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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 210: All about the 5-baggers

Portfolio Performance

week-210-yoyperformance

week-210-Performance

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

A few weeks ago I was talking to someone who works at a large fund.   He was telling me about a retail clothing chain that their fund was interested in.  To help evaluate the opportunity, they commissioned a research firm to canvas and scout locations across the country.

That is amazing intel.  It is also wholly impossible for me to replicate.

I generally have a pretty good idea about a business before I buy into it.  I do a lot of work up front, far more than the highlights that go into these posts.  But I’m always left with elements that are uncertain.   For an individual investor with access to limited information and with limited time, certainty about one’s beliefs is more hubris than reality.

In the face of such disadvantages, my strategy is to take smallish positions and add to them if they begin to work out inline with my expectations.  If they don’t, I cut them.

By keeping my positions small until they start working and cutting my losses before they get big I guard against the big hit to my portfolio.  On the winning side of the ledger I generally end up with a similar number of winners that cancel out the losers.  But I also end up with 2 or 3 big winners that lead to out-performance.

It’s the 5-baggers that make the engine go.

Another portfolio year has passed (I started writing this blog on July 1st 2011) and you can see from the results that the last year was not as good as the previous few.  I still did better than the market, but I didn’t do that great.

In part the under-performance was caused by not sticking to my rules.  I have already rehashed my failures with Bellatrix and other oil names in past posts so I won’t go into that again here.

But I also attribute it to my lack of “5-baggers”.  I haven’t had a big winner in the last 52 weeks.  I’ve had a lot of good picks (Air Canada, Axia NetMedia, PNI Digital, Extendicare, Radcom, Rex American, the second go around with Pacific Ethanol and so on) but only one true double and nothing that tripled or quadrupled.

Realizing how important multi-baggers are I’m sending myself back to the drawing board.  I’m not sure why I’ve failed to discover the big movers over the last year.  But I suspect that it is at least partially due to ignorance of the sectors that have had the momentum.

Up until recently I never owned a bio-tech.  I’ve stayed away from technology in all but a few exceptions.  I’ve only been in healthcare on a couple of occasions (one of those being Northstar Healthcare, subsequently Nobilis Health Corp, which I rather amazingly sold last October, at no gain or loss, literally days before it began a climb from $1.20 to over $10 in thee next six months).  Yet these sectors are where the big winners have been.

My attitude towards these and other outperforming sectors is going to change.  I have invested in a couple of bio-techs and in technology (shorts mind you, as I will explain later) and in the last couple of months.  More new ideas will follow.

What I Sold

Usually I discuss my new positions next.  While I have a couple of these, they are not significantly sized and my actions have been more weighted to the sell side of the ledger, so it seems appropriate to discuss what I sold first.

As I tweeted on a couple of occasions I have been skittish about the market over the past month and a half.  I sold out of some positions and reduced others when Greece went on tilt and announced a referendum two weeks ago.

Since that time as my worries have subsided I have bought some of those positions back. It doesn’t look like an immediate contagion is upon us, which was my main concern.  Still I’m keeping a healthy amount of cash (20%) and where I can I am short a number of stocks.

In what turned out to be an unexpected consequence of my recent research expansion, over the past month I spent a lot of research hours looking at short opportunities. Trying to take more of an interest in tech, I read through reports describing the state of business and dynamics at play in everything from telecom infrastructure to smartphone.  As I did I felt most of the near term opportunity was on the short side, and so I took positions there.

My tech shorts have been based on three-fold expectations: PC sales are declining faster than consensus, smart phone sales will grow slower than consensus, and rumors that the big data build out by cloud providers has been overdone will prove to be true and future spending will be scaled back.  Without going into the individual names, I’ve stuck mostly with the big players and mostly with semi-conductor providers, which seem to be the most susceptible to spending downturns.

I think however that this play has almost run its course.  I have been taking off some positions heading into earnings (for example I was short Micron going into their June quarter but took it off the day after earnings were announced), and plan to exit my remaining positions as earnings are released.  I don’t like to hold short positions too long.

