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Week 2015: Maybe its just a bear market

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 don’t flash sensational headlines about bear markets for the sake of getting attention.  I get about 100-150 page views a day and given the frequency and technicality of my writing I don’t expect that to increase materially regardless of the headline I post.

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

A breakdown of the performance of the Russell 2000, which is where a lot of the stocks I invest in reside, was tweeted out this week by 17thStrCap and I think illustrates the pain quite well:

us market

The Canadian stock averages have been made respectable by Valeant and not much else. In a Globe & Mail article appropriately capsulizing my comment here called “The market is in much worse shape than the TSX index suggests” the following comparison was made between the TSX Composite and an equal weighted version of it that dampens out the Valeant effect.

tsxperformance

When the Federal Reserve ended its quantitative easing program last year I was concerned that the market might revert back to the nature it had demonstrated after first two QE endeavors.  But for a number of months that didn’t happen.  Stocks kept moving; maybe not upwards at the speed they had previously but they also did not wilt into the night.

I am starting to think that was nothing more than the unwinding of the momentum created by such a long QE program.  Slowly momentum is being drained from the market as the bear takes hold.

A week late

I am a week late getting to this update.  We were on vacation last week, which made it tough to write.  As well I was in no mood to ruin my vacation and write with my portfolio going through significant perturbations to the downside.

It is frustrating to see my portfolio doing poorly.  My investment account is being saved by two things:

  1. Shorts
  2. US stocks in Canadian dollars

As I mentioned last month I have had a number of technology shorts, some shorts on Canadian banks and mortgage providers, and hedges on energy and small caps via the XOP and IWM.  I actually took a bunch of the tech shorts off in the last few days for the simple reason that they are up so much.  I had some decent gains from INTC, SNDK, MU, ANET AVGO, RAX, HIMX and TSM.  I also ended my multi-year short on YELP.

I am covering my shorts because with earnings season over I think there could be a counter rally resulting from the news vacuum.   The China collapse angle has been beaten up and priced in; I could see the perception shifting towards the positive outcomes of the stimulus. And I’ve read that Apple is increasing orders for the iPhone 6s and 6s+ which may or may not be warranted (I suspect not) but could lift tech results in the short term.

I would put these shorts back on if the stocks recovered.  But I don’t feel like I know enough about tech to be pressing my luck on the names.  And as I reduce my long portfolio and raise cash, I feel less need to have what feel like stretched shorts to hedge those positions.

Without the benefit of short hedging this blog’s online tracking portfolio has done worse.  I’m down about 5.6% from a brief peak I hit in mid-July (when the tankers were at their highs) and I am essentially running flat for the last 4 months.

At the center of my frustration are tankers, airlines, small caps and the REITs.  So pretty much everything.  Let’s talk about each.

The Tankers

With oil oversupplied and refiners working at record capacity producing gasoline, jet fuel and heating oil, one would expect that the market would turn to crude and product tankers as a natural beneficiary.

No such luck.

The recent moves by my favorite tanker plays: DHT Holdings, Ardmore Shipping and Capital Product Partners, have been to the downside.  There was a brief move up towards the end of July that coincided with earnings (which were outstanding) but it was quickly unwound and now we are back to levels seen a few months ago.  While I sold some along the way up, it wasn’t (and isn’t) ever enough.

Ardmore Shipping

Particularly with the product tankers (specifically Ardmore Shipping), I just don’t get why the behavior is so poor.  I found it difficult to come away from their second quarter conference call with anything but an extremely bullish take on the company’s prospects.

The product market is benefiting from extremely strong refinery utilization and strong demand for products.  It is also benefiting from the move by Middle East nations to add refining capacity with the view of exporting finished products.

Ardmore had earnings per share of 30c.  They achieved those earnings with 18.4 ships. By the end of the year, once all of their newbuild fleet is delivered, the company expects to have 24 ships.  If newbuilds had been operating in the second quarter, earnings would have been 43c for the quarter.

In the second quarter Ardmore saw spot rates of $22,400 TCE.  So far in the third quarter spot rates are up again to $23,500.  At current $23,500 spot rates and with 12 MR’s in the spot market, EPS would be $1.85.  The stock has been trading at around $13.

Yet the stock sells off.

DHT Holdings

Likewise, I couldn’t believe it when DHT Holdings traded down to below $7 on Wednesday.  At least the crude tanker market makes some sense in terms of rates.  Voyage rates have come off to $40,000 TCE for VLCC ships.  This is seasonal and if anything rates have held up extraordinarily well during the slow third quarter.

