such losses well, so I prefer to take the cautious road.

If I am wrong it will hurt my performance a bit.  But if I am right in my stock picking, that should more than compensate for the mistake.  Thus far, it hasn’t really helped my performance, but it hasn’t hurt it either.

It is the individual positions that will make or break my portfolio which is how I want to position things.  So, let’s talk about a few of those ideas.

Tankers – I waffled back and forth a bit, but I finally sold the last of my tanker trade this morning.  I unloaded most of my position a few weeks ago, but as seems to be the case with ideas I’ve tied myself to for a while, its never a clean split.  It may still not be, but I want to see an entry that is not so elevated and over-bought to interest me.

Schmitt Industries – My most recent purchase.  I wrote about it here.  This stock has been slowly working higher, but my best guess is that it does nothing until the next step in their restructuring is announced, which could be months away or could be tomorrow.  I do not know if or when more assets will be sold but given the activist nature of the new CEO, I suspect they will be at some point.  With cash still making up most of the capitalization I will patiently wait.

Evolent Health – I wrote about here.  We will likely get some resolution on Passport Health Plan in the next few weeks.  Interestingly, Piper wrote their thoughts on Passport a couple weeks ago.  They were quite positive.

Nuvectra – I wrote about here.  My entry in this one was poor, but I added to it after it fell into the $1.30’s and I am now in the black on the stock.  I am hoping (this one indeed has a bit of hope involved) that we hear a positive outcome of the strategic review in the next few weeks.

Vertex Energy – I most recently wrote briefly about Vertex here.  There is always at least one position in my portfolio that confounds my expectation.  Vertex is it for now.  In short order they should be a beneficiary of falling HSFO prices (the futures curve, where prices were as high as $50-something per barrel as recently as September, is setting up just as I had hoped) and that should mean blow-out margins.  However, one might expect the market to anticipate this and it is not.  So I am puzzled.

Gran Colombia Gold, Roxgold, Wesdome – My primary gold stock holdings.  They have all corrected over the last month.  Roxgold in particular has seen a rather dramatic plunge.  They all have their own nuances, but they will all move up or down along with gold and the state of the financial system which I guess is a hedge in itself.

To balance my long portfolio, I am keeping a higher than usual level of hedging by way of inverse index ETFs.  As well I remain short a few individual names.  My shorts are the same as they were at last mention – a few SaaS names, a couple biotech’s with questionable histories, a couple of cannabis names that are levered to a Canadian extraction market that appears to me to be very oversupplied, a couple of US shales that are seeing their access to debt dry up and that I believe will struggle as a result, and a couple of Canadian banks that I will continue to be wrong about.

Portfolio Composition

Click here for the last five weeks of trades.

Back Online

I have had the blog private for the last 4 months.  During that time there were no emails sent out and only those that requested access could view the blog.

I did this after getting some odd emails and being linked to by a short report.

I enjoy writing this blog and explaining my decisions.  I enjoy getting feedback from the core group of readers that find some of the ideas worth investigating themselves.  I love going back over my own historical record and seeing what I thought at various times and how I was wrong and why.

In the last 4 months while the blog has been private, I realized what I did not like.

I did not like the email blasts that went out to followers every time I posted.

I found it kind of stressful to have a write-up sent out to what had become a significant number of accounts.  Of course, I don’t know how many people read them.  But nevertheless, the email blasts bothered me, and I have come to realize that they made me reluctant to write.

Therefore, before opening the blog up again, I have deleted 95% (or more) of my followers.  The only one’s that remain are emails or monikers that I recognize from some interaction.

I’m not selling a service, nor do I have any intention to, so I really don’t care if I have a large following or not.

What I value is if someone reads something I wrote and sends me useful information about it or strikes up a healthy debate.

My basic assumption going forward will be: if you find my stock and portfolio write-ups worth reading, you will be inclined to visit the blog from time to time.  If not, then it probably isn’t that useful for you anyway.

For those of you who didn’t request access to the blog over the last 4 months when it was private, I invite you to go over the last 4 months of ideas and thoughts.  I’ve had a few interesting picks over that time.

With all that said, I am working on a portfolio update that I will have out in the next day or two.

Schmitt Industries

I took a position in Schmitt Industries this week on the wake of news that they had sold their Schmitt Dynamic Balance Systems (SBS) business line to Tosei Engineering Corp. and Tosei America, Inc., for a purchase price of $10.5 million in cash.

The sale sets up an interesting situation whereby Schmitt is now trading at what is essentially cash levels.

After the close of the sale Schmitt will have between $11 to $12 million in cash on the balance sheet depending on closing costs.  In addition, the working capital position of Schmitt was quite positive at the end of the last quarter (ended September 1st) at $7.5 million (though I don’t know how the sale of the SBS segment will impact this).