While I have yet to take any short positions in healthcare, I get the feeling that the recent merger mania may be leading to valuations that prove difficult to justify once the feeding frenzy subsides.  I note that a top pick of Jerome Haas, who I have followed and found to be a solid thinker, was a short on Valeant Pharmaceuticals.

In my online portfolio, in which I cannot short, I sold out of my gold mining shares, my oil stock shares, some of my tanker shares (Euronav and Frontline), a hotel play (Red Lion), reduced my airline exposure in both Air Canada and Hawaiian Holdings as well as my Yellow Pages and Enernoc positions.

I also sold out of DirectCash Payments, though I subsequently added the position back later (at about the same price).  I really want to hold this one through earnings because its been beaten down so far and I still have doubts as to whether the first quarter is the secular harbinger that the market seems to think it is.  In the turned out to be an unexpected consequence of my recent research expansion

Similarly, while I sold out of RMP Energy, I bought it back (at a lower price) because I want to see their quarter before giving up on the stock.  Like DirectCash Payments, I question whether results will be as dire as the market suggests. In the same segment of his BNN appearance Haas also made DirectCash Payments another top pick.

I only added to a couple of positions in the last month.  Patriot National continues to execute on their roll-up strategy, buying up smaller insurers at accretive multiples.  The stock is up 40% from my original purchase (though in the online portfolio I forgot to add it when I originally mentioned it so its up somewhat less there) and I decide to add to the position since its working out.

Second, I added to my position in Capital Product Partners on what I believe is unwarranted selling on Greece.  The company is incorporated in the Marshall Islands, does not pay Greek taxes but does have offices in Greece, which is at the heart of the sell-off.  A scan of the company’s annual filings shows that their exposure to Greece is potentially some deposits in Greek banks and the risk that one or more of their subsidiaries could face higher taxes.  I don’t think that correlates to the 20% plus sell-off in the share price.

I also added two new positions to my portfolio.

Intermap

I have followed Intermap for years.  Its a company that my Dad owned. While it always held out the promise of a significant revenue ramp Intermap could never quite figure out how to monetize their world class geo-spatial data.

Then, a couple of weeks ago, the company signed a large contract with unnamed government for the implementation of a National Spatial Data infrastructure program.

For years Intermap was primarily a mapping services provider.  They owned 3 Lear jets equipped with radar technology that scanned and mapped large swaths of terrain.  They would land contracts to map out a country or region and be paid for providing that data.

The company always kept the rights to their mapping data and, over time, Intermap compiled a database of geospatial data for a large part of the earth.   This spatial database became a product called NextMAP.   The database can be accessed through commercially available GIS software like ArcGIS or web browser apps developed by the company. Customers can license either parts of or the entire NextMAP database for their use.

The latest version of the database, called NextMAP World 30, is “a commercial 3D terrain offering that provides seamless, void free coverage, with a 30meter ground sampling distance, across the entire 150 million km2 of the earth’s surface.”

Intermap has always had a leading technology.  But they have struggled with coming up with profitable ways of marketing that technology.   Over the last three years the company has been working on applications that can be layered over their basic mapping data.  They have a program for analyzing the risk of fires and floods (InSite Pro), a program for managing hazardous liquid pipeline risk (InSite Pro for Pipelines) and a program for assessing outdoor advertising locations (AdPro).

None of these niche solutions have resulted in significant revenue to the company.

The carrot has always been that they land a large government contract for the full implementation of a geo-spatial solution for the country.  Most investors have given up on this ever happening, but then it did.

The announced contract is for $125 million over two years, during which time Intermap will implement the infrastructure solution.  This will be followed by an ongoing maintenance contract valued at $50 million over 18 years.

When I saw the number on the contract I knew immediately that the stock would jump significantly.  Including warrants and options Intermap has 127 million shares outstanding.  So at the closing price the night before the deal was announced the market capitalization was around $10 million.  When it opened around 25 cents I figured the upside was only about half priced in, so I jumped aboard.