DHT stated on its conference call that they had more than 50% of their third quarter booked at $80,000 per day.  The company has a net asset value of around $8.50 per share.

While I already had a pretty full position heading into the last move down I held my nose and added more at $7.15 (i never catch the lows it seems).  I’m not holding these extra shares for long though.  In this market having an over-sized position in anything seems akin to holding an unpinned grenade.

The Airlines

While Hawaiian Airlines has been an outperforming outlier, responding well to strong earnings, Air Canada has languished.  The stock got clobbered after the company announced record earnings and great guidance.

Air Canada reported 85c EPS and $591 million EBITDAR.  In comparison, BMO had been expecting 90c EPS and $618mm EBITDAR and RBC had been expecting 77c EPS and $558mm EBITDAR.

The story here really boils down to the Canadian economy.

Both WestJet and Air Canada are increasing capacity.  The market is worried that they are going to flood a weak market and pressure yields.  On the conference call Air Canada addressed the concern by pointing out that A. the capacity they are adding is going into international routes and B. they have yet to see anything but robust demand for traffic.

What’s crazy is that while investors have responded negatively, analysts have been bullish to the results.  I read positive reports from RBC, TD and BMO.   Only Scotia, which I don’t have access to, downgraded the stock on concerns about no further upside catalysts.

Its rare to see multiple upgrades accompanied by a 7% down move in a stock.  I would love to see one of the darling sectors, tech or biotech, respond in such a manner.

So the analysts are bullish and the company is bullish but right now the market doesn’t care.  As is the case in general, the market cares about what might happen if some negative confluence of events comes to fruition.  And it continues to price in those worries.

Its just a really tough market.

Trying to find something that works

Another contributor to my poor performance has been that what has worked over the last five years is working less well now.

In particular, over the last give years I have followed a strategy of buying starter positions in companies where I see some probability of significant upside.   In some cases I will buy into companies that do not have the best track record or are not operating in the most attractive sectors.  But because the upside potential is there I will take a small position and then wait to see what happens. If the thesis begins to play out and the stock rises, I add.  If it doesn’t I either exit my position or, in the worst case, get stopped out.

This has worked well, with my usual result being something like this.  I have a number of non-performers that I end up exiting for very little gain or loss, a few big winners, and a couple of losers where I sell after hitting my stops.

I’ve had a lot of winners this way over the last few years: Mercer International, Tembec, MGIC, Radian, Nationstar, Impac Mortgage (the first time around in 2012), YRC Worldwide, Pacific Ethanol, Phillips 66, Nextstar Broadcasting, Alliance Healthcare Yellow Media and IDT Corp are some I can think of off-hand.  In each case, I wasn’t sold on the company or the thesis, but I could see the potential, and scaling into the risk was a successful strategy of realizing it.

Right now the strategy isn’t working that well.  The problem is that the muddling middle of non-performers is being skewed to the downside.  Instead of having stocks that don’t pan out and get sold out at par, I’m seeing those stocks decline from the get-go.   I am left sitting on either a 5-10% loss or getting stopped out at 20% before anything of note happens.  Recent examples are Espial Group, Hammond Manufaturing, Versapay, Higher One Education, Willdan Group, Acacia Research, Health Insurance Innovations and my recent third go round with Impac Mortgage.

All of these stocks have hair.  But none has had anything materially crippling happen since I bought them.  In the old days of 2012-2014, these positions would have done very little, while others, like Patriot National, Intermap, Photon Control, Red Lion Hotels and most recently Orchid Island would run up for big gains and overall I’d be up by 20% or so.  Instead this year the winners still win, albeit with less gusto, but its the losers that are losing with far more frequency and depth.

So the question is, if what has worked is no longer working, what do you do?

You stop doing it.

I cleaned out my portfolio of many of the above names and reduced a couple of others by half.

So let’s talk about some of what I have kept, and why.

Health Insurance Innovations

HIIQ announced results that weren’t great but the guidance was pretty good.  Revenue came in at $23 million which is similar to Q1.  In the first quarter the company had been squeezed by the ACA enrollment period, but in the second quarter this should have only impacted April.  So I had been hoping revenue would be a touch better.

The guidance was encouraging though.  The company guided to $97-$103 million revenue for the year which suggests a big uptick in the second half to around $28 million per quarter.  In my model, I estimate at the midpoint they would earn 40c EPS from this level of revenue if annualized.

Also noted was that ACA open enrollment would be 90 days shorter next year, which should mitigate the revenue drag in the first half of the year.  And they appear to be doing a major overhaul of management – bringing on people from Express Scripts (new president), someone new to evaluate the web channel and a number of new sales people.

