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Week 231: Tax Loss Buying

Portfolio Performance

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

Monthly Review and Thoughts

I didn’t make a lot of trades this month.  I added a couple of beaten down stocks (Dixie Group and Iconix Brands), added to a couple of existing beaten down positions (Acacia Research and Health Insurance Innovations), added to a less than beaten down position (Axia NetMedia) and sold out of a few poorly performing positions in PDI Inc, Nevsun, Independence Realty and Hammond Manufacturing.  I also reduced two of the three out-sized positions that I talked about in my last update, New Residential and DHT Holdings on pops.  At this point the only really uncomfortably large position I have is in Air Canada, a stock that seems to do nothing but go down.

It is my experience that the last three months of the year can be very quirky.  The confluence of redemptions and tax loss selling leads to seemingly endless downward moves.  While its easy to describe this as an obvious opportunity when you limit yourself to generalizations or retrospectives, the reality is that it is not so easy to buy that which has collapsed when it goes down every day.

I have plenty of examples of stocks I am following that are examples of this. Most are either yield stocks or energy names of one type or another.

First the REITs.  I could pick from a litany of REITs here but I’ll focus on Northstar Realty because I know it fairly well.  The stock can’t seem to get out of its own way, having endless down days followed by briefing sharp rallies that are followed by further relentless selling pressure that can’t be overcome by even a 2% up day by the market like we had on Friday.  Northstar has a yield 15%.  The dividend is backed up by real estate assets, mostly healthcare and hotels.  On September 29th the company announced a $500 million buy back.  Given the current market capitalization of a little over $3 billion, this is not insignificant.  On the negative side, the stock is externally managed, something that seems to be the kiss of death right now, and its hotel properties have underperformed lately.  Risks for sure, but at what point are those risks priced in?

Another example is Navios Maritime Partners, a dry bulk/container shipper.  Navios cut their dividend in November from $1.77 to 85 cents.  They operate in an extremely tough market, but at the time of the dividend cut they made a strong case that the current level was fully supported by existing contracts with almost a 9 year period.  This outlook was confirmed in a solid analysis posted in Seeking Alpha.  The stock has went down relentlessly both pre and post dividend cut.  It’s at $270 as of Friday’s close so its about a 30% yield.

A third example that I just started looking at over the weekend is Suncoke Energy Partners.  Suncoke owns three facilities that turn coal into coke for steel making.   The company has a market capitalization of $300 million versus a tangible book value of around $500 million.  Earnings for the first nine months were $1.16 per share and full year estimates are $1.50 per share.  The stock trades at $6.59 at Friday’s close.  The steel industry is hurting and Suncoke’s partners are expected to shutdown mills that Suncoke supplies.  On the other hand Suncoke has take or pay contracts and their customers are large producers: US Steel, ArcelorMittal USA, and AK Steel.  So are they really doomed, as the stock price performance (down from $15 since August) suggests?  Or will the partners pay and this a great buying opportunity for assets that are temporarily impaired?

Here is one from the energy sector.  Surge Energy.  I’ve owned it before, in the late spring/early summer.  They are currently producing around 14,000 boe/d with 80% of their production being liquids.  In the first half of 2015 they generated $85 million of funds from operations with the oil price (including hedges) averaging a little less than $60.  In the third quarter they generated $17 million of funds from operations on an oil price of $41, so about the current price.  Capital expenditures in the third quarter were $17 million.  The company has about $140 million of debt, so less levered than most.  Is oil destined to float around the $40 mark forever, in the process sending basically the entire North American industry into bankruptcy, or will it eventually find a higher equilibrium?  If it does what will one of the survivors, as Surge would surely be, trade at?  At 5x cash flow on $60 oil Surge would be worth more than 50% more than it is today.

And one last one from energy infrastructure.  Willbros Group.  Management has been much maligned and struggled to turn a profit in the past.  This year, perhaps because of the pushing of activist investors, they’ve sold off a number of their divisions, raising cash and paying down debt.  With the recent sale of the Professional Services segment to TRC Solutions for $130 million they have reduced debt to under $100 million and they have cash on hand of $50 million.  With 63 million shares outstanding Willbros has a market capitalization of about $170 million.  They generated $2 billion of revenue in 2014 and this year, even after the sales of multiple divisions and the devastating downturn in the energy industry their revenue run rate is close to $1 billion.  The company will likely not be profitable until oil prices turn, but when they do there is a lot of leverage to margin improvement and incremental contracts.

So there are some names.  None are sure things, all can have cases made for and against.  My point is simply that at this time of year there tends to be real bargains, but pulling the trigger is a lot harder because there are also always real questions, and the answers are rarely clear.

The stocks I’m going to talk about below, with the exception of Axia NetMedia, all positions that fit into this mold.  These are stocks that have been beaten up, that have warts, but that I feel are overdone.  I just hope that I am right in more cases than I am wrong.

Dixie Group

Dixie Group is a company I have owned in the past, followed for a long time but held out from buying until it got to a price that I thought presented very little downside.

Dixie Group is a supplier of commercial and residential carpet.  They have 16 million shares outstanding at $5.50 for $88 million market capitalization.  They have $131 million of debt that consists primarily ($84 million) of a revolving credit facility that comes due in 2019.

Dixie Group has undergone a lot of changes in the last couple of years.  They made a number of acquisitions of high end commercial and residential businesses in 2013 and 2014, and have spent the last year digesting the capacity.

The results so far have been lukewarm.  Sales have shown some slight growth while the rest of the industry has seen slight declines.  But the increased scale has not translated into improved profitability.