The implementaton of a full geo-spatial solution as per the contract will involve the implementation of the company’s Orion platform, which includes the company’s NextMAP data integrated with other relevant third party data and with applications for accessing and analyzing the data.   The platform will be used to help with decision making with infrastructure planning, weather related risks, agriculture, excavation, and national security.  Because this is basically a new business for the company, its difficult to peg margins or profitability.  So I’m not going to try.

Nevertheless, just based on the rough assessment of what $125 million in revenue would mean, at this point, with the current stock price of 50 cents the contract is probably mostly priced into the stock.  I maybe should have sold on the run-up to 60 cents, but I decided not to.

The company has suggested in the past that they have a number of RFPs in the works and some of those they have already won but cannot announce until funding is secured.  The upside in the shares is of course a second contract. That could happen next week or next year.  Its impossible to predict.

The other consideration, and something I have always wondered about, is why some large company doesn’t pick up Intermap for what would amount to peanuts, securing what is truly a world class data set and a platform that would seem to be more valuable in the hands of a large company with the resources to sell large projects to governments.  Somebody like an IHS comes to mind.

Pacific Biosciences

This investment idea is a little out of my normal area of expertise and consistent with my desire to expand my investing horizons.   Its an idea I came up with after reading  this Seeking Alpha article which I think does a good job explaining the trend we are trying to jump on.

PACB has 74 million shares outstanding, so at $5.20 (where I bought it) the market capitalization is $385mm.   The company has $79 million of  cash and investments and $14 million in debt.

They are in the business of gene sequencing.  Pacific Biosciences sells gene sequencing machines and related consumables for running tests to map an individuals gene in hopes of detecting a mutation that will diagnose the future susceptibility to disease.  The machine of course is a one-time sale but the consumables are a recurring revenue stream so the business has a bit of a razor-blade type revenue model to it.

The big player in the gene sequencing arena is a company called Illumina.  This is a $30 billion market cap company that did nearly $2 billion in revenue last year.  They dwarf Pacific Biosciences, which did around $60 million of revenue last year.

In fact I read that Pacific Biosciences has only sold around 150 machines.  One interesting thing from their presentation is that for each of the machines Pacific Biosciences sells, they generate about $120,000 of consumable sales a year.   Thus the opportunity for significantly higher recurring revenues is there if they can sell a few more machines.

What seems to set Pacific Biosciences apart from Illumina is that their technology produces much longer gene sequencing strings which results in far lower error rates.  Below is a comparison between the two.

comparisonilluminaOne thing I am not sure of is where Pacific Biosciences sits compared to some of their non-public competition.  I was reading through some of the comments on a site called Stock Gumshoe that suggested that some private competition may have as good or better sequencing technology.

Pacific Biosciences also has an agreement whereby Roche will market their product for the diagnostics market in 2013.  In May Pacific Biosciences met the second milestone of that agreement.  The only thing that is a little disconcerting about this agreement is that Pacific Biosciences did not announce how much revenue they would be giving up once (and if) the product is commercialized.

My bottom line is that there are enough interesting things going on for me to speculate in the stock.  The key word being speculate.  There is a chance of wider adoption, there is a chance of an expansion of their relationship with Roche, there is maybe even an outside chance of a takeover.  And its an industry that is clearly growing, is in investor favor, and the stock was at a 52-week low when I bought it.

But I will flatly state that I would not take my comments about Pacific Biosciences too seriously.  My knowledge of this industry remains weak (though its improving as I read more).  They could be, or maybe even have been, surpassed by competition and I would not be the first to know.  So we’ll see how this goes and chalk up any loss to the cost of education.

Portfolio Composition

Click here for the last four weeks of trades.

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Week 206: The Thin, Steep Line

Portfolio Performance

week-206-yoyperformance

week-206-Performance

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’ve been listening to interviews with traders.   I found two interesting podcasts, one called Chat with Traders and another called 52 Traders.  I go through an episode a day on my bike ride into work.

The interviews are generally at odds with my own investing style.  These guys don’t pay attention to fundamentals and they are short-term in nature (mostly day trading).  Nevertheless I have found the interviews insightful.