Its been a crappy position for me but I don’t feel like there is a reason to turf it at these levels, so I will hold.

Impac Mortgage

As usual Impac’s GAAP numbers are a confluence of confusion.  The headline number was better than the actual results because of changes to accretion of contingent expense that they incurred with the acquisition of CashCall.

The CashCall acquisition had contingent revenue payout and that payout expectation has decreased leading to lower accretion via GAAP.  Ignoring accretion the operating income was around $8 million which was less than the first quarter.

The decline was mostly due to lower gain on sale margins, which had declined to 186 bps from 230 bps.

While origination volumes were up 8% sequentially (see below) I had been expecting better.  The expansion of CashCall into more states was slower than I expected.  In the second quarter CashCall was registered in 19 states.  I actually had thought that number was 29.

q2volumesBy the third quarter CashCall is expected to be compliant in 40 states.  And really that is the story here.  Volume growth through expansion.

CashCall is a retail broker dealing primarily with money-purchase mortgages (mortgages to new home owners).  Therefore Impac is not as dependent on refinancing volumes as some other originators.

While it was not a great quarter the company still earned 70c EPS.  Its lower than my expectations but in absolute terms not a bad number.  On the conference call they said that Q3 margins looked better than Q2, and while July production was only about $700mm, they expected better in August-September as the pipeline was large.

I made a mistake buying the stock at $20 on the expectation of a strong second quarter.  But I think at $16 its reasonable given earnings power that should exceed $3+ EPS once CashCall is operating nationwide.

PDI Inc

The response to the PDI quarter is indicative of the market.  The company released above consensus earnings on Thursday along with news that their molecular diagnostic products were being picked up by more insurers.  In pre-market the stock was up 20% and it looked like we were off to the races.

It closed down.

Recall that PDI operates two businesses.  They have a commercial services business where they provide outsourced sales services to pharmaceutical companies looking to market their product.  And they have the interpace diagnostics business, which consists of three diagnostic tests: one for pancreatic cysts and two for thyroid cancer.

I suspect that the market decided to focus on the one negative in the report: reduced guidance for interpace revenues from $13-$14 million to $11-$12 million.  The guidance reduction was caused by a delay in receivables from some customers.  The metric by which to judge the growth of the actual operations, molecular diagnostic tests, increased from 1,650 in the first quarter to 2,000 in the second quarter.

But in this market you gotta focus on the negative.  At least on Friday.

Patriot National

When I bought Patriot they were a new IPO whose business was a platform that allowed them to procure and aggregate workers compensation policies for insurance carriers.  They sign a contract with a carrier for a bucket of policies with particular characteristics and then distributed that to their pool of agents, collecting a fee in return.

But over the last couple of months Patriot seems to be expanding that role to something more holistic.  Among their nine acquisitions in the past six months is an insurance risk management firm, an auditing and underwriting survey agency, an insurance billing solution platform and a beneits administration company for self-funded health and welfare plans nationwide.

Patriot describes themselves in their latest presentation as follows:

whattheyarePatriot has shown solid growth since their IPO, both through their roll-up strategy of small insurance businesses and organically.  They have increased their carrier relationships from 17 to 82.  They are expanding their relationship with a few big carriers like AIG and Zurich.  They have grown their agent pool from 1,000 to 1,750.

I’m not really sure what it was about the second quarter that caused the stock to sell-off like it has.  It was down 16% at one point on Wednesday, which is about the same time I tweeted that this is crazy and pulled the trigger.  I suspect its simply another case of a bad market, a run-up pre-earnings and a release that didn’t have anything clearly “blow-outish” about it.

Nevertheless the company provided guidance along with its results and for 2016 predicts 37% revenue growth and 55% earnings growth.  These numbers make no allowances for further accretive acquisitions, which undoubtedly will occur.

The stock trades at 6.5x its 2016 EBITDA multiple.  From what I can tell its closest peers trade at around 10x, and they aren’t growing at a pace anywhere near Patriot.  As I said I added under $16 and would do so again.

Orchid Island

I have followed Orchid Island for a long time having been an investor in its asset manager, Bimini Capital, in 2013.  I never bought into Orchid though; it seemed small, it always trade around or above book value and being an mREIT it seemed that you had to have more of an opinion on the direction of rates than I have had for a while.

But when the stock got below $8, or a 30%+ discount to book value, it just seemed to me like the opportunity was too ripe to pass up.

