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Posts from the ‘Extendicare (EXE)’ Category

Week 258: In Search of the Next Big Thing

Portfolio Performance

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week-258-Performance

Top 10 Holdings

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

Thoughts and Review

I’m wrapping up the fifth year of the blog and portfolio I track here.  Unfortunately it was my worst year since inception.  With about a week to go I’ve eked out a miserly 3% gain.

In my last few posts I touched on what I think I’ve been doing wrong.  My observation is that I am spending too much time looking for value and not enough time looking for growth and finding major trends underway.

To put that in context, let’s look back at the last number of years for a minute.

I did well in 2009 and 2010 as I bought stocks that benefited from the infrastructure build-out in China, in particular a number commodity producers, mostly copper/nickel (FNX, Hudbay, Quadra) and met coal (Western Canadian Coal and Grande Cache Coal).

In 2011 I extended that thesis into pulp stocks, with wins from Mercer International and Tembec.  In 2011 I also made a few bets on gold stocks that paid off.

In 2012 I stuck with gold and began to see opportunities in small community banks that were recovering but where the market had yet to acknowledge this.  I also saw a slowly recovering housing market, and made successful bets on mortgage servicing stocks like Nationstar, which was a recent IPO, originators like Impac Mortgage, and hated mortgage insurers like MGIC and Radian.

In 2013 I continued the theme of a recovering housing market, with my mortgage insurer bets continuing to pay off, added more underappreciated community banks, and bet on a number of oil and gas opportunities that were taking advantage of the new fracking revolution.  I also correctly discerned that the market would take a more favorable attitude to debt, and so I made some of my biggest gains with stocks with debt, particularly YRC Worldwide, which rose from $6 to $36.

In 2014 my biggest gains were thanks to the ethanol stocks, in particular to Pacific Ethanol, which rose from $4 to $24.  I also did quite well playing the cyclical turn in airline stocks, particularly Air Canada and Aercap.

And how about 2015?  What led to my less than remarkable results?

For one I think that I spent too much time following tanker stocks.  While these stocks were cheap, they couldn’t and can’t shake their cyclical stigma.  Looking at the ships being delivered later this year and into 2017, maybe that is for good reason.

I focused too much on companies that were only marginally undervalued or where there was no real catalyst at hand to improve valuation.  In particular, I wasted far too much time on REITs, both simple single asset REITs like Independence Realty and Sotherly Hotels, and more complicated multi-asset REITs like Ellington Financial, Northstar Realty and even New Residential.  I remember Brent Barber commenting to me at one point to be careful with REITs in the environment we were  entering into, and I should have heeded that call.

I also spent too much time trying to justify the airlines.  As a whole the group is captive to their own history of pitiful returns.  One day multiple expansion may come, but holding too many of these stocks in anticipation of that day is not a good use of capital.

And finally, and more generally, I didn’t have a big theme or trend that worked for me.  There was no China infrastructure, pulp stocks, mortgage servicing, community bank or ethanol idea that I could ride.

For the upcoming portfolio year (beginning July 1st) I am going to focus on finding trends and growth.  The one I have latched onto so far is the move of telecom service providers to software defined networks and network function virtualization, and more generally, the continued move by businesses to locate resources to the cloud.

So far I have made the bet with Radcom, Radisys Vicor, Oclaro and Apigee.  Each of these is bearing or at least starting to bear fruit.  Unfortunately I also came extremely close to taking a position in Gigamon, a company I really like, but instead waited for it to slips into the mid $20’s. It never did and now its $37+.

While I made a couple of endeavors into bio-tech stocks last year and for the most part got taken to the cleaners on those, I’m not giving up on this sector yet.  I have been prepared to lose a few dollars under the agency of education and I am slowing learning more. I have a few more words about TG Therapeutics below.

Overall I really like the stocks that I own right now.  While the risk of what I own remains high as always, I also haven’t felt like I have had so many potential multi-baggers in some time.

I’ve been talking about some of the above mentioned names in the past few posts.  Below I am going to highlight a few others: a new position in RMG Networks, a position revisited in TG Therapeutics and some more information about Radisys.   Lastly I’ll review Intermap, which is more of a crap-shoot than the other names I own, but if the cards align it most certainly is a multibagger.