One concept that comes up a lot is “edge”.  An edge is essentially the advantage that allows you to beat the market more than it beats you.  For many of these traders understanding their edge; a system, a pattern, a money management technique; has been a major step toward consistent success.

So what’s my edge?

I have been pretty good about beating the market for the last 10 years.  I don’t know if you can chalk it all up to luck.  Though there is much I do wrong, there must be something I’m doing right.

I’m not going to dissect the details of what specifically I do “right”.   I’ll leave that to a future post.  I bet that if you read the last 3 years of writing you’d get a pretty good idea.

I want to talk more generally.  I’m going to hypothesize about what I believe to be some general characteristics of my edge.

First, I doubt you could boil my edge down to a single thing.  I think its more likely there are a number of small things I do right that together add up to decent out-performance.

If true, this means that I have to be careful about cutting corners.  Not being sure exactly what aspect of my process leads to out-performance means that leaving out any one piece could be critical.

I also don’t think that these tiny edges act together linearly in an independent fashion.  Let’s say I have 6 things that I do that contribute to the overall edge I have.  I highly doubt that if I do 5 of these 6 I will get 83.3% of the returns.  It will likely be significantly less.  Maybe even I don’t outperform at all.  The sum of my edge is greater than the parts.

Finally, I think that the slope of out-performance to edge is likely quite steep.  In other words, if I am off my game, my performance deteriorates quickly.

As the chart below illustrates, the degradation of performance due to small changes in edge is closer to vertical than to horizontal.  Think of the right side of the curve in the chart below as being the execution of maximum edge.  In other words you are doing everything right.  As you do more and more wrong; less due diligence, cutting corners on a spreadsheet, not following a stop rule, adding to a losing position, etc; you slide to the left of the curve and with your dwindling edge comes dwindling performance.

edge

The point I am trying to illustrate is that small deviations from what make me successful will likely result in outsized drops in performance.  If I don’t do everything right: do the mounds of research up front, follow my buying patterns, follow my stops, correctly discern when I should not listen to my stops, etc; I will see my edge decline and my out-performance will drop significantly when it does.

It’s a bit like I’m balanced above the ground on a pole, and the slightest wrong move, one way or the other, and I’ll fall off back down to earth.  This is quite analogous to how each day on the market feels to me.

Continuing on with updates of some of the stocks I own

Hawaiian Holdings

Hawaiian got hammered along with the rest of the airline sector over the past couple of weeks.  The hammering was precipitated by A. raised capacity guidance from Southwest Airlines, B. comments from the American Airlines CEO that they would defend their market share against competitors pushing forward with capacity increases and C. reduced passenger revenue (PRASM) guidance from Delta Airlines.

There is a good article on SeekingAlpha discussing the severity of these factors here.

What is frustrating about the above developments is that they should only be peripherally correlated to Hawaiian Holdings.  Hawaiian runs 3 basic routes:

  1. Inter-Island
  2. Island-Mainland
  3. Island-Asia

None of these really have much to do with mainland capacity.

I think Hawaiian is cheap in the low $20’s.  A move above $25 and I look to lighten up as I did earlier this month.  Below is my 2015 earnings estimate based on the company’s high and low guidance.  All of the inputs come directly from guidance with the exception of RASM, which I estimated as -2% year over year on the high side and -4% year over year on the low side.

guidancetoeps

When I look at analyst estimates they trend to the low end of guidance. The average analyst estimate (per Yahoo! Finance), is $2.79.  The high estimate is $3.05.  If the company hits the high end of their own guidance they are going to blow away these numbers.

I’m hoping that a combination of earnings beats and what has so far proved elusive multiple expansion for the airlines combine to send the stock price up closer to $30, which would be a nice gain from current levels.

DC Payments

I’ve spent a lot of time debating what to do with my position in DirectCash Payments.  After a lot of thought but still without consensus (of my own mind), I added slightly to my position at $14.

The stock has dropped from about the $16 after reporting weaker results in the first quarter.  The market is concerned about poorer revenue and gross margin decline.