There have been a number of good SeekingAlpha articles by ColoradoWelathManagementFund on Orchid where he describes the MBS investments and also the Eurodollar hedges.  These hedges, which require a different GAAP accounting then other more commonly used hedges, seem to be at least partially responsible for confusing the market and leading to the massive discount to book.

However I don’t plan to wait this out until book value is realized.  When the stock hits double digits again I expect to be pulling the trigger.

Higher One Education

I bought back into Higher One after it got clubbed down to $2.20, where it seemed to be basing.  Upon buying the stock was promptly clubbed down again to below $2.

Like many other names I am not sure if the clubbing is warranted.  The company’s second quarter results were better than my expectations.

Adjusted EBITDA in the second quarter came in at $8 million versus $7.2 million in Q2 2014.  While the disbursement business EBITDA was down, both payments and analytics were up (46% and 38% respectively).  EPS was 8c which again was better than last year.

They lost 6 clients representing 86,000 signed school enrollment (SSEs), signed 4 new clients with 16,000 SSEs and renewed 59 clients with 675,000 SSE’s.  Their total SSEs were 5mm at the end of Q2.  Given the headwinds in the industry, Higher One is holding their own.

The overhang in the stock is because the DOE proposed new rules that ONE and others are pushing back on, with the biggest issue being that you can’t charge fees for 30 days after deposits.  From their conference call:

The way the rule is proposed every time there is a disbursement made into the students accounts, we’d have to freeze all fees for 30 days.

This of course would severely impair Higher One’s ability to be profitable with these accounts.

On Friday after writing this summary I decided to sell Higher One.  I’m waffling here.  I like the value but don’t like the uncertainty and if the market can knock it down to $1.90 then why not $1.50?  Uncertainty reigns king.  I might buy it back but its difficult to know just how low a stock like this can go.

My Oil Stocks

I’ve done a so-so job of avoiding the oil stock carnage of the last few months.  After the first run down in the stocks I added a number of positions in March and ran them back up as oil recovered to the $60’s.  Then oil started dropping again and in May I began to sell those stocks.

oiltweetBy mid-June I was out of all my positions other than RMP Energy.  By July I had reduced RMP Energy down to about a percentage weighting in my portfolio.

So far so good.

Unfortunately I started buying back into the oil names in mid-July, which was too early.  I bought Jones Energy in the mid to high-$7s but sold as it collapsed into the $6’s.  I tried to buy RMP again at $2.20 but got pushed out as it fell to $2.  I bought Baytex and Bellatrix which was just stupid (I sold both at a loss).  I’ve probably given back half of the profits I made on the first oil ramp.

In this last week I made another attempt but I am already questioning its efficacy.  I took small positions in RMP Energy and Jones Energy and a larger position in Granite Oil.  The former two have done poorly, while the latter had an excellent day on Friday that provides some vindication to my recent endeavors.

One thing I will not do with any of these names is dig in if the trend does not turn.  I’ve learned that commodity markets can act wildly when they are not balanced, and the oil market is not balanced yet.  So its really hard to say where the dust settles.

Even as I write this I wonder if I should not have just waited for a clear turn to buy.

These positions are partially hedged in two ways.  First, I shorted XOP against about a quarter of the total value of the positions.  And second by having so much US dollar exposure (still around half my account) as a Canadian investor they act as a bit of a counter-weight to the wild moves I can see from currency changes.

Jones Energy

One of the interesting things happening right now is that natural gas production is flattening, in many basins it’s declining, and yet no one cares.  When natural gas first went to new lows in 2012 many pointed to the declining natural gas rig count, believing prices would quickly bounce back.  They didn’t, in part because of the associated gas coming from all the liquids rich plays.

With the oil collapse much of the drilling in those liquids rich plays is no longer as attractive.  You have to remember that even as oil has fallen, natural gas liquids like propane and butane have fallen even further (ethane, which is the lightest of the liquids, is now worth no more than natural gas).  Many producers that were labeled as oil producers, because they produced liquids, really produced these lighter liquids that are now trading at extremely depressed levels.  Drilling in light-liquids rich basins (the Marcellus but also the Permian and parts of the Eagleford) has declined precipitously, and with it all of the associated gas being produced.

Meanwhile much needed propane export capacity is on the horizon and expected to arrive en-masse in 2016.

Jones Energy has too much debt (around $770 million net) but they also have oil and natural gas that take them out into 2018.  I think they are a survivor.  They have reduced their drilling and completion costs in the Cleveland from $3.8 million to $2.6 million.  They actually increased their rigs in the Cleveland in June, though I have to admit that might be dialed back again with the prices declining.  I bought back into the stock for the third time this year when it was clobbered on what seemed to be pretty good earning results (a beat and guidance raise).  Its a play on oil, but also on falling natural gas production, as natural gas makes up 43% of production and much of the associated liquids are light.