As for stocks I haven’t talked about in a while but will have to review in a later post, Swift Energy is treading water in the grey market and the warrants I received post bankruptcy don’t even trade, but I remain optimistic that when the stock gets to a big board it will go significantly higher.   While I remain wary of the Iconix debt load a few astute moves by management and the stock will trade at a more reasonable free cash flow level.  And Accretive Health, a very small position that trades on the pink sheets, is struggling through its transition but will soon begin to on-board patients via its long term agreement to manage services for Ascension, the largest non-profit health system in the United States.

It was a tough year but I feel good about the future.  Hopefully its a year that I have learned a little from, and that will set me up for a better one to come.

RMG Networks

RMG Networks provides what is called “digital signage” solutions.  They provide the hardware, content, content management system, and maintenance of the product.  The easiest way to understand “digital signage” is to see a couple of examples:

whatisdigitalsignageThis is a small company with 37 million shares outstanding and about a $37 million market capitalization at the current share price.  Yet even though the company is tiny, they do business with 70% of the Fortune 500 companies.

I came across the idea from a hedge fund letter I read by Dane Capital.  At first I wasn’t very excited about the idea; it seemed like a turnaround story with a struggling business, something I have been trying to stay away from.  It was really this quote from Robert Michelson, CEO, that led me to persist in my investigation:

I joined the company and was incentivized by two things. One, was on the company’s position in a really interesting growth industry, and two, my ability to make a lot of money and not salary bonus, but through equity. And you know, for me — I guess everyone wants to make a lot of money but I want to be able to make millions and millions of dollars. And you know I certainly go back and do the math and say, “you know, to get where I want to get to and it’s not just me — obviously, I’m doing this for the stockholders — this company needs to be significantly larger.” And I didn’t come to a company that was grow at like you 5% or 10% per year. You know, if you take a look at public companies, they get higher multiples when their growth is 20% plus.

The other thing that made it interesting to me is its size.  I already mentioned that RMG Networks has a miniscule market capitalization.  The company generated about $40 million of revenue in the trailing twelve months.  That means that relatively small amounts of new business are going to have an out sized impact on growth.  I will outline the growth strategy below.

The turnaround story at RMG began in 2014 when Michelson was brought in.  He proceeded to cut what was a fledgling international expansion, reduce the sales staff and bring back R&D spending to a more sustainable level.  We’re just on the cusp of seeing the fruits of that turnaround.

While the graphic I posted above shows five distinct end verticals the company has only made significant penetration into the contact center market.

This, in part, is where the opportunity lies.  Michelson is trying to address new markets.  His focus is the supply chain vertical and internal communications.

RMG’s supply chain solution provides real time data to distribution centers and warehouses.   Think about big screens in warehouses providing information about shipments, and performance metrics of teams.  The company currently sees a $10 million pipeline and has been seeing progress with leads with 40 prospects.   In the last few months they moved ahead with pilot programs with five of those leads.  RMG is targeting $5 billion companies with 80+ distribution centers and they expect to generate $1 million of revenue from each pilot if closed.

As for internal communications, RMG has a solution that delivers the existing content and management system but directly to employee desktop computers, mobile devices or to small screens around the office.

Internal communications is a $2 billion market.  The company has had advanced discussions with large customers to roll out their solution across their enterprise.

Maintenance revenue has been a headwind over the past two years, falling from over $4 million per quarter in 2014 to $3.4 million in the last quarter, but should stabilize going forward.  There have been two factors reducing maintenance revenue.  First has been the election to end-of-life older equipment that has componentry no longer supported by manufacturers.   Second, the new products being introduced can have a list price 40-50% less than their predecessors that were purchased 8 years ago and because the company charges maintenance as a percentage of sales, this has led to a reduction in maintenance revenue.  Both factors should begin to abate going forward.

Since Michelson started with the company a focus on sales productivity has led to an improvement in lead generation and new pilots.  Sales productivity was up 50% year over year in the first quarter as measured by sales orders per sales representative.  Michelson describes management as having “a relentless pursuit on costs” which is validated by the decline in general and administrative costs from the $5 million level in early 2014 when Michelsen took over to around the $3 million level and a decline in overall operating costs from $11 million per quarter to $5.6 million per quarter.