At $3 the stock trades with a market capitalization of the company is $12 million.

For that $12 million, in addition the cash, this is what you get:

  • A measurement business with TTM revenue of $4.6 million, operating income of $447,000 and a recurring revenue component
  • 40,000 square feet of Portland commercial and industrial real estate
  • An activist investor CEO that is intent of extracting value

The Measurement Business

Let’s talk about the Measurement business.  The company has two product lines, Acuity and Xact.  They have owned these businesses for a while – Acuity was purchased in 2000 while Xact was purchased in 2007.

The Acuity product line are lasers and white light sensors used for making precision distance measurements.  They include short range lasers (3 – 1,300 mm) used in manufacturing processes and long-range lasers (up to 3,000 m) used in construction.

Xact is a product portfolio of remote tank monitoring equipment.  There are gauge or ultrasonic sensors that measure water levels.  Measurements are transmitted to the Globalstar satellite network where they are monitored and recorded.  The Xact product line targets IoT applications with its real-time monitoring capability.

While the SBS business has been the bigger of Schmitt’s two business lines, the Measurement business is in many ways the better of the two.  The SBS business has long struggled with profitability while the Measurement business has not.

The Measurement business has another interesting element – it has a recurring component.

Because its targeting real-time measurement of tank fill levels, customers pay for the data on a monthly basis.  While sales of measurement products can be lumpy (this is what accounts for the poorer performance this recent quarter) Xact’s recurring monitoring revenue amounted to $367,000 last quarter, or about 35% of the segment’s total and up 16% year-over-year.

Gross margins of the combined Xact and Acuity businesses were 46% last quarter.

Xact also recently partnered with the start-up Tank Utility, which will offer their gauge readers to their customers.

Xact and Tank Utility can offer an industry-leading package of tank monitoring products and related monitoring services to the delivered fuels market, regardless of where customers’ tanks are located. Tank Utility’s leading-edge cellular technologies will cover customer needs wherever reliable cellular connections are available and Xact’s industry leading satellite-based solutions will fill in the coverage gaps with dependable service.

What you are left with a businesss that has a profitable and recurring revenue stream and is partially levered to the growing IoT vertical.  I don’t think it is unreasonable to speculate whether the Measurement business should be valued similarly to the SBS business.

Real Estate

Schmitt owns 3 buildings with 40,000 square feet of real estate in Portland Oregon.  As best I can tell, these buildings have two addresses: 2765 Nicolai St and 2755 Nicolai Street and comprise two offices and a manufacturing space.

The 2765 Nicolai Street address is where the company main offices have been.

The 2755 address, which is a 3,961 square foot office, was up for sale a couple of years ago for $825,000, or around $200 per square foot.

The 2765 address building is a lot bigger than the 2755 building at 7,712 square feet.  It also appears to have had better upkeep, at least from the outside.

Though I wasn’t able to find a square footage associated with the manufacturing floor, I believe the rest of the building space is manufacturing space.

Part of the SBS deal is that Tosei agreed to a 10-year lease on at least part (maybe all?) of the facility.

Activist Investor

An activist investor approached Schmitt last summer and this started the ball rolling on what has so far resulted in a sale of SBS.

Michael Zapata and Sententia Capital sent this letter to Schmitt management.  Zapata and Sententia own about 18% of outstanding shares of Schmitt.

Sententia followed up with a second letter in August where they became more hostile and nominated two board members.  They also produced this research piece on the company.  Zapata eventually took over as CEO in August of this year.

For more depth about the company I would recommend reading their piece.

The bottom line is that Schmitt should be worth at least $4 per share.  Probably more.

While I don’t expect the Schmitt to become a multi-bagger, this seems to me to be a very, very well set up risk/reward situation.  I am purchasing shares of Schmitt for what is basically the cash value.  They have sold less profitable of their two businesses and now have what I would suspect to be the easier task of selling the profitable one.

In Sententia’s report they valued the SBS business at essentially what they sold it for.

If they are similarly prescient on their estimate of the Accuity and Xact businesses, sale proceeds would be $6 million to $8 million.  This would mean $1.50 to $2 per share.

In addition, Sententia estimates that the real estimate is worth another $7 million to $9 million.  This would be another $2+ per share.

While I don’t know if all this value will be realized, I think it is safe to conclude what Sententia’s intentions are.  In one of their letters Sententia expressly said that they would sell the Accuity and Xact business lines if given the chance.

After the sale of SBS it seems likely that the intent here will be to sell the entire business and realize the value.  As much as I like the Xact business, stand-alone this seems to small for a public company and I suspect Sententia would feel the same way.

I made Schmitt one of my largest positions after the stock opened on Thursday.  I added to that position Friday.  I think it is a very favorable risk/reward.