RMP Energy

I think that the miserable performance of this stock is overdone, but I have thought that for some time and down it continues to go.  RMP gets punished over and over again for essentially the same concern – Ante Creek declines.  This latest pummeling seems to have been precipitated by the disclosure that August volumes at Ante Creek were around 8,500 boe/d.   This is a decline from April volumes of 12,200boe/d but similar to end of June volumes.  Below is a chart from Scotia that details Ante Creek production:

antecreekvolumes

The April increase coincided with the new gas plant.  The subsequent fall was because the company drilled no new wells in the second quarter.  That production has stabilized from June to August without any new wells being drilled is encouraging.

But the market sees it differently.

Lost in the shuffle (with nary a mention in any of the reports I read) is that RMP has reduced its drilling and completion costs by 30% and that operating expenses were down from $5.26/boe to $3.89/boe.  Also forgotten is that the company is experiencing positive results at Waskahigan with it new frac design.

RMP trades at about 2x Price/cashflow and has debt of about 1.35x expected 2015 cash flows.  Its not levered like many peers and its not expensive.  These constant concerns about Ante Creek need to be priced in at some point.

Granite Oil

Of the three names I own, this is the one I am going to stick with the longest.  Granite has a $150 million market capitalization and $50 million of debt.  Their asset is a large position in the Alberta Bakken (350,000 net acres).  They can drill 240MBBL wells that are 98% oil for $2.8 million per well.

And they are beginning a gas injection EOR scheme that is showing promising results.  Below is company production as gas injection has increased.

alberta-bakken-eorThe results are well above expectation and show minimal decline even as the number of wells drilled has only increased marginally.

The result is some pretty strong economics even at lower oil prices.

economics

Granite management had been loading up on shares in the $4’s.  I did too.  The company announced earnings on Friday and is probably the only oil company to announce a dividend increase.  Like I said, this will be the last oil position to go for me.

Portfolio Composition

As I’ve said a number of times in the past, I sometimes forget to mimic my actual trades with the online RBC portfolio I track here.  After a while these differences get too out of whack and I have to re-balance.  I did some of that on Friday, and so the transactions on that day are simply me trying to square up position sizes.  I don’t have things quite right though; the cash level of my online portfolio is negative while my actual investment account is about 15% cash.  I looked at why this is and its the contribution of a number of positions that are all slightly larger in the online portfolio than they should be.  I didn’t have time to adjust everything exactly so I’ll just try to reduce this discrepancy naturally over time.

Click here for the last five 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 189: Playing the oil trade from all angles

Portfolio Performance

week-189-yoyperformance

week-189-Performance

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

Updates

One of the themes  over the last few months has been a shift in methodology towards taking what I can get.  Less have I been holding out for the big gain, and more have I been booking 10-20% gains when they materialize.

The change arises from my confidence, or lack thereof.  I know we are in a bull market and still at all-time highs but it doesn’t feel like that and so I remain somewhat cautious.   I’m just not comfortable waiting for upsides to play out in full.  So I take what I can get.

Sticking with the Airlines for now

This business of scalping, for lack of a better term, worked quite effectively with Hawaiian Holdings.  Leading up to Hawaiian Holdings earnings report on January 29th I held a fairly large position.   But believing that caution is the better part of valor, I reduced that position to its shadow in the days leading up to the earnings release.   The stock was subsequently pummeled after reporting lower guidance than anticipated.  While I still took some lumps, it was not nearly to the degree it would have been and I was left to decide where to go from here.

After much review I decided to add back, at least part way.   Here’s what I think.  The stock was hit because their revenue per average seat mile (RASM) is being squeezed on a couple of fronts.  First, on their Asian destinations fuel surcharges are shrinking down to nothing because of the drop in the price of oil.  Second, the strength in the US dollar is hurting their competitiveness to book flights from Asia; naturally the majority of Hawaiian’s customers on their Asian routes are traveling from these destinations and flying to the US: Hawaiian’s US dollar cost structure is hurting them here.  Third, the company said that North American capacity would be at a record high this year, with capacity growth peaking in the first half and this would put some downward pressure on prices.

The bottom line of all of this is a year over year total RASM decline of 3.5%-5.5% in the first quarter (including 3% that is attributable to currency and fuel surcharges).  I think that the market looked at that and said, whoa that’s a lot of headwinds for a stock that is up some 100%+ in the last year, and promptly sold it off.