Some of this is skewed by continued restructuring and sampling costs, and some of it is because there have been employee and quality issues that have arisen along with the capacity additions.

Revenues in the third quarter was $109 million which is flat year over year and up somewhat from the first half.  Ignoring working capital changes cash flow was in the third quarter was $8.4 million.

Even though the headline showed a big miss on both revenue and earnings, I didn’t think it was a terrible quarter in a lot of ways.

Gross margins were up to 26% which is a little above the 25% I had been hoping for two years ago when I was looking at the stock.  G&A is rising more than it should and this appears to be due to restructuring costs, increased medical expenses, consolidation of offices.  They introduced a number of new brands over the last few quarters and those new brands are requiring higher sampling costs.  So there are lots of one time things.

But I think that it is the quality problems that are holding back the stock the most.  They said the impact to quality in the third quarter was 1% to their gross margins.  While they suggested this would decline in the fourth quarter, they weren’t very specific about how quickly that decline would occur and implied it could persist into the first quarter of 2016.

I don’t think the market likes the uncertainty.  Heading into earnings the stock wasn’t that cheap if it was producing no earnings and EBITDA on a $20 million run rate.  But after the collapse from $9 to $5 much less is priced in.  The stock trades at a little under book value.

In their third quarter earnings presentation Dixie presented the following pro-forma to restructuring 2014 earnings.

proformarestructuringSo if the dust settles you are looking at a $27 million EBITDA company with a $219 million enterprise value.  So about 8x EV/EBITDA.  Its not incredibly cheap but with some growth the equity portion of that enterprise value could quickly grow back to the $9 level.

Now of course this is the carrot not a forecast.  I don’t know if Dixie will regain operating momentum, get past their integration issues, and begin to grow the business.  They have the capacity now to produce $550-$600 million of carpet.  They just need to find the customers.  What I do know is that at the current price their is not much expectation priced into the stock.  I think its worth a position, one of those stocks where if anything good happens its bound to go significantly higher.

Acacia Research Third Quarter

Acacia had a really bad third quarter.   Revenue was $13 million down from $37 million in the third quarter last year and a $44 million average revenue over the prior two quarters.

So the stock got clobbered.  For four weeks it went down almost every day, from the $9 level to almost $5.  Was it deserved?  Well, the thing about Acacia is that revenue is always going to be lumpy and one quarter does not suggest any particular trend.  The company generates revenues primarily through the settlement of patent litigation.  The nature of the business is that the counter-party in the litigation is unlikely to settle until the very last moment, usually right before the trial starts.  So Acacia’s revenue recognition is always at the mercy of court dates and negotiations.

The poor third quarter was due to delays on litigation on a number of their patent portfolios.  This quote, from the third quarter conference call kind of summarizes their thoughts on the quarter:

The third quarter developments created paradoxical outcomes. On one hand, our marquee portfolios were strengthened through Markman inter-parties review and new patent issuance wins, and now have even greater future value. But on the other hand, we experienced a delay in collecting on that value.

In particular, their Adaptix portfolio is going to trial against Alcatel-Lucent and Ericsson but that was postponed by a quarter.  This is because of the introduction of evidence that actually strengthened Acacia’s case but required delays for all parties to review.  They also announced that they had won two infringement cases on their Voiceage portfolio (HTC and LG), but that it would take time for a formal opinion from the German court that would lead to a settlement.  Subsequently, Acacia announced a settlement with HTC on November 17th.

Acacia’s business model is to partner with patent holders, applying their legal expertise in patent litigation to help the patent holder maximize the value of their asset.  On that note Acacia said that in the current environment they expected to be able to partner with other patent holders without putting up their own capital going forward.  The environment was a “buyers market”.

At a little over $5, where I was buying, the company was getting close to its cash level of $3 per share.  Even here at $6 it still doesn’t attribute a lot of value to the patent portfolio.  There are a couple of good SeekingAlpha articles that discuss the stock here and here.

Health Insurance Innovations Third Quarter

Health Insurance Innovations (HII) had a so-so third quarter. The revenue number was a little lower than I expected at $25.8 million versus the $28 million I had been hoping for.

But there are a number of changes going on at HII that make the story interesting enough for me to add to my position.   First is the development of an online insurance portal, AgileHealthInsurance.com.  They have had Agile up and running for a few months now, and reported that it had accounted for 1,300 policies in July and 5,800 policies in Q3 (suggesting it averaged 2,250 policies in August and September).  Second, through the addition of a number of former sales personnel from Assurant, HII has expanded their broker channel significantly.

Overall the business is progressing.  Total policies in force increased in the third quarter to a record 137,000, up 31.7% year-over-year and 21.2% sequentially.

The revenue recognition associated with policies procured online is part of the reason for lower revenue.   Unlike broker or call center procured policies, those come from Agile have revenue recognized over the full term of the policy while the customer acquisition cost is taken up front which in the short run will depress margins.

Going forward HII expects to gain from a shorter ACA enrollment period and the reality that premiums on ACA plans are “rising rapidly”.

On the third quarter conference call management seemed quite upbeat about how well they are doing through open-enrollment:

Our short-term medical, our hospital indemnity plans, they really fit the need and we’re seeing, unlike last open enrollment period, a dramatic increase in our sales. We can’t wait to share with you the fourth quarter results when we get to that point. This is for the first time, we’re really playing offense during open enrollment versus last year, we were playing a bit of defense.

The fourth quarter will be interrupted by the ACA period, which began in November.  Still, I think that if the company can put up a decent showing during this period the market will take notice.  Perhaps we are already seeing the start of that with the recent $1 move up.