I am somewhat sympathetic to the spirit of these concerns.  DCI is in the ATM business.  They buy an ATM, sign an agreement with the owner of a space to place that ATM into a space for a fixed period, and then depending on the agreement they either split the profits with the owner or lease the space for a fee.  Clearly, this is not a growing sector.  You would expect pressure on revenues and margins as society moves towards the use of less cash.

However I think the market is making a mistake to think that the first quarter results are evidence that this transition is accelerating.  There were a lot of one-time items and events that impacted the first quarter.  The company lost revenue from its CashStore ATMs, which has been going through bankruptcy proceedings.  They lost 120 ATMs as Target exited Canada.  In Australia, the recent implementation of cash-and-pay technology (something that has been in Canada for a while) led to steeper than usual declines (though not out of line with the declines experienced when the technology was introduced in Canada).  Finally year over year comparisons were impacted by a one-time GST gain in 2014.  On the expense side, they saw one-time accounting expenses due to the Australia acquisition as well as expenses related to the upgrade of the Australia fleet.

So I’m not convinced this is a secular decline story just yet.  The second quarter is going to benefit from an additional 340 BMO ATM’s in Canada and 120 ATMs being installed at Morrisons in the UK.  Some of the one-time expenses are going to roll off.  Increased surcharges are being implemented in both Canada and Australia.  And finally, beginning in the second half we will see some of the intangible amortization related to acquisitions begin to run off, which will result in a better income statement.  So we’ll see.

New Positions

PDI Inc

I like to find companies with one of the following attributes:

  1. A market capitalization that is a fraction of their annual revenue
  2. A small but growing segment that is being obscured by a larger mature business

I really like it when a company has both of these attributes, which PDI Inc has.

PDI’s mature legacy business is a outsourcing sales force for the pharmaceutical industry.   This is a 20% gross margins business that has seen some headwinds in the last year.  These headwinds are responsible for the poor stock performance.

The growing business is molecular diagnostic tests.  PDI entered molecular diagnostics via a couple of acquisitions, Redpath and some assets from Asuragen. They now offer diagnostic tests for malignancy of pancreatic cysts (PancraGen), and of thyroid nodules (ThyGenX and ThyraMir).

marketopp

The molecular diagnostic test segment generated very little revenue in 2014. They have been ramping up the business through acquisitions since the summer of 2014.  Below is a timeline, taken from the investor presentation, of their progress so far.

timeline

The company points to a recent report from Visiongain estimating that the molecular diagnostics market is around $6 billion and that it is growing at a 15% CAGR.

In the first quarter of 2015 revenue from molecular diagnostics was a little over $2 million.   Guidance for the segment is $13-$14 million, which suggests that they think they can grow the segment by nearly 100%.   Keep in mind that the company has a captive, experienced sales force at their disposal to help them reach that goal.

The company has significant net operating loss carryforwards of over $240 million so there will be no taxes paid for quite some time.

As part of the acquisition deals they also granted significant contingent considerations.  In addition to two milestone payments of $5 million, they pay a net revenue royalty of of 6.5% on annual net sales above $12.0 million of PancraGen, 10% on net sales up to $30 million of PathFinderTG and 20% on net sales above $30 million of PathFinderTG.

While I like the direction and I like the leverage to gross margin improvement, I caution that even with growth from the molecular diagnostic segment profitability remains somewhat distant. If they meet their guidance for 2015 they will still have an operating loss for the year.

However the bet is that if they show some success the market will reward them for the potential of their acquisition strategy, rolling up new treatments and integrating them into their sales platform.  Its not hard to see that strategy being worth significantly more than the current $25 million market capitalization.

Versapay

Versapay is another tiny market capitalization company ($29 million).  They have a newly launched SAAS offering that could scale quire quickly.

In the past Versapay’s product offerings have revolved around point of sale solutions: point of sale terminals (basically the little hand helds that you use at every shop), payment gateways for online purchases, app’s for mobile payments, and virtual terminals.

Margins on the legacy business are north of 60% but it is not a high growth business; it grew at around 5% in 2014 and showed flat revenues in the first quarter of 2015.  The business generated $2.1 million of EBITDA in 2014, so at the current market capitalization Versapay is probably slightly expensive if valued on this business alone.

