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Week 401: Treading Along

Portfolio Performance

Thoughts and Review

Treading water might be the best way to describe my portfolio performance.  I haven’t participated much in the rally we’ve had over the past 7 weeks. My stocks got the initial bump in early January but since then its been only a little bit up.

In fact the tracking portfolio looks better than my actual portfolio because I don’t hedge the Canadian dollar here.  That has helped the numbers by about 2-3% since my last update.

But what are you going to do?  I said last update that I didn’t feel comfortable buying heavily into the rally and therefore I wouldn’t be chasing it.  And I haven’t.  The lack of performance is a consequence.

Nevertheless I am happy with the stocks I own.  I think there are some that could turn out to be decent winners.  Digital Turbine looks good.  No one cares about Mynd Analytics but there is every indication that the merger with Emmaus is going to happen.    Smith-Micro, Mission Ready and Evolus,  all of which I will discuss below, give me plenty to be excited about.

Smith Micro

Smith-Micro had a great quarter.  I added to the stock at $2.30 last week and added again Monday (which won’t show up in the portfolio totals below) as I think it could really turn out well if things continue in this direction.  BTW, a thanks to Mark Gomes for his video on Smith-Micro, which helped give me some insight on the quarter.

I am told that the subscriber count, which is expected to see a doubling of between the third quarter and the end of the first quarter, was not a surprise, but to me it was, and I saw this as very positive news.  Those subs should ramp to over $2 million in quarterly revenue over the next few quarters. That’s a pretty big jump from the $1.2 million of SafePath revenue that we had in the fourth quarter (which itself was up from $1 million sequentially).

Speaking in maximum double negatives, there seemed like there was not much not to like here.  The fourth quarter revenue was really good ($7.4 million which was up from $6.5 million the previous quarter).  They had positive earnings (3c EPS) and positive cash flow.  Smith-Micro forecast another tier-1 win for SafePath in the first half and suggested they could have more than one new tier-1 by year end.

And the valuation is still not expensive at all.

The average estimate here pegs growth in 2019 at 30%.  While that number could be higher or lower depending on how the Sprint ramp continues and the other Tier-1’s materialize, let’s take it at face value for now.  I believe there is about 34 million shares outstanding including the warrants that are in the money again.  So the market capitalization is $85 million.  I realize there is cash with the warrants and on the balance sheet but I’m going to ignore that.  At an $85 million market capitalization Smith-Micro trades at 2.5x forward revenue.  If I didn’t tell you this was Smith-Micro and I just said I had a 30% grower with 80%+ gross margins and recurring revenue at 2.5x sales… I think you’d have to say that sounds like a deal.

Now I realize its never quite that simple and you can go down the road of why Sprint still hasn’t sunset the legacy software, why they didn’t Smith get a Tier-1 by year end like they had suggested they might, why are reviews still mixed on GooglePlay.  There are always questions.  But after these results and with the color they gave on the call I felt comfortable adding.

Mission Ready Solutions

One of the more interesting positions in my portfolio right now is Mission Ready Solutions.  It is a stock I’ve held for a year and a half.  For most of that time I have been flat to underwater on it.  The original thesis I invested on is busted – there was an LOI with a distributor for purchases of their BCS armor vest (called Flex9Armor) from a foreign military.  It never amounted to anything and the LOI was eventually dissolved at year end.

When orders from the LOI didn’t materialize many investors lost interest and were rightfully ticked off.

I stuck with the stock because… well, I don’t know exactly why.  Probably some hope mixed in there. Also their lead product, the Flex9Armor vest, always appeared to be a legitimate product to me, maybe the best ballistic combat shirt out there.  Same for the team at their subsidiary, Protect the Force, which on all indications is a premier R&D firm for tactical gear and body armor.  I kinda took the opinion (and this is purely my opinion) that Mission Ready was likely given the run around by the distributor on the foreign military LOI.  Also, the price of the shares remained surprisingly resilient through the first half of last year, a period of basically zero news and few positives to speak of, which made me wonder why that might be the case.

It turned out that Mission Ready was about to sign a merger deal with Unifire.

Unifire is a manufacturer and distributor of fire, military, emergency, and law enforcement equipment.  The following are their own manufactured products, but in addition they distribute over 1.5 million products from a whole pile of different vendors.

In the first half of 2018 Unifire had $18 million USD of revenue (that number comes from Mission Ready’s original press release on the acquisition).   We don’t have a lot of information yet on revenues prior to that.  Government data shows that Unifire had $31 million of revenue via Federal Government contracts in 2017.

The interesting part, and I wrote about this before in this blog post back in September but will give an update here, is that Unifire is one of six participating vendors in Defense Logistics Agency contracts (DLA).

The most recent awards for two DLA contracts came out in February. Unifire is still one of six vendors for the “$4,000,000,000 bridge contract under solicitation SPM8EJ-13-R-0001 for special operations equipment” and one of six vendors for “$90,000,000 bridge contract under solicitation SPM8EH-12-R-0009 for fire and emergency services equipment”.

These are big numbers but before we get carried away there are lots of unknowns here.  The biggest one is what piece of the pie Unifire will get.  Historically it’s been small.  Like I said, in 2017 Unifire received $31 million of government revenue.  In 2018 that appears to be down to more like $6 million (which may or may not be because they have been tied up with this merger with Mission Ready over that period).

The story behind the merger is that Unifire has been capital constrained and that has prevented them from bidding on higher volumes.  A $20 million available credit line was announced by Mission Ready a few weeks ago and with it in hand Unifire/Mission Ready should be able to bid on (and presumably win) more product.  It makes sense, but we’ll just have to see how it plays out.