Iconix Brands

It’s been a while since I have been drawn into a company with a recent accounting scandal.  And while I am wary that these sort of situations often go down far further than I expect, I also know that in many cases the eventual profit can be quite significant if you can get through the rough waters.

Iconix is a company that essentially rents out the usage of their brands.  They buy the rights of well known clothing and entertainment brands and then for a price licenses the usage of the brand by department stores and manufacturers.  Their portfolio of brands encompasses a wide variety of low to high end men’s and women’s fashions as well as well known entertainment brands like Peanuts and StrawBerry Shortcake.

brands

Its a pretty good business that has consistently generate 30% margins and significant free cash flow.

The company ran into problems earlier this year. In March the CFO resigned.  Two weeks later the COO resigned.  And then the biggie in August, the CEO resigned.  At the same time they announced their second quarter results and said that they would be reviewing the accuracy of past financial statements.

This was followed up on November 5th by a mea culpa by the new leadership team that past financials were not accurate and would have to be restated.  Shares which had already fallen from the $30’s to the mid-teens, got halved again to around $7.

What’s interesting though is that the accounting irregularities revolve entirely around the income statement.  Here is what the interim CEO, Peter Cuneo said on the third quarter conference call.

This review has identified errors regarding the classification of certain expenses as well as inadequate support and estimation of certain revenues, and of retail support for certain licenses. As such, we will restate our historical financial statements for the fourth quarter of 2013 through the second quarter of 2015.

A table detailing these adjustments was included in last Thursday’s press release. What should be emphasized is that the amounts of the restatements have no impact to 2013 net income. They do result in a small reduction of approximately $3.9 million or 2.5% to 2014 net income, and they are slightly positive for 2015 net income.

Further, these changes do not impact cash, do not impact historical free cash flow and do not impact debt covenants or securitized net cash flow as defined in our securitized financing facility. In fact, gross collections for our securitized brands are up 3% for the first ten months of the year, which reflects the strength and stability of the assets in the securitization.

Now that its down almost 80% Inconix, with 48.5 million shares outstanding has a market cap of about $325 million.  Iconix also has a lot of debt,  $1.47 billion.  Included in that debt is a $300 million 2.5% convertible that comes due in June of 2016.  Normally this convertible would not be an issue.  Given the company’s problems they may have to fund its repayment out of cash.  When I look at the cash on hand and cash flow they can generate from operations, they should be able to do that without too much problem.

The bullish story here is simply that once the accounting issues are behind them, what will be left is a company that generates significant free cash and trades at an extraordinarily low free cash multiple.  Iconix issued the following guidance for 2016:

We expect organic growth to be flat to up low single-digits driven by double-digit growth in our international business and U.S. revenue down slightly. We’re including no other revenue in our 2016 forecast.

Reflecting these expectations, our 2016 guidance is as follows: We expect revenue to be in the range of $370 million to $390 million. We expect non-GAAP diluted earnings per share to be in the range of $1.35 to $1.50 and we expect free cash flow to be in the range of $170 million to $185 million.

Free cash of $170 million is $3.50 per share.

There are hurdles to reaching that guidance to be sure.  On the third quarter call they said their mens apparal segment was performing poorly because of poor performance by Rocawear and Ecko, both mature brands that may be reaching end of life.

Also one of their biggest brands is Peanuts which is experiencing some headwinds.  Peanuts accounts for somewhere in the neighbourhood of $100 million of licensing revenue, so 25%.  While the recently released Peanuts movie has done fairly well in the box office and in ratings, it is suffering on the merchandising side because it has to compete with Star Wars for shelf space over the Christmas season.

Nevertheless, even with the debt, even with the accounting issues, it seems too cheap to me.  Unless there is something further that comes out on the accounting front I think the stock has to move higher at some point next year. It could go down more over the next few weeks with tax loss selling, but I can’t see it staying here for good.  The fundamentals, un-obscured by fraudulent accounting, just aren’t bad enough to justify it.

Axia NetMedia

I’ve owned Axia for years now and recently added to my position.  The company has 63.4 million shares outstanding, and at its current price of $3 they sport a $190 million market capitalization.

Axia owns and operates fiber networks in Alberta, France and Massachusetts.  Each of these networks supplies high speed connections to smaller cities and towns throughout the area.

Axia has already built fiber trunk lines that provide high speed connections to the major centers in each of their networks.  Now they are in the process of signing up homes and offices and building out fiber to individual customers (called FTTH and FTTO respectively).  The addressable market is over 1 million homes only counting the 20 largest of the 400 communities that the fiber reaches.

In Alberta they have completed at pilot FTTH in one community (Vulcan) and are in the process of ramping up in Drayton Valley and Lloydminster.  The package they offer (which I believe is via third party providers) is $59 per month for 25Mbps rates.  In Massachusetts they offer 100Mbps rates for $49 per month.

This doesn’t seem to me to be a bad package for small town households that previously were limited to slower cable or satellite connections that was intermittent or experienced outages.  Having lived in a small town and having had first and second hand experience of the existing internet options I can say that the following commitment would be a major step up:

We are confident that Axia provides the most reliable Internet possible. In fact, for business we commit to 99.9% availability and a maximum 4-hour mean time to repair in the rare event of a fibre cut.

You can view the Canadian and US plans here and here.

In France the opportunity for growth is even better than in North America.  Covage, of which Axia has a 50% ownership, has 10,600 km of fiber including 3,400 km of fibre backbone.

covagenetworkIn the third quarter Covage’s customer connections were up year over year 36% for FTTO and 61% for FTTH.  On the third quarter conference call Art Price (the CEO of Axia) said that “Covage has sustained growth on its existing networks and has tangible FTTO and FTTP opportunities that could more than triple Covage’s size.”