While it’s a fair assessment, they are a lot less of a concern now that the stock is down some 30% in the last few weeks.   What is easily overlooked is that all of the negatives are more than made up for by the drop in jet fuel prices.  Using the company’s 2015 fuel guidance I calculate that the savings will be $230-$240 million for the entire year.  That is over $4 per share.

If the experts are right and oil prices are going to stay in the $50-$60 range for 2015 I simply do not see how a company like Hawaiian Holdings, or for that matter the other airline stock I continue to own, Air Canada, will continue to trade at such low PE multiples.  I have based this discussion on Hawaiian but I could have made similar arguments with Air Canada, with the primary differences being different events leading to a perceived earnings miss (in Air Canada’s case it was employee benefits, adjustments to pension assumptions and a lower Canadian dollar) and that the stock has quickly gained back its losses.  But Air Canada, like Hawaiian, will see gains from the lower price of jet fuel that far exceed any currency or revenue headwinds they encounter.

Getting back to Hawaiian, using the company’s guidance leads to earnings of about $2.75 per share.  Do they really deserve a mid-single digit multiple in a market where the average multiple of an S&P stock is somewhere north of 20?  I feel like the upside potential is, as they say, asymmetric to the downside risk.

The downside risk, of course, is that the price of oil rises  significantly.  While this is something to keep a close eye on, particularly with disruptions in Libya and Iraq, I feel well hedged by the oil stocks I own in my portfolio.  My positions in RMP Energy, Mart Resources, and my recently taken position in Rock Energy will all do very well if the price of oil spikes.  And as always, if things start to go south, I plan to exit my positions quickly to limit my losses.  But I don’t think I will have to.  I think this is probably at least a somewhat new paradigm for oil, which means its also a new paradigm for the airlines, something that even with the run up in the fourth quarter last year I don’t think the market has fully appreciated.

New Position: Willdan

I got the idea for Willdan from a couple of SeekingAlpha articles that outlined the investment case for the company (here and here).

Willdan provides consulting services.  They separate their business into four segments: engineering services (Willdan Engineering), energy efficiency services (Willdan Energy Solutions), public finance services (Willdan Financial Services) and homeland security services (Willdan Homeland Solutions).  Of these, the energy and engineering services make up the bulk of the revenue.

revenue_breakdownTo get a sense of the sort of consulting Willdan performs, its worth taking a closer look at a few of their contracts.  In 2009 Consolidated Edison awarded Willdan with one of if not the largest contract, $67 million to perform the role of “program implementation contractor” for an energy efficiency program directed at small businesses.  The contract was extended in August of last year.  Willdan’s role as contractor includes:

providing outreach to small businesses, completing on-site energy efficiency surveys, implementing energy-saving projects, and partnering with the community and local businesses.

As another example, Willdan provides engineering services to the city of Elk Grove California. After a bit of investigation I found that the services Willdan provides are things such a road construction and repair, drainage construction, lighting design and maintenance and traffic engineering.  Basically all the civil engineering tasks that one would associate with maintaining a city.

So this gives you an idea of what Willdan does.  Its probably not a bad business, not terribly reliant on the economy, but not really much of a moat beyond the skills of the individuals you employ who do the work for your customers.

Willdan is a small company, trading at a market capitalization of about $100 million.  When I first stepped through their historical results, Willdan looked somewhat interesting to me but I could have easily passed.  But what caught my attention were two recent acquisitions for $21.2 million. Both of these businesses are complimentary; typically Willdan provides energy audits and consulting but does not perform the engineering services for energy efficiency projects; these companies will expand that offering to the latter.  The businesses also expand Willdan outside of their core areas of California and New York and into the Pacific Northwest and Midwest.

So Willdan benefits on two fornts: they can expand their energy services auditing into new territory, and can market the engineering services of the new businesses within their own operating regions, presumably for energy efficiency audits they already have under contract.

On the conference call to discuss the acquisitions management said they paid 4.3x EBITDA for the guaranteed portion of the acquisition price.  The acquisition structure is tiered, by which Willdan pays 60% of the price (about $12.7 million) up front, with the balance contingent on the performance of the acquired businesses.  In particular each business has to grow operating earnings by 25% to obtain the full payment. It seems to me like a great structure for Willdan.