With the focus on the new verticals and improve productivity of the sale force new opportunities in pipeline are up over 40%.  And here is where we start to see an inkling that the strategic shift is bearing fruit.  In the sales pipeline, Michelsen said that the number of deals $100,000 or greater has increased by 50% in the last year while the number of $1 million deals have tripled.

My hope is that these early signs of sales improvements lead to an uptick in revenues in short order.

The stock is reasonably priced given the potential upside and it will only take a few good sized contracts to move the needle substantially.  I can see this one becoming a bigger position over time if they continue to execute along the current path.

Wading Cautiously back into a Biotech – TG Therapeutics

Here are a couple of thoughts on Biotechs that have begun to crystallize for me. I just finished reading a book called “Cracking the Code” and have started reading another called “The Billion Dollar Molecule”.  Please let me know if you have any recommendations for other good books or articles to help me with the sector.

While I am still a newbie in the bio-tech world, I am starting to understand a few things about the business.   I would distill the most important of my thoughts into the following three points:

  1. Approval/non-approval of any drug and the subsequent market for it is under SIGNIFICANT room for interpretation. Apart from a few obvious blockbusters that get snapped up by the large pharmas well in advance, there is a lot of uncertainty about what will work and what won’t and if it does work what kind of sales it will generate
  2. There is a big difference between the value of a company in Phase II or II trial that will eventually have to ramp up its own sales and marketing of the drug versus what that drug would be worth rolled into a larger entity that already has the salesforce, marketing engine and infrastructure in place.
  3. Biotechs in Phase 1-3 are event driven, open to interpretation, and their share price is as dependent on the capital markets as it is on the state of their particular research.  In this respect they have a lot of similarities to gold exploration companies.

With those points said, and being fully aware of what remains to be limited knowledge in this sector, as I wrote about last month I did purchase, or re-purchase, a biotech position this month.  I have been buying shares in TG Therapeutics.

The story at TG Therapeutics is the same one I wrote about a few months ago.  But that thesis has moved forward in some ways.

TG Therapeutics has two drugs that are in late stage trials for B-cell cancers.  The first, TG-1101, is what is called a CD20 monoclonal antibody.  To dissect what that means, an antibody is a protein designed to attack a pathogen, monoclonal means it is an antibody that latches on to one particular cell type, and in the case of TG-1101, the cell that is latched onto is a B cell, the latching achieved by way of a protein called CD20, which is expressed on the surface of B-cells. Once TG-1101 grabs onto the CD20 receptor it works eventually to destroy the cell.

The second drug that is in the pipeline is called TG1202, which is a PI3K-delta inhibitor.  An inhibitor blocks a particular pathway (a pathway is a series of action by which a cell changes or creates something), in this case the pathway is called the 3-kinase pathway.  The 3-kinase pathway is one of the most activated pathways in human cancers.  So the theory is that if it can be blocked, cancer development will be stunted.

TG-1101 is in Phase 3 trial in combination with an already approved drug called Ibrutinib, which goes by the trade name Imbruvica, and is owned by Abbvie.  Ibrutinib inhibits another receptor on the B-cell called Bruton’s tyrosine kinase.  Abbvie bought Imbruvica for $21 billion in 2014.   Ibruvica has been approved and has shown strong sales; it generated $1.3 billion in sales in 2015 and estimates are that sales could peak at as much as $12 billion.   TG-1101 is expected to improve both the efficacy and safety profile of Ibrutinib when used in combination and so far the results are bearing that out.

A second Phase 3 trial has TG-1101 and TGR-1202 working together.  TGR-1202 is also in a stand-alone trial.  In the stand-alone trial efficacy rates of TGR-1202 are tracking at slightly better than Ibrutinib monotherapy.  In combination, efficacy is even better.

One of the concerns that I believe has hit the stock is because of results that have recently been released for two other PI3Kdelta drugs in development.  Duvelisib (owned by Infinity Pharmaceuticals) and Zydelig (owned by Gilead), have run into issues with efficacy. The market could be looking at this that the read through to TGTX drug is that it is a PI3K inhibitor so in same class as these drugs and so maybe concerns spill over

Everything I have read suggests that Duvelisib and Zydelig had very similar structures whereas TGR-1202 does not.  More importantly, so far TGR-1202 is showing a good toxicity profile (meaning manageable side effects).  So I think we could see the current read through go in opposite direction as the data is digested.