Subsequent to quarter end Covage won a large FTTO contract that encompasses an additional 22,000 businesses.  Covage currently has a little over 7,000 FTTO connections.  Bringing on 10-20% of these additional sites would mean a large uptick.

Earlier this year Axia won a contract to provide Fiber to Seine et Marne that will pass through 319,000 homes.  Right Covage has around 7,000 FTTH connections.  So think about that for a second.

Right now they are growing steadily (see chart below) but the profitability of this growth is masked by the continued build outs of networks and connections.

connections

 

 

On the third quarter conference call they had a long discussion talking about the need for capital in the business they are in and what this means the eventual end game has to be.   I think its worthwhile reproducing the response in full:

Well, we’re looking at different options, and the way the company is harnessing the capital markets. I would say in the broad, we’ve been a company that is incrementally growing from a small size to a €200 million market cap size. But now we’re a company that has opportunities in front of us that are multiples of our current market capitalization.

And if we were just going to make the comment that where is this fiber infrastructure ultimately destined in the capital markets, well, clearly this fiber infrastructure is going to end up in billion dollar equity market cap, with capital structure that can issue its own bonds for debt. I mean that’s where this kind of investment ultimately ends up and we all recognize that.

So the question is what’s the path to get to that point? Is that path an incremental path similar to the one we have been on, but moving to a different shareholder class in a different size or is it some other path? And the Board is actively looking at that set of issues and looking at it in the context of the current market and looking at in the context of our investment opportunities having this sort of North American and France character, which some of the capital markets looks together at and other parts of the capital market look at that as segmented.

So we’re in that process, because besides the opportunity in front of us, in order to make those available or actually take those opportunities on, of course there is quite a bit more capital involved and our path is either we line up the company for that capital to rate shareholders’ evolution or we aren’t able to take advantage of the number of opportunities in front of us.

That’s a pretty interesting comment.  It basically says that they see the bottleneck and they are going to figure out what is the best way to address it.  It means they either are going to get the market to buy into the Axia story (and produce much larger share price) or try to find an acquirer with the financial clout to build out the infrastructure that they require to grow.

Either way it seems like a likely win for shareholders.  I think Axia is in the right place at the right time.  I’ve been adding.

Portfolio Composition

Click here for the last four weeks of trades.

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Week 202: Better Late than Never

Portfolio Performance

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

Monthly Review and Thoughts

I am a week late getting this portfolio update out due to a really busy weekend that kept me from doing any writing.   Fortunately very little is pressing.  I only made a handful of portfolio changes and added two stocks, small positions at that.

Given the relative dearth of transactions, I thought this would be a good post to give an overall update on some of the stocks I own. I have stepped through my thoughts on a few positions, giving a brief summary of why I own them and what I expect going forward.

But before I do…

This week I picked up the book Reminscences of a Stock Operator.  It is a book that, in addition to which this blog received its name, I read again and again, rarely from start to finish, usually just a chapter starting at whatever page I happen upon.  It has is so much knowledge and so much of my own investment philosophy is tied to its precepts.

This week I opened the book to the chapter about Old Partridge, an fellow with a thick chest who carried a big line and had been around the block a few times.  Its quite a well known chapter, mostly for two comments made by Partridge.

The first is perhaps the most famous.   Being one of the senior members of the house, and given the propensity of speculators to look for an outside influence to sway their opinion, Partridge was often asked for his opinion on tips and whether they should be bought or sold.  When asked such a question he would always respond with the same answer: “You know, its a bull market”.

The weight of this statement is the simple recognition that in a bull market the general trend of stocks is up and if you are confident of the general condition of the market, you can’t go too terribly wrong.  The general trend will  lift most boats.  A precept to be taken seriously for sure.

The second well known passage occurs when Partridge is being presented with advice from a tipster who had given him an idea that had worked out well and was now suggesting that Partridge sell and wait for a correction. To this tipster Partridge replies that he cannot possibly take the man’s advice, for if he were to do so he might lose his position, and he could not bare to do that.

This is really a statement about our own fallibility and our own psychology.  Regarding the former, if the correction does not materialize, then where are is poor Partridge now?  Without a position and up against his own mind’s wrongness to get it back.

As for the latter, are we really so sure of our own emotions that we can stomach either A. buying back the stock at a lower price only to have it fall further or B. waiting too long for the bottom so as to miss it entirely and not being able to stomach a later purchase at a price more dear?

Anyone who has played with real money will know that the mind plays tricks in each of these circumstances.

So this is what is well-known and often quoted from the chapter.  But I was struck by a less often, if ever, quoted passage that is, in my opinion, equally or more important.  I will quote this exactly since it is less well known, with emphasis on one sentence in particular:

“In a bull market your game is to buy and hold until you believe that the bull market is near its end.  To do this you must study general conditions and not tips or special factors affecting individual stocks.  Then [when the bear market comes] get out of all of your stocks; get out for keeps!

Now step back and think about this for a moment.  Livermore is not saying that one needs to be cautious in a bear market, or flee to safety stocks, or go net short.

He is saying sell it all.

How easy would it be to sell every position tomorrow if you had to?  Forget about the logistics, think only of the psychological strain.  Could you really let go of every stock you owned?  Or are reasons already creeping into your mind about why this one or that one should be different, should be held onto, will persevere through the carnage.

I know those reasons are abound for me.