Recently though Versapay expanded their offering to include a B2B e-commerce platform called ARC, or Accounts Receivable Cloud.  ARC is aimed at small to medium sized business and provides an accounts receivable process for business to business transactions.  Below is a slide from the company presentation that gives a high level overview of ARC’s functionality.

howarcworks

The company says existing offerings on the market either focus on accounts payable (so on the buyer), are geared towards large enterprises, or are accounts receivable applications for business to consumer transactions.  ARC fills a niche that is largely unaddressed.  The slide below depicts ARC’s target market:

arcmarket

The company says that its biggest competition are excel spreadsheets and inertia, for which, coming from a small business whose accounts receivable management consisted of a large excel spreadsheet with many tabs that had been maintained in the same way for years and emails sent out by salespeople with PDF invoices, I can sympathize with.

So I think there is a market here if Versapay can prove that their software is more efficient and can create more timely payments than the alternative.

What I really like about this idea is that if it does begin to take off the nature of the application could cause it to snowball quickly.  When a supplier uses ARC for invoicing, all of their customers are introduced to the platform via their bill paying portal.  If the portal is perceived as suitably impressive, these customers become natural targets for Versapay.

ARC also has synergies with Versapay’s existing point of sale solutions.  Both can leverage the same payment backbone for processing transactions.

synergiesWhile the platform is in its infancy (basically at a pilot/early adopter level), the early results show what could be in store.  As of the May conference call, Versapay had 16 suppliers signed up, 8 who are live, but already there are 14,800 buyers invited and 2,450 buyers who had signed up and registered.  This was up by 1,000 buyers in past 20 days.

The numbers of the buyers who are somewhat incidentally being introduced to the system is impressive.  It illustrates the need for quality before a full roll out.  Just as it is extremely beneficial to Versapay if these buyers have a positive experience, it will be a disaster if they don’t.

So far the early response is positive.  Two of the eight early adopters, Metroland and Teachers Life, went so far as to give positive testimonials at the Versapay investor day.  Versapay also announced on their first quarter call that they had signed up a large commercial real estate firm subsequent to the quarter.

There is enough potential here for me to take a position.  But I have to be careful.  I’ve talked before about companies whose product is a bit of a black box, where I can’t really be sure whether its going to be a hit or miss and so I have to judge it based on the evidence but show humility if things go south.   Radcom is a name I own that fits in this category.  Radisys is another, as is Enernoc.  The idea makes sense, the sector makes sense, but there is a bit of a leap as to whether the solution will be the best fit for the niche being marketed.  I just can’t be sure.

I am being careful about position sizing and will be on the look out for any adverse developments, comments or even just poor price action that may imply things aren’t going rosily.  This risk is justified by the reward; while the downside is that I get out at $1 after some poor results, the upside is likely multiples of the current price.

These are exactly the kind of bets I’m looking for, even if they all can’t pay off.

Transat AT

When I sold Transat AT at the beginning of the year it was always with the intention that I would get back in.  As I wrote in the comment section of my February post (after it was pointed out to me that I had neglected to mention my sale):

I sold the stock because I think the weak CDN dollar is going to make Q1 and Q2 difficult. They also hedge fuel so in the very short term they are going to be hit by the dollar over the winter but not going to gain from fuel to the same extent yet. The winter routes also have a lot of added capacity from Air Canada and such so that is making it more competitive.

I still really like Transat though in the medium term. I think once we get Q1 released I will look to adding it back, because the summer is going to be stronger, they will begin to benefit from fuel more, and presumably the dollar will stabilize… I’m just stepping aside until the uncertainty has passed.

With the release of second quarter results last week the uncertainty has passed.  And really, the results weren’t too bad.  Because Transat runs a very seasonal business, it is useful to compare quarterly results from year to year.  Below are second quarter results for Transat over the last 7 years.

Q2compThe company guided that its summer quarters (Q3 and Q4) would be similar to 2014.  That means that for the year they are going to have earnings that are pretty close to last year.  Income adjusted for one time items and for changes in fair value of fuel hedges was $1.16 per share last year.  The company has mounds of cash on the balance sheet and will also begin to benefit more from lower oil prices in the second half.  I believe that things are setting up for another run at double digits here.