This Barrons article quotes Wedbush as saying that the Zydelig problems have a negative read through for Duvelisib:

Zydelig safety issues raise red flags for duvelisib program. Given their structural similarities and similar mechanism of action, we believe the new Zydelig-related safety concerns provide a negative read-through for Infinity Pharmaceuticals’ ( INFI ) duvelisib program. Zydelig and duvelisib are both inhibitors of PI3K, a family of enzymes that regulate a variety of cell signaling processes, with Zydelig inhibiting just the delta isoform while duvelisib inhibits both the delta and gamma isoforms. A comparison across clinical studies suggests that duvelisib has a poorer safety profile compared to idelalisib, which we attribute to the potentially immune-weakening effect of PI3K-gamma inhibition.

Zydelig, before the recent issues, was approved and brought in $130 million in sales last year.  I saw estimates that Zydelig could reach peak sales of $1.2 billion by 2020.  If TGR-1202 can continue to show a better safety profile, presumably it should be able to take

The differentiation of TGR-1202 the other PI3Kdelta drugs was addressed by TG Therapeutics in a recent press release:

The integrated analysis, which includes 165 patients treated with TGR-1202 alone or in combination with TG-1101, demonstrates that the toxicities observed with other PI3K delta inhibitors such as liver toxicity, colitis, pneumonitis and infection are rare with TGR-1202 with discontinuations due to TGR-1202 related AEs occurring in less than 8% of patients.  We see this as particularly compelling given the recent setbacks for idelalisib with the closure of a series of randomized studies due to safety concerns.  The data presented today provides strong evidence to support the hypothesis that the adverse events seen with idelalisib are not necessarily a class effect.”

TG Therapeutics has about 55 million shares outstanding.  At the current price the market capitalization is about $380 million.  They have $85 million of cash on the balance sheet which should be good for a couple years of cash burn.

Success in the TG-1101 trial will give them a complimentary drug to the widely used Ibrutinib that can be prescribed alongside it.  Success in the combination trial will give the company a “platform” of two drugs from which others can be layered in order to attack the cancer from multiple angles and deliver the knock-out punch.  There are a couple of drugs addressing other mechanisms of attack of B-cells in earlier stages in the pipeline.  And there are investigations ongoing into whether TG-1101 can be used in the treatment of Multiple Sclerosis.

Radisys – Comments on the B Riley Conference

For some reason I get a lot of emails about Radcom and absolutely none about Radisys. I don’t know why? I would be hard pressed to call Radcom the better investment of the two. Maybe there is more upside to Radcom, particularly if they can evolve their product into something that could be used in a larger market (ie. Data center or security) but in terms of product and sales performance, not to mention stock performance, Radisys is the clear winner so far.

Radisys presented a very bullish call at the B Riley conference.  It isn’t coincidence that the stock moved up from $4.20 to $5 in the subsequent days.

To recap the story, Radisys is growing off of three products. FlowEngine, MediaEngine and DCEngine.

FlowEngine is a software defined network (SDN) friendly load balancer; basically a packet forwarding box. It already has a Tier 1 customer (Verizon) that uses it to triage packets in their network. FlowEngine had no revenues in 2014, had $5 million in 2015 and is expected to double revenue in 2016.

At the B Riley conference Radisys CEO Brian Bronson said it’s a $100 million business in the long term.  Towards the end of the Q&A Bronson pointed out a specific deal in India where they were competing against incumbent equipment manufacturers that were delivering similar functionality in a more traditional appliance for $750,000, while FlowEngine could provide the same for $250,000.

MediaEngine manages and manipulates media, is used in the conference space (I believe Mitel is a customer) as well as in VoLTE and transcoding. It’s the biggest revenue driver of the software and systems segment, had about $50 million in revenue last year, and while further growth is expected, it will not be the driver of growth going forward.

DCEngine is a rack solution for telecom datacenters.  As they upgrade service providers are migrating equipment to a data center environment, replacing the central office that they operate in today. The DCEngine rack is half as expensive as the competition. Bronson outlined that their advantage with DCEngine is that they are not the incumbent equipment provider, which stands to lose revenue and margins by replacing their fully populated custom solution with a rack populated with 3rd party equipment.