My point is this.  This is not a precept to be taken lightly, and not one to be first dwelled upon at the time when action is required.  To follow it requires training the mind to ruthlessly let go of all your former beliefs and go to 100% cash (or as close as is possible) when the time comes.  This is something that requires practice, and something I am trying to ingrain in myself right now.

With that said, on to the stocks.

New Positions – Enernoc and others

I had a few new positions in the last month.  I bought Enernoc (ENOC) I bought Chanticleer Holdings (HOTR) and I bought some gold stocks for another swing.  I’m not going to talk about the gold stocks.  I bought a few very small one’s on the recommendation of a friend that I agreed not to talk about on the blog and so I won’t.  I bought a few larger one’s for the online portfolio that I have talked about before and really have nothing new to add other than that gold looked ready to break-out (it did) and so I thought the stocks would follow (they did).

The idea behind Chanticleer came from this SeekingAlpha article, which I found to be quite good. But to be honest I bought the stock as more of a short-term momentum play than a long-term hold.  I have to spend more time on it to know whether it is anything more and if I do and decide favorably, I will write more about it later.

On the other hand I expect to hold Enernoc for at least the immediate term.

Enernoc operates two businesses, a legacy demand response power management business and an evolving energy intelligence software (EIS) business.

The demand response business is very lumpy, and that lumpiness leads to the kind of stock reaction that happened in February and again a few weeks ago.  The company partners with enterprises to provide load reductions in times of high power demand.  By pre-buying into generation capacity that is no longer required (and thus no longer needs to be delivered) they split the winnings from the savings derived thus profiting from the result.  The difficulty is that the company’s profitability depends to a degree on the volatility of the power market, which is cyclical and hard to predict.

This year Enernoc is experiencing this negative cyclicality in Western Australia.  In addition, a contract they have with PGM cannot have its revenue recognized until fiscal 2016.  This combination led to revenue guidance in 2015 of about $100 million below 2014.  The market didn’t like that.

It is the second business, an EIS software platform, that really has me interested.  The EIS platform is sold to enterprises and utilities and allows for the centralized monitoring, analytics, reporting and most importantly management of energy to reduce consumption and manage supply.  From what I can tell they have one of the leading solutions on the market.  And I really like the market.

As a general rule I’m not much for technology story stocks but this makes sense to me.  I believe that the electricity grid is in the early stages of a pretty profound transformation.  Anyone can pull up a graph of solar costs and see that while we are not there yet, we are headed for a world where solar will be cheap enough to be competitive in say the next 5-10 years, if not sooner.  As that time comes upon us the management of energy, both to and from the grid  and at the level of each individual enterprise or consumer, is going to be much more important.

Meanwhile, the evolution of the industrial internet means a general trend toward the greater use of measurement and analytics in all areas of business.  Energy consumption and distribution will be forefront of this shift.

Enernoc says that right now their primary competition to their EIS platform are spreadsheets and apathy.  I believe both of these impediments will become less viable as the electricity grid evolves.

I would urge readers to give a listen to at least the first 45 minutes of the investor day presentation, available here.  I thought they painted a compelling picture.  Please tell me if you think I’m on crack.

Of course one look at the stock and the numbers and they are terrible.  So terrible that I am not going to roll out any spreadsheets or models because they are just too ugly.  I think 2015 guidance was for -$3 per share in earnings or something like that; I can’t even remember the exact number because it was so bad that it wasn’t even  worth remembering.  Cash flow isn’t quite so bad because much of the earnings hit is due to the revenue deferral.  The company expects break-even cash flow in 2015.

The stock delivered crappy numbers in the first quarter and got smacked and it could easily deliver crappy numbers in the second quarter too.

Nevertheless I think at some point we see the EIS business overshadow the results.  The key metric is annual recurring revenue (ARR), which the company reports for both utilities and enterprises.  ARR growth will reflect annual subscriptions to the software.

In 2015 Enernoc is expecting 70% ARR growth for enterprises and 15-20% growth for utilities.  If they hit or exceed those numbers I don’t think the stock will continue in the single digits.

This is the kind of story that could get a silly valuation if things turn out right.   It is a somewhat un-quantifiably large opportunity that could be extrapolated to a big number if it starts to work.  Its not working yet and that’s why the stock is in the $9’s.  I think there is a reasonable chance that changes in the next 6-9 months.

Revisiting some existing positions

Air Canada

I made this my largest holding after first quarter earnings were announced.  Air Canada continues to get very little respect from the investor community.  With estimates that top $3 for the full year 2015, the stock trades at around 4x earnings.

Even after accounting for the relatively difficult business of air travel, and recognizing that free cash generation hampered in the near term by the build out of the fleet, I have trouble believing the stock isn’t worth more than this.

I was talking to a twitter acquaintance about Air Canada and WestJet.  He was making the very valid argument that WestJet was an easier position for him to make larger because it was A. less leveraged and B. had lower cost.

The conversation made me revisit a comparison I made of the two airlines.  One thing I looked at was analyst estimates for the two companies.

epscomp

Air Canada trades at a discount to WestJet on both and EBITDAR and EPS basis, but the discount is far greater with regard to the latter because of the leverage that Air Canada employs.  Air Canada has about $5.5 billion of net debt while Westjet debt is  around $1.1 billion.

I believe that the discount Air Canada receives is due to historical biases that are beginning to close.  There is evidence that Air Canada is taking market share from Westjet.  Costs are coming down and CASM declines nearly every quarter.