Ship Finance

I added a position in Ship Finance after they announced an amended agreement with Frontline along with their first quarter results.  The new agreement gives Frontline lower time charter rates ($20,000 for VLCC and $15,000 for Suezmax instead of $25,500 and $17,500 respectively) and higher management expenses (Ship Finance will pay $9,000 per day instead of the previous $6,500 per day) in return for a larger profit share (50% rather than 25%) and 55 million in Frontline stock.

I bought Ship Finance on the day of the deal because the stock wasn’t moving significantly (it was a little under $16) and I thought the deal was accretive by at least a couple of dollars.  At the time I also bought July 17.50 options for 10c as I liked the short-term outlook.

Even though I don’t expect to hold Ship Finance for the long run, I did do a background check on the company before buying the stock.  In addition to the Frontline charters, Ship Finance has 17 containership charters, 14 dry bulk charters, and 10 offshore unit charters (consisting of 2 jack-ups, 2 deep water vessels and 6 offshore supply vessels).

The supply/demand dynamic of these 3 other industries is not great but Ship Finance has very long term charters locked up in most cases.  With the exception of 7 Handysize dry bulkers, everything is locked up until at least 2018 and most of the charters extend into the next decade.  I don’t see anything particularly concerning about these other lines of business that would interfere with my thesis, which revolves around Frontline.

As I have been thinking more about the deal this weekend, I think I was wrong with my original conclusion that the deal was very one-sided for Ship Finance.  Ship Finance is giving up a lot of guaranteed income for the speculative upside of much higher rates.   I still think its a good deal for Ship Finance, but its also not a bad deal for Frontline.  While I sold my Frontline position on Friday, I am very tempted to buy it back.

The dynamics of the new deal will lead to lower guaranteed cash payments for Ship Finance.  They receive $5,500 less for the charter and pays $2,500 more to Frontline for operating the ships.  This $8,000 is offset by the 25% increase in profit share and the 55 million shares they receive.

Under the old agreement at a low charter rate of $30,000 for VLCC’s Ship Finance would have gotten about $25,500 for the charter and paid back $6,500 of operating expense for Frontline management.  They would have received 25% of the profit of $4,500 per day (I realize the profit calculation may be more complex than this but I’m ballparking here) that the ships made.  So the total profit per ship per day would have been about $20,000.

Under the new agreement Ship Finance gets a charter rate of $20,000 per day, pays Frontline $9,000 in operating expense and Ship Finance receives 50% of the profit, which is now $10,000 per day.  Total profit per ship is $16,000.

If you work through that math at higher rates, earnings accretion of the new deal doesn’t begin until somewhere around a $45,000 per day charter rate.  Above that level every $10,000 per day increase in charter rates adds $0.16 per share to Ship Finance’s annualized earnings.

That means that at current VLCC rates in the mid-60’s, the accretion is around 30c.  Pricing the deal at a 10x multiple would mean Ship Finance is worth about $3 more than it was before the deal.  None of this includes potential upside from the 55 million Frontline shares they received.

Even though the deal isn’t quite as one-sided as I originally thought, I am inclined to hold onto my Ship Finance shares for another month or two and hopefully get $18+ for them.  I came close to selling my shares at $17.50, which turned out to be unfortunate given the down draft in the stock over the last two days.   Having sold my Frontline shares on Friday (something that I am looking at this weekend as a mistake)  I’m inclined to hold onto my Ship Finance shares a little bit longer to see if they take part in a move up from Frontline that the chart is suggesting may occur and fully reflect the impact of the new agreement.

Closed Positions

Gold Stocks

I had a couple of gold stock positions (Timmins Gold, Argonaut Gold and Primero Gold) that just haven’t done well.  The price of gold seems to be languishing below $1,200 and I’m not sure what the catalyst will be that will move it higher in the near term.  Both Timmins and Argonaut hit my 20% stop loss and I couldn’t think of a good reason to hold onto either of them.

