Orbit Garant – A Bear in a Bull Market

This is a very simple idea.

Orbit Garant is a micro-cap (~$38 million market cap) contract driller. Not for oil, for metals.

If you want a picks and shovels play, this is literally a picks and shovels play. When a mining company wants to drill out a deposit or explore a new area, they call on Orbit to do the drilling.

They own 231 drills, 75% of them in Canada. They operate in Canada, Africa and Chile.

Customers include (from the AIF): Glencore PLC, Agnico-Eagle Mines Limited, Newmont Goldcorp Corporation, and intermediate mining companies, including Eldorado Gold Corporation, Hecla Mining Company and Tahoe Resources Inc.

Their fortunes are driven by miners looking for: gold, base metals and iron ore.

There is a decent chance that metals are in a long-term bull market. Old arguments apply: the lack of new deposits, the need for exploration, the rise of EVs, and then on the gold side all that stuff about central banks and money printing. As Greta would say: blah, blah, blah.

Orbit Garant is the beneficiary, whichever poison you pick.

If you go read the MD&A, just about the first thing Orbit talks about is how mining finances are trending. That is because Orbit is simply a bet on the bullishness or bearishness of investors on the mining sector. The more money investors pile in, the more companies drill. The more they drill the more they need Orbit.

In the last real mining bull market, so 2011-2012, Orbit Garant was a $7 stock. Really, the company is not all that different now.

In 2012 there were 33 million shares and $26 million of long-term debt. Today there are 37 million shares and $32 million of long-term debt.

That increase in debt has been to facilitate growth. Over the last 11 years Orbit has increased the number of drills they own from 155 to 220.

If you make a spreadsheet of the financials for the last 11 years of the business, you will see that G&A expenses have been pretty flat, dilution has been minimal and debt increases have been reasonable. The company makes money when margins are good and does not when margins are bad.

In a bull market Orbit has pricing power and in a bear market it does not. In the bull market of 2011-2012 Orbit had enough pricing power to increase gross margin % to the low 20’s. In the ensuing bear market gross margins dropped to mid-single digits. This last fiscal year gross margins rose again, to 12%.

Right now, the main pressure on gross margins appears to be the large increase in work. Orbit said in the last MD&A that they are seeing a shortage of experienced drillers in Canada and are having to train them up. This is not good for margins in the short-term. But it should be “transitory”.

They are also upgrading their drill rig technology so that fewer workers are needed.

If this was a SaaS company, the market would cheer the margin compression that comes from growth. With a drilling contractor, the market sells the stock off even as revenues increase from $20 million to $50 million year-over-year because margins are still weak.

I said this was a simple story and here is the reveal. In 2011 and 2012 Orbit did $25-$30 million of EBITDA. Right now the stock trades at a market cap of $38 million and an EV of $67 million.

The trend back towards that level of EBITDA is already well on its way. In fact, the top-line is already there. Orbit did more revenue in its last fiscal year (ending June) than it did in 2012 (because they have more drills). They just don’t have the margins yet (gross margins were 12% versus 22%).

FCF is also already strong. Ignoring working capital changes the company did $12+ million of cash flow this last year and generated $6 million of free cash. Their free-cash margin this last year (ex-working capital changes) was actually about the same as it was in 2011-2012 (though at that time they were adding to their fleet so capex was much higher).

I bought Orbit too soon. I started a position at $1.20. This is one of those cases where I broke my rules and added to a losing position at $1.

With these dinky little Canadian venture stocks you kind of have to add on weakness. The stocks go down not because anything is wrong but because nobody cares. It has nothing to do with the business. Look at Apollo. I had that stock in my portfolio for almost a year now and all it did was go down. I should have added to it.

Unlike Apollo, Orbit has improving fundamentals, which makes it easier to add to. It also has zero liquidity, which means you can’t make a position too big no matter how much you like it.

Nevertheless, at a buck it seems worth breaking a rule or two.

PS: Just some general thoughts:

The biotechs have worked and the gold stocks seem to be working so far (though who really knows)… I’ve kept most of my index short positions through this melt-up, which certainly hasn’t helped my performance… I did cut loose some of the single name shorts, mostly before they reported earnings, and surprisingly, even into a melt-up this has turned out to be a mistake more times than not. Even as the market has gone up many single names that I was short but covered have been trashed. Which is interesting if not unfortunate… Last week I started to scale back longs: I sold CENX (which has not worked), GRIN (which has not worked this time around), CLBT (which I only held a couple days), and cut a couple of my spec bio’s in half after a nice move: EIGR and SGMO… My overall thought for the coming week is to scale back more so that I don’t get smoked on a drop from this crazy run-up… Wondering if I should be cutting these bank stocks a bit – CUBI, BSVN, TBBK but I like holding bank stocks for the long run… I bought two new positions: SBEA and SID but I’m not going to write about either unless I’m sure I will keep them and I’m just not sure yet.