The acquisition price implies that businesses are generating about $3 million of EBITDA in the trailing twelve months.  Before the acquisitions Willdan said they could grow their top line organically by 15% in 2015.  Below is a rough estimate of earnings per share assuming that Willdan achieves their top line growth, maintains their existing margins, and that the acquired businesses perform sufficiently to achieve the full acquisition price.

earningsIts not unreasonable to assume that a company with $1.30 earnings and a growth profile over the last few years would be given a multiple of greater than 10x.

This is a small company and small position for me, and not one I am likely to add to.  I think there is a decent chance I will make a few bucks on it as it has a run to $17 or $18 or if I’m lucky even $20.

One new Energy Position: Rock Energy

As I mentioned in my last update, I had been in and out of Penn West a couple of times during the first month of the year.  I held Penn West for perhaps the last time a couple weeks ago when I bought the shares for a little under $2 (Canadian) and sold them at $2.60.  Regretfully I sold much too soon, the stock kept roaring all the way up to $3.30. But consistent with my theme this month and with the thesis I presented in my last update, the nature of my purchase was a short term scalp and to stray from the nature of my intent would have been little better than a blind gamble.

But having some conviction that oil prices have hit bottom, and as I mentioned already, having an eye on the production shut-ins in Libya and Iraq, I did peruse the energy universe for other names that I might want to take a position in.  I am by no means convinced that oil prices have bottomed, we may have, may not have.  Thus I was looking for companies that could weather a continuing storm but still pose a decent upside to a stabilization in price.

A lot of the stocks I looked at had gone too far too fast; reviewing Baytex, Suncor, the larger Canadian names, and they all seemed to be already pricing in an oil recovery.  Ditto for smaller names like DeeThree Energy, which I should have been looking at $2 ago.  Others, like Penn West and Lightstream, certainly have a lot of upside if a truly bullish scenario develops, but they run too much risk of a big drop on some bad news event driven by lenders getting skittish.  I don’t want to have to worry about that.

I settled on Rock Energy, a name I used to own at prices not far off what I bought it for now. Here are the reasons I like Rock:

  • Their debt is nearly non-existent at $20 million as of the end of third quarter and now, after a recent $13.2 million bought deal (done at $2.32 per share) debt is even lower.  There is no question that this company survives.
  • Rock revised their 2015 guidance and cut capital expenditures to the bone, to $25 million for the year, down from their original guidance of $90 million.
  • At an average price $40 USD WCS, with a US/CAD exchange rate of 1.25, they will generate $35 million of cash flow for the year, more than covering capital expenditures.
  • At this low level of capital expenditures the company would exit the year at somewhere in the neighbourhood of 4,600 boe/d. That values them at $28,000 per flowing boe upon exit.

The sensitivity analysis I did below shows how the company will cover its capital expenditures even at current WCS prices and illustrates the upside to an increasing oil price.

earnings-forecast

Rock will rise when the price of oil rises.  If the price of oil does not rise, Rock will flounder, but I doubt it will crash much further.

Hammond Manufacturing

I’ve been on the look-out for Canadian manufacturers that stand to benefit from the dramatic fall in the Canadian dollar. I haven’t had a lot of luck.  There aren’t a lot of manufacturers left in Canada, and most of the big one’s move dramatically in November, anticipating the move, and I wasn’t quite so quick to the trigger.

However I did find one overlooked name a couple weeks ago.  Hammond Manufacturing.  Hammond is engaged in the heavily moated business of electronic enclosure manufacturing.  I’m kidding of course, but when your business is one of commodity manufacturing there is little more that could be asked for than for a 20% currency devaluation to bring down your unit costs.

Hammond is a pretty simple story so I’ll keep this short.  The company manufacturers electronics enclosures, so racks, cabinets, wire troughs and a few more technically complicated items like air conditioners and heat exchangers.  They manufacture these products in Canada (Guelph) and thus they incur their costs in the Canadian dollars.  That means their costs have declined significantly of late, and that puts them at a competitive advantage.  The company is expanding production to meet the increased demand brought on by what is likely increasing market share.

The stock is also cheap.  Looking back at the trailing twelve months, at the current price the stock is at 6x free cash flow.  That free cash flow is going to decline in the upcoming quarters as the company looks to expand their business which means an increased level of capital expenditures.  I think there is a reasonable chance that capital translates into meaningful growth, and in turn, a higher stock price.

The Tanker Trade – DHT Holdings

I have remained patient with my position in Frontline even as it sank significantly from my original purchase.  When the stock hit $2.90 I reluctantly reduced because it had crossed my 20% loss threshold.  I held onto the rest as it sank further and subsequently added back as it recovered.  The thesis still seems intact and my position sizing is not so big as to make me uncomfortable with the wait for it to play out.  In addition to Frontline I continue to own Nordic American Tankers (which I mistakenly referred to as Navios Marine Acquisition Corp in my last update).