TC Transcontinental

Transcontinental is one of those stories that would fit into the bucket of “cheap stock with a little bit of earnings momentum so let’s see if something goes right here”.  I buy these sorts of names all the time and sometimes they work out and sometimes they don’t.  What I have learned is that if they don’t seem to be working out its best to dump them before they become “clearly not working out”.

Transcontinental is in a declining industry (printing flyers, packaging materials, newspapers, magazines and books) that will continue to produce a headwind that the stock will have to overcome.  While I didn’t think the second quarter results were that bad, probably not justifying the 10+% drop in the stock the last couple of days, I also didn’t see a lot in them to give me confidence the price will bounce right back.  So I sold.

I wrote about my purchase of Transcontinental TC here.

Fifth Street Asset Management

One strategy that I’ve employed in the past but gotten away from recently is the “sell now ask questions later” strategy.  If a stock begins to sell off heavily I am better off getting out of it now and figuring out the right thing to do later rather than staying in it, dealing with the sell-off and taking a potentially larger loss in the future.

I think this is a common bias of investors.  We believe that because we hold a stock we have to keep holding it until we are certain we should sell it.  But this is false.  There is nothing necessary about what we should do predicated on whether the stock is or isn’t already in our portfolio.  If I do not hold a stock and news comes out that makes me uncertain about whether I would purchase that stock I certainly wouldn’t go out and purchase the stock.  Why should that logic not work just because I already hold the stock?

So when Fifth Street came out with a crappy first quarter I sold it at the open.  On my list of things to do is to revisit Fifth Street in more detail and look at whether my assumptions about assets under management growth outside of the BDC’s was unrealistic or just a little delayed.  Until I have time to do that though, I would rather be out of the stock than in.

I wrote about my purchase of Fifth Street here.

Portfolio Clean-up

As I have discussed in the past, the portfolio I follow in this blog is based on a practice account that is available through one of the Canadian banks.  While I do my best to track my actual portfolio transactions, from time to time I do forget to buy or sell positions to coincide them.  Therefore I periodically have to clean-up the online portfolio to better reflect the actual securities I hold.

I haven’t done a clean-up in a while and so when I finally on Friday I noticed I was missing a number of positions that should be included.  Thus I added Canacol Energy, Red Lion Hotels, Adcare Health Systems, Radisys, and Ardmore Shipping.  Fortunately with the exception of Radisys and Red Lion none of the other positions had moved significantly from my actual purchase level.  I bought Radisys at a little over $2 and Red Lion at around $6.25 so I did miss out on some gains there.  But in the grand scheme of things the differences are minimal and now the tracking portfolio for this blog is much more closely aligned with my actual positions.

Portfolio Composition

Click here for the last five weeks of trades.

week-206

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

Week 181 Doing ok but not loving this market

Portfolio Performance

week-181-yoyperformance

week-181-Performance

See the end of the post for the current make up of my portfolio and the last twelve weeks of trades (its been a while since I did a full update).

The last few weeks have been a rollercoaster.  It was less than a week ago, on Tuesday night, that  I was deliberating whether I should be making dramatic cuts to my exposure the next morning.  By the market close Friday my portfolio was back to the post October peak.

The gyrations have not been due to particular volatility in the stocks I own.  Over the last month I have basically been tracking the market, doing a little bit better but not much.  Its just that the market is going up and down like a yo-yo.

While I am happy to have gained back the losses I took over the past couple of weeks, this whole dynamic makes me uneasy.  Too many extremes for my liking.  In my investment account, which is where most of my risk is and the one I track here (its also by far the most fun one to write about) I’ve taken down some exposure over the last few days by reducing some positions that seem to be the most prone to gyrations in this market.  Stocks like Ocwen, Nationstar, Aercap and the like (note that I wrote this over the weekend and had reduced my servicing positions before the Ocwen settlement today.  Today I sold Ocwen entirely at the open, being a little surprised that it was trading at $19+, bought back some Nationstar at a little over $28 later in the day and then bought back a bit of a position in Ocwen at the end of the day on hope of a short term bounce). Read more