The nature of their network is that it is always going to be higher cost, but what matters are margins and margins have been increasing.   In the first quarter operating margins reached 6.3% and return on invested capital rose to above 15%.  If they continue to roll out their plan, expand margins while increasing capacity, it will be harder and harder to justify a 3-4x earnings multiple on the stock.

Axia NetMedia

Axia is one of about  five stocks that I rarely look at.  I have no intention of selling my position.  I have confidence in the long-term direction of management.  And I think they provide an important service to rural residents and businesses (high speed internet access) that has, if I were to steal the term of a value-investor, a wide moat.  I’ve also lived in Alberta all my life, grew up in one of the small towns that Axia provides service to and know the family of their CEO and Chief Executive Officer to be stand-up people.

The business is not without its faults: it requires large up-front capital expenditures to lay fiber to mostly out of the way places.  In Alberta it is dependent on a somewhat complicated agreement between Bell (which owns the fibre backbone connecting the 27 largest communities), the Alberta government (which owns the backbone to the rest of the communities) and Axia (which operates the backbone owned by the Alberta government as well as owning branches to individual communities and businesses off of the backbone).

The stock has appreciated over the last couple of years but still trades reasonably at around 7x EBITDA.  Once the build-out of fibre in France and Alberta is complete and capital expenditures trend into maintenance, the business should produce ample free cash.

Its a stock I hold without concern and add to on any of its infrequent dips.

DHT Holdings

This is my biggest tanker holding.  DHT owns a fleet of 14 VLCCs, 2 Suezmax and 2 Aframax vessels.  They have another 6 VLCC vessels scheduled for delivery in 2015.  I like that they have growth on the horizon and I do not feel like I am paying up for that growth.

In the first quarter DHT reported earnings of 25c.  They booked VLCC rates of around $50,000 per day and Suezmax rates of about $30,000 per day (note that in the press release DHT referenced $60,000 per day for its VLCC’s but this referred to spot exposure only).

Along with the first quarter results the company gave guidance on new builds, saying on the conference call that “under a rate scenario, say, $50,000 per day, we estimate that each of these ships will add some $3.7 million of additional EBITDA per quarter.”

Take a look at my model below.  Those 6 additional ships, delivering $3.7mm of EBITDA at $50,000 day rates, are going to double earnings to around 50 cents per share quarterly.  This is comparable on a per share basis to Euronav, yet Euronav trades at $13.

newforecastLike the other tanker companies reporting earnings DHT had mostly positive things to say about the future.  The company pointed to a 2 year plus wait to get VLCC delivered from Korean or Japanese yards.  They also don’t think the strength in the tanker market has anything to do with contango – instead that it’s a function of higher demand, longer routes and limited order book bringing on little new supply.

Empire Industries

I was really happy when I found out that the Canadian government had decided to support the 30 meter telescope.  As I’ve written in the past, Empire had significant contract work lined up for the telescope, but the work was contingent on financial support for the telescope from the government.    The company expects the 30 meter telescope contract to add about $80 million to their backlog.

Even without the $80 million, Empire’s backlog has been increasing.  Backlog at the end of the first quarter was $155 million versus $93 million at the end of the fourth quarter.  The increase in backlog due to orders for the Media Attractions group, which continues to make inroads in Asia and the Middle East for its amusement park rides.

So with all this good news, why is the stock languishing?  Oil.   The Hydrovac truck business is getting squeezed on volumes and margins and the steel fabrication segment is weak:

hydrovacandsteelfabbizSo the problem with the stock is that some business are doing quite poorly.  Even with positives from the telescope revenue things remain a bit up in the air because of these other lagging businesses.

Finally I have read on Stockhouse that there is the Chinese seller trying to get out of their position.  I have no idea whether this is true, but it makes some sense particularly given the pressure on high volume that the stock experienced after earnings.   Earnings day is often a good opportunity to liquidate in these low volume venture stocks.

Teekay Tankers

This was my third largest tanker position (behind DHT Holdings and EuroNAV), but after being downgraded by Deutsche Bank on concerns about supply in the second half of 2016, I hemmed and hawed, modeled what looked like it was going to be a very strong quarter and after a whole lot of consternation, I added to my position.

I actually got a copy of the Deutsche Bank report thanks to one of my very helpful twitter pals.  It’s a reasonable report.  Deutsche Bank expects higher supply growth in 2016 than they had previously estimated.  This is because of a pull-in of 2017 new builds into the second half of 2016, and lower scrapping of ships.

I don’t totally agree with their numbers; in one case in particular they assume scrap of 0.5% for 2015 and 2016 while the actual year to date numbers for 2015,which have been extremely low, are 0.3% over the first four months.  It seems a little to pessimistic.  Nevertheless the themes are reasonable.

The question I wrestled with through the day on Tuesday was whether the tanker rally would end prematurely on the basis of an expected re-balancing of ship supply in year and a bit down the road.  My conclusion was that it’s too far to see; too far to expect the market to discount.

What is the new equilibrium price of oil?  What is the new demand level at that price?  How many new-builds are going to get out on the ocean?

We are already seeing the EIA increase oil demand estimates and we know they are typically behind the curve.  We are already seeing costs come down for oil services, suggesting a lower price of oil will deliver similar margins.  Deutsche Bank assumed a 38% non-delivery of the order book.  This is probably reasonable, but after listening to comments from Euronav and DHT about the composition of the order book its conceivable that the number could be higher.

I get the feeling that Deutsche Bank, and presumably many others, are basing their conclusions on the narrative that tankers are a fragmented industry that has never and will never get their shit together.  The problem with this narrative is that its not really historically accurate.