Because most of the rack is populated by third-party equipment, DCEngine is a low margin business, pulling in 15-20% gross margins though it does deliver 10% operating income. More importantly it will begin to pull through FlowEngine sales beginning in the second half of this year, as there will be as many as two FlowEngine appliances installed per rack, depending on the application.  Bronson suggested that at some point it could pull through MediaEngine sales as well but that is the first I have heard of that so I don’t know what sort of volumes we are talking here. Finally, selling the rack makes Radisys the natural player for profesional services (ie. installation, integration and maintenance) which on a gross margin basis are only about 20-30% but most of that drops to bottom line.

I gave my model for Radisys in the last update. What I have learned in the last month only strengthens my belief that I am likely going to be conservative on my revenue growth forecast.

Intermap Gambling

I had a friend go to the Intermap AGM, and some questions he subsequently asked about the company got me to review my research on the name.

I’ll review the details again but first the conclusion.  Same as what I concluded originally, this is a coin flip with a large potential upside if things pan out, and an absolute zero if they don’t.   I still feel the odds are favorable given the reward but only for a small “option” position type that I have reconciled to losing in its entirety.

Let’s review.  The story is that of an Spatial Data Integration contract, or SDI.  An SDI encompasses data acquisition, which in Intermap’s case entails crisscrossing a jet  over the country collecting IFSAR data, and data integration, which includes bringing the mapping data into Intermap’s Orion platform, integrating it with existing data (both geospatial, think LIDAR, and other layer information that can be tied to a GIS location), and building queries to automate searches and perform analytics on the data.

The SDI that Intermap has won is with the Congo.  Intermap is not dealing directly with the Congo. They are dealing with a prime contractor, of which the rumor is a company called AirMap.  The purpose of a prime contractor is to provide the local contact and regional expertise, and to arrange project financing.

The project financing is what everyone is holding their breath on.  You do project financing on a big contract like this SDI to help address the mismatch between project costs and funding timeline by the government.  It basically is put in place to insure that Intermap gets paid on time and has the cash flow to keep executing on the deal.

The project financing was supposed to be completed within 90 days of some date in February.  This would have put the deadline at the end of June at the latest.  On the first quarter conference call management implied that there could be an extension, but that the expectation was, by way of the prime contractor, that the financing would close by the end of the quarter.   Management said that financing discussions had moved away from financial details and were now focused on operational details, which presumably is to say things are progressing.

Intermap has 120 million shares fully diluted, so about a $20 million market capitalization.  They have $21 million of debt, mostly payable to a company called Vertex One.  The relationship with Vertex One is another wrinkle.  Here is Vertex One’s position in Intemap:

  • They owned 19.8mm shares in June 2015 (from here) and have subsequently reduced by 4.1mm (from this Sedar Filing)
  • 7 million warrants at 7.5c (from Gomes and from Vertex One filing)
  • They have a 17.5% overriding royalty on revenue
  • Hold $21 million of debt as already mentioned

The question is, given the distributed position, what is in Vertex One’s best interests?  I remain of the position that as long as the SDI is in play, Vertex One interests are best held by keeping their hand.  The equity upside is at least $1, the royalty will skim off the top, and they will collect on the debt through cash flow repayments.

But if the SDI is lost the relationship with Vertex likely means game over for Intermap in their current form.  Interest payments will overwhelm cash flow generated from data sales and InsitePro.

Its worth noting that InsitePro is a product sold to the insurance industry to help them identify insurance risks such as flood plains.  While InsitePro is an interesting little product, and management has noted that the addressable market is upwards of $500 million with a similar competitor product from CoreLogic currently running at $50 million annual sales, the company is really all in on the SDI and it is the success or failure of it that will determine Intermap’s fate.

So Intermap is a binary bet worth holding a small slice of if you don’t mind taking a significant risk.  I’m ok with it, I still think it makes more sense at this point that the deal closes then doesn’t.  But I won’t be shocked if I am wrong.

Extendicare’s Slide

In retrospect Extendicare was probably fully valued when it crossed above $9 into that $9.50 range. But I like the long-term trends in the business which always makes me reluctant to sell a stock like this. With the stock back down to below the $8 level it looks like I am in for another cycle. While I didn’t add any in the tracking portfolio, I did add to the stock in my RRSP.

I can’t be sure what has precipitated the sell off. It could be that the activist is reducing or exiting. The first quarter results were a little light, they are struggling with the Home Health business that they are integrating and margins are coming up a bit short.