I added another name to the trade a week ago: DHT Holdings.  DHT is a bit safer way to play the thesis, insofar as any of these stocks can be considered safe.  Their ships are newer, they have a number of new builds scheduled for delivery over the next two years, they do not have the debt overhang, and with ~60% of their ships on the spot market they still stand to benefit from improved rates.

DHT has 14 VLCC tankers and another4 Suezmax tankers.  There are another 6 VLCC new builds that will be delivered over the next two years.  When I look at DHT’s earning performance at rates even slightly below today’s level, I am left to conclude there is significant upside in the stock if the thesis does play out as I expect.

forecast

A couple of weeks ago I posted Teekay Tankers monthly update video onto twitter.  It is available here.  In the video it was noted that supply growth over the next year or two for the three classes of ships used for crude transport (VLCC, Suezmax and Aframax) is non-existent. Meanwhile demand is expected to increase, including further pressure given the fall in the price of oil, and a number of VLCC tankers are being taken off the market for 1 or 2 years for storage.  I think that what we have seen over the past month is a short attack on the tanker stocks from those that believe we are seeing a repeat of last year; a brief spike in rates that will soon be followed by a collapse down to marginal levels.  What I think the shorts are failing to realize is that the dynamic is quite different then last year.  Indeed as we move through February you are not seeing significant weakness in rates and as a consequence the tanker stocks are being to firm up again.  I suspect (and am anticipating) that this is the precursor for another move up.

Scaling back on US names

I sold out of a number of positions in the last month, most of them for reasonable gains.  Included on this list was Engility Holdings, Rosetta Stone, CGI Group, Electromed and ePlus.  Each is an excellent illustration of the scalper trade in action.

Of the group, I most reluctantly sold out of CGI Group.  I think there is a decent chance it continues to trade higher.  But I also note that they are predicting somewhat weaker results in the first half of the year, followed by strength in the second half, they may experience some currency headwinds with the Canadian dollar falling, because they trade in the US and its not clear to me whether it is the Canadian or US ticker that determines the price they may also face share price headwinds if the Canadian dollar rises, and they simply aren’t as cheap as they were when I bought them 20% lower.  But really, my primary reason for selling the stock is because when I bought it I assessed that there was an easy 20% of upside but that my outlook was cloudy after that. I’ve gotten that first 20%, so to hold on without a change in thesis feels like a bit of a gamble.

I was pleased with the results from ePlus but surprised that the stock took off to the extent it did after earnings.  Shares were up nearly 15% at one point.  Much like CGI Group, ePlus is coming up on weaker seasonality in the next two quarters.  Also much like CGI Group, the discount I saw originally has been eaten up with the 20% gain in the share price.  Were I convinced we were in a bull market I may have held out for another leg up.  I’m not so sure though, so I just took my profits and walked away.

I spent a lot of time thinking about Rosetta Stone.  You can read my comments on a couple of short articles that were posted on Seeking Alpha.  I finally sold out of the stock for about a 10% gain and with some reservations about whether I am doing the right thing.  I still don’t really buy the short argument.  But I also didn’t feel confident enough about the business to hold the stock through its fourth quarter results.  I think the fourth quarter is going to be good; seasonally it is the best quarter by far. I’m less sure about guidance.

My actual 2014 portfolio performance

As I have noted before, I write this blog based on the performance of a tracking practice portfolio that is made available from RBC.  This portfolio is intended to mimic the general trend of my most risky investment portfolio.  However the practice portfolio has some limitations, in particular that you can’t short stocks in it and you can buy and sell options.  Every year I try to give a quick update on my actual portfolio performance as comparison.  In this last year the gap between the real portfolio and the one I track here was a bit bigger than usual, and mostly for a single reason: Pacific Ethanol.  In my actual portfolio, when given the fat pitch that was ethanol back in the early months of 2014, I not only loaded up on Pacific Ethanol stock but on options as well, with the result being very large gains on the calls.  Thus below, you can see the discrepancy between my more speculative account, where the options were bought, and the more restricted retirement account where you can only buy stock.  I had a pretty good year in my retirement account, but my investment account flourished particularly well thanks in large part to our good friend Pixie.

actuals

Portfolio Composition

Click here for the last four weeks of trades.  Note that the name change of Yellow Media to Yellow Pages removed that ticker from the practice account so there are a couple of transactions there to add back the 1,000 shares that disappeared.

week-189