Below is a chart from the Euronav roadshow giving historical VLCC rates, followed by one from Teekay Tankers investor day giving historical Suezmax and Aframax rates:

vlccrates

historicalratesThe VLCC, Suezmax and Aframax markets went through a 4 year period, from 2004-2008, where rates were extremely profitable.  In fact they were higher than today.  Yet the narrative is that at the first sign of positive earnings, tankers will flood the market and so the current cycle will be 12 months tops.

I’m not so sure.

I’m not suggesting that the questions and history paint a clear picture for tankers.   I’m simply suggesting the picture is not convincingly dark.  And the valuations, in particular Teekay, reflect a lot of darkness.

Rather than give you my model for Teekay, just take a look at the following slide of the company’s cash flow.

freecashflowThe company’s cash flow increases by 57 cents for every $5,000 increase in day rates.  Its extraordinary leverage.   Now albeit their definition of “free cash” is a little suspect – free cash for tankers is basically, “we’ve bought all our ships and don’t plan to buy any more”.  But nevertheless a cash flow multiple  of 3x, when that cash will go straight to the balance sheet in one form or another absent further ship purchases, seems inexpensive to me.

Extendicare

Sometimes you just have to wait out the speculators.  When Extendicare announced the sale of its US assets in November, my first instinct was to sell my position.  It was a poor deal, though maybe not as bad of a deal as the market reaction insinuated.  I did a lot of work in the days after the deal, basically distilling what remained of the thesis into a simple observation: the current market price at the time (around $6.50) was essentially assuming that Extendicare did nothing right going forward: that they remain underleveraged and that they don’t put the cash from the deal to work in a accretive manner.  When I thought about the chances of this happening, I saw it as a real possibility, but not a certainty.  I also suspected that there were some very large shareholders who had been betting on a positive outcome to the US divestiture and they were now forced to sell shares of an illiquid stock with no momentum at the end of the year.

The picture was thus one of abnormal and perhaps unwarranted weakness. Thus I concluded that I would hold onto my shares and in fact added to them when the stock got as low as $6.20.

Since then we have had a recovery.  Extendicare has proven that it can put the cash proceeds towards a positive end, having purchased Revera Home Health homecare business for $83 million.  The acquisition is expected to add 10 cents to Extendicare’s AFFO.  This has allayed concerns that the dividend may need to be cut to what is sustainable for the Canadian only operations.  Also in the first quarter the company bought back 978,000 shares, or a little over 1% of shares outstanding.

Perhaps most importantly, the Ontario government amended its subsidies for redevelopment at the of February.  The base subsidy for large homes was increased to $162,000 per bed from $121,000 per bed over a 25 year life.  Also the revised design standards no longer include LEEDs certification, which should bring down construction costs.  Below is the outcome of Extendicare converting 1,876 of its Class “C” beds (the lowest type) into 1,972 Class A beds.

newontsubsidies

The amendment of subsidies is a big deal for Extendicare.  The vast majority of their beds are in Ontario.  When asked on the call whether the latest changes by the government would make it economically attractive to redevelop their Class-C beds, Extendicare responded that while there are still practical details to iron out, in theory the economics are there.

Given that Extendicare now has multiple options for its cash including further acquisitions in the homecare segment, redevelopment of existing Class C facilities, and new developments in the independent living/assisted living space, investors can begin to look forward at possibilities rather than backward at missed opportunities.  I’m holding my shares.

Hammond Manufacturing

Taking the what they do statement right from their MD&A: “Hammond Manufacturing Company Limited manufactures electronic and electrical enclosures, outlet strips and electronic transformers that are used by manufacturers of a wide range of electronic and electrical products. Products are sold both to OEM-direct and through a global network of distributors and agents.”  Simple business. No real moat.  But the type of business that can see a very positive impact from a change in their cost structure such as that brought on by the current weakness in the Canadian dollar.

The stock has so far been a bit of a disappointment.  They had a great quarter on the top line – revenue was up to $30.5mm from $24.5mm in 2014, which is inline with my thesis that they would be one of the manufacturers to benefit from the lower Canadian dollar.  The revenue gain was partially due to foreign exchange gains and partly due to market share gains.

Income from operations was also up significantly:

q1

The problem with the quarter, and what was unexpected for me, is that they had a really big foreign exchange loss of $623,000 versus $145,000 last year. $380,000 was due to a USD loan for their US subsidiary. This really depressed the bottom line.

Excluding the foreign exchange loss, Hammond actually didn’t have a bad quarter.  The stock remains reasonable.  Below are the trailing twelve months results for the company.  The free cash generation (below computed before changes in working capital) is compelling and I see no reason for a return to parity for the Canadian dollar and thus no reason to think this level of cash generation can’t continue.  I am considering adding to the position, even as I am down fairly significantly on it.

ttm-results

Euronav

Euronav had a very interesting conference call, which unfortunately has no transcript via Seeking Alpha, so it is difficult to quote.  I’m paraphrasing.  Euronav said they believed we are at the beginning of a multi-year run for the market.  They see the catalysts for this run being:

  1. limited vessel supply
  2. increasing demand for oil
  3. rising tonne-miles as cargo moves over greater distances and ships reposition over greater distances

One of the most interesting points that Euronav made, and one that I had not heard before, is that there is a significant amount of vessel tonnage available for sale.  They estimated that 10% of the tanker fleet is up for sale from private owners, distressed entities, and opportunistic speculators.  Of that 10% a significant number of the vessels are in the 0-5 year range.  The point here is that the quality of available fleet is not far off of new builds, and so if capital begins to come into the tanker market looking for a home, there are plenty of places for it to go without adding to supply via new build orders.