I believe they are correct to expand into the home health space. Government is going to try to keep people in their homes as long as possible because its cheaper.  While the publicly funded side of the business is always going to be constrained by funding, it does give the company a base from which to build a private business, which they are starting to do.

I think of my wife’s parents, who take care of her mom’s parent in their home in Ontario. They get a nurse every day for an hour that is publicly funded but even with that help its becoming too much.  One option is to start paying a nurse to stay longer, or come a second time later in the day, out of pocket.  Its those kind of needs that Extendicare can serve.

What I learned about listening to Oil Bears

Its pretty interesting to look back at what has been said about the oil market on twitter over the past 6 months. From January to March there was a decidedly negative bent on oil market tweets. Many of these tweets were made by users with a large follower base, which presumed a degree of authority to their comments. I actually made a list of these tweets at the time, because I really wondered whether the market was as dramatically out of balance as was being suggested.

I’m not going to call out names, but it just reiterates that twitter has to be taken with a grain of salt.

I mostly sold out of my position in Clayton Williams Energy and Surge Energy.  I hold a few shares in one account but am out of these stocks in the practice portfolio.  I’ve replaced the position with another name that feels a bit safer with oil at these levels, an old favorite of mine called RMP Energy.  I continue to hold Granite Oil.

What I sold

I sold out of Health Insurance Innovations after the announcement of the proposed ruling by the Health and Human Services department to limit short term medical plans to three months and not allow renewals.   This is their whole business model, and if it goes I don’t know what happens to the company.  I also noticed that I have been seeing complaints about the company’s call centers aggressive sales tactics pop up, which is worrisome.

I also sold out of Oban Mining, which has been another gold stock winner for me, more than doubling since the beginning of the year.  I just don’t want to overstay my welcome here.

Also note that I did take a position in BSquare, which I will write up in the next post.

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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week-202-Performance

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

Week 163: Knowing when you are not at an advantage

Portfolio Performance

week-163-yoyperformance

week-163-Performance

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

Recent Developments

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

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

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

Week 150: Stepping Back a little

Portfolio Performance

week-150-yoyperformanceweek-150-Performance

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

Recent Developments

For the last number of months I have been increasingly uncomfortable about being fully invested.  Throughout the amazing rally that we’ve had since the beginning of 2012 I have been haunted by the idea that the rally is a liquidity induced euphoria .  In particular, I am given humility by this chart. Read more

Week 149: Earnings Update on a few companies

This isn’t a complete portfolio update. I won’t be posting my performance or trades; I will leave that for another week.  I just want to give a short update on some of the earnings reports that have come out or are still to come out while the thoughts are still fresh in my mind.  Here is a quick snapshot of the top positions in my portfolio as of Friday’s close.

05-10-14 topholdings

MagicJack

MagicJack earnings come out Monday after the market close.  I’m nervous about them, because the stocks action has been poor, it is a large position for me and because I’m not convinced the numbers will be great.

The company lowered advertising spend significantly in the quarter in anticipation of the release of the new version of the device and the app.  That will help costs, but it will also probably hurt revenue. On the fourth quarter call the company said that they expected the first half of the year to be “soft”. Read more

Extending the idea of Extendicare

I am more superstitious than I would like to admit. For example, when I was a kid I used to take the same number of steps to my bedroom, close my door before bed to the same angle, and never step on a crack on my way to school.

Nowadays I’ve toned things down a bit but I still have a few little rituals, many of which revolve around investing. I always check MSFT when I log in before checking any other symbol (even though I don’t own it), I never check the price of a Canadian stock on Yahoo! Finance, and from time to time I “sacrifice” some stock to the gods when a particular security isn’t going my way.

While superstition can be dangerous if its left to run awry over one’s decision making, if its kept in check it is not entirely a bad thing. While we all like to believe that we are rational and objective and that therefore our conclusions always stand on their own accord, I think this is mostly a delusion. Our convictions are more based on faith than we would like to admit.

From this observation comes the usefulness of coincidence. If a leap can be made, even somewhat half-heartedly, that coincidence is born of some sort of necessary intent, its conceivable to think that this might bond you to the event that you would otherwise disregard. The result can be constructive: a firmer stand of integrity, an oath more closely held. Under less desperate circumstances, it may simply lead us to pursue an opportunity that we may have otherwise ignored. Read more