Another interesting comment that Euronav made was that you need 40 new build VLCCs per year to keep up with oil demand.  Returning to the Deutsche Bank analysis I mentioned in my Teekay Tankers remarks, Deutsche Bank is estimating an increase in 30 VLCCs in 2016, followed by only 10 in 2017.  Again, I’m not so sure that their analysis is as bearish as their price target changes suggest it is.

Euronav’s bottom line is the same one I have already stated for DHT Holdings and Teekay Tankers.  Its too cheap if you think rates in the current range can sustain themselves.  The company can generate earnings north of $2 per share at current rates (earnings were 55 cents in the first quarter).  At $13, which is where I was buying it, it trades at 6x earnings.   If that multiple goes to 8x you are looking at a 36% upside in the price.

Stocks I sold

I exited a number of positions in the last month.  I sold out of Handy & Harman (HNH), Ellington Financial (EFC), Hooper Holmes (HH), Amdocs (DOX), Ardmore Shipping (ASC), Impac Mortgage (IMH) and Avid Technologies (AVID).

In the cases of Amdocs, Ardmore, Impac and Avid, I sold out because the stocks had risen to a level that I thought closely reflected a fair price.   With Impac Mortgage in particular I caught the top with the on-line portfolio sales, but I regret to say that in my real dollars portfolio I only sold half at $27, and had to let go of the rest at $22.  I may revisit Ardmore in the future if it dips but I just have so many shipping plays in my portfolio right now I thought it prudent to take profits on some of them.

Handy & Harman and Hooper Holmes both just weren’t working out, I was down about 20% and so I had to make a decision of what to do.  I decided to cut the positions because I am simply less certain about their future direction than I am with other stocks in my portfolio.

I still own Ellington Financial in my other account where I hold mostly dividend payers.  I just didn’t think holding a stock where the upside is mostly yield makes much sense in a portfolio that does not track dividends.

Portfolio Composition

Click here for the last five weeks of trades.

week-202

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

Some Cheap Canadian Stocks (PART I)

I’ve been finding bargains harder to come by.  Six months ago I was finding it almost too easy to come up stocks that were worthy of consideration. The problem then was more one of pruning. Now it seems like the stocks I find all have a bit of hair.

Rather than venturing further afar to find ideas, I’ve been looking closer to home. I have mostly ignored the Canadian market over the last year and a half. I found a couple of special situations, like Yellow Media and Extendicare, but for the most part the opportunities in the US were more compelling. But that has changed. Over the last couple of months I have been finding and adding more Canadian stocks to my portfolio.  I’ve already had some good luck with the endeavour, as both Novus Energy and Ainsworth Lumber received takeover offers in the last few weeks.  In the next two posts I am going to talk about some of the names I’ve been adding in my portfolio.  In this one I’m going to talk again about Axia, and introduce Vecima Networks.

Axia NetMedia (AXX.to)

Axia is a stock I’ve written about on a couple of occasions (here) and lately I’ve been adding to my position in whenever it has dipped to $1.90.  A major overhang has been lifted.  When I wrote my last post on Axia, I highlighted the renewal of the Alberta Supernet contract in June of 2015 as my one major area of concern. Axia removed that concern last week when they announced an extension of the contract to 2018. Read more

The Thesis has changed but I remain Long Axia NetMedia

Last weekend I wrote a nice little piece summarizing the investment thesis for Axia NetMedia (AXX.to).  Would have made a great post, was concise, clear, short.  Perfect… except that the company came out and sold the asset that I had centered the entire post on.

So the post lost some of its relevance.  Still, it presents a good starting point with which to discuss the post-OpenNet version of Axia, so I have included the main body of it below, followed by a discussion of what’s next for Axia.

A big thanks to @17thStCap for this idea. I actually knew of Axia from years ago,  my hometown is a recipient of the Alberta Supernet, but I hadn’t looked closely at the company until @17thStCap mentioned it.

Axia trades at an enterprise value of $95 million (Note: actually $70 million post-OpenNet transaction), and yet I think that the assets it owns that provide fibre broadband transport services in France Alberta and Singapore, are worth quite a bit more than that.

Let’s focus on Singapore for the moment, as I believe it is the immediate catalyst. The company owns 30% of a partnership called OpenNet (look here for an overview of OpenNet), which provides fibre to 1.1 million residential and 26,000 commercial premises as of the end of the June quarter. OpenNet grew its top line and EBITDA by just slightly less than 100% in the last year. In the month of June alone, fibre broadband subscribers increased 31,000 to 380,000. Read more

Week 111 Portfolio Update: When Things Aren’t Working…

Portfolio Performance

week-111-yoyperformance

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

week-111-Performance

Shake-up

In a previous post about Walker & Dunlop I described the consequence of being on vacation while the company announced poor results, which was that I was not able to take advantage of a clear selling situation.  The same was the case for Dex Media.

In the past I used the term “good enough investing” to describe what I’m trying to do with my portfolio.  I work a full time job, have a life and need a break now and then, and all that means I just can’t be on top of everything.  I try my best but I have found it necessary to employ techniques to mitigate this.  In particular, I sell stocks when things aren’t working out.

While I’ve had my share of winners over the past month and a half (AIQ, NVS, NCT, NRF, IQNT to name a few), I’ve also had my share of losers (NKO, EXE, VTNC, and the above mentioned duo) with the result being that my portfolio has done not much of anything. While I remain hopeful that both Niko Resources and Extendicare eventually pan out, the fact is that thus far they haven’t. Read more