At any rate I don’t think it is any coincidence that Mission Ready announced a private placement after these DLA awards were announced.   Literally the next day a $2 million private placement was announced.  Likely a lot of investors had been hesitant to participate in anything until they knew for sure that Unifire was still on the DLA go-to list.

Today they announced that the PP was over-subscribed and would be increased to $3 million.  A good sign as it means they at least have the original $2 million.  It’s certainly better than the alternative.

A successful private placement is good news because it will mean we can finally get closure on the merger.  After being halted for 7 months (maybe it was more? I lost track…), in February Mission Ready announced they had an escrowed close on the merger that still required approval by the TSX Venture to close (this is the first time I’ve ever heard of an exchange escrowed merger close?).  So the merger has so far been a kind-of-mostly-done-deal.  Once the money from the private placement is in hand I suspect it will become a fully done deal.

I added to my position in Mission Ready.  While there is still a lot I don’t know, I do like the direction the story is going.  Finally.

Overstock

Overstock announced fourth quarter results on Monday morning.

While the results missed estimates, disappointed many, and so on, I have to say I actually thought the retail business was in better shape than I had expected.  I mean the fourth quarter wasn’t ideal but that wasn’t really a surprise.

Apart from the fact that I firmly believe that I cannot take anything Patrick Byrne says at face value, the thing that has most kept me from getting behind Overstock again over the last 9 months or so has been this retail traffic problem.

Overstock has had a problem for about two years.  Their search engine optimization (SEO) traffic had been collapsing.  I’m no online retail guru but even I can figure out that if your free traffic is declining precipitously you are probably in big trouble.

I’m pretty sure Byrne knew they were in big trouble too.  In fact I would hazard to guess that the crazy marketing spending spree that Overstock did in Q1/Q2 of last year was a smoke screen to cover for the disaster that was SEO.

Byrne saw that the numbers were going to continue to get worse so he ramped marketing spend to cover for it.  This created a false bump in revenue and allowed him to play the market with his growth schtick. You can even get hints of what they were really up to on the third quarter conference call, where they admit that they spent a lot of that money on testing and R&D. I have my doubts that the spend had much to do with competing against Wayfair.  I think it was about ploughing money into a collapsing retail business in a last ditch attempt to right the ship.

Like many of the things Byrne does, while you can’t take it at face value you can have some confidence there is some legitimate plan behind it.  Just probably not the one stated.  And this time it appears to have worked.

The fact they are off that train and on the conference call said they would bring ad spend back down implies to me that they have some confidence that they will right the ship.   I would be willing to bet that if Byrne didn’t think they could do it he’d come up with some new sleight of hand to get the market to look elsewhere.

There are two pieces of good news here.

The first good news is they did turn around their contribution dollars.  And they are saying they can keep that going.  The first quarter number they gave is quite good.  The fourth quarter number wasn’t terrible either.

The better news is that there is a definitive turn in SEO.  It’s not exactly a hockey stick but at least the collapse appears to be in the past.

I have struggled to see why an acquirer would be willing to buy retail for anything other than a very low-ball offer while SEO was in free fall.   Any acquirer would see the pre-Q4 numbers as part of their due diligence and realize the business is likely doomed.  Even if they were interested in Overstock’s logistics and back-end platform, I doubt they’d be willing to pay much given the negotiating position Overstock would be in.  But the numbers above suggest this is changing.

The final bit of news is that while the first quarter revenue comp looks ugly it is bogus IMO because the marketing spend deluge that was done Q1/Q2 of last year.

Putting this all together, my wild guess would be that they might actually be able to sell retail once they show a couple quarters of solid contribution number and get above that break-even EBITDA number.

Meanwhile on the blockchain front in August tZero opens up to retail investors.  This seems like a big deal to me and I like the idea of holding the stock heading into that.  Its a tiny position but will be interesting to watch.

Evolus

Not much to say here as the stock treads water in the mid-$20’s, I hold my position and wait. Evolus released their fourth quarter results Monday night.  Everything is going fine with the upcoming launch.

The most positive news was that they alluded that they already have the head-to-head data with botox and that the results are thumbs up. That should be a big positive as they will release those results in conjunction with the launch.

The second most positive news was that they received $100 million of debt financing.  This reduces the worry of dilution.

Nevertheless I’m not increasing the size of my position.

Its still going to be a few quarters before we really understand the uptake.  They said that the second and third quarters will be full of trials and free samples as they try to gain traction and take share.

I also need to understand the competition better.  There was a discussion on the call last night about a longer acting toxin that will hit the market in a few years:

Irina Rivkind Koffler, Mizuho Securities: how do you contemplate the market entry of a long-acting toxin sometime maybe towards the end of next year or middle of next year? Does that change the #2 positioning? And can you stay at #2 beyond 24 months?

This toxin, called RT002, is owned by Revance Therapeutics.  They had a Phase 3 study completed and plan to submit a Biologics License Application in the first half of 2019.  A longer acting toxin, if the results are comparable, will likely be tough competition.  Just how tough?  I don’t know.

So I’m not sure yet how I should expect this all to play out.  I’ll keep my position small.

A few comments on stocks I sold

Gran Colombia – it remains cheap and after I sold they changed the offering from shares and warrants to debentures.  Had it been debentures in the first place I’m not sure I would have sold.  I might have though.  The small, worrisome piece of the story that always had me a little on edge is that if you read through the technical report on Segovia the grades are expected to start to decline after 2019.  Now the veins they are chasing have been around forever and have always been high grade so there is every possibility that they find more high grade gold and this is not a problem.  Still, it was the other contributing factor to me selling.

Golden Star – I’d like to see some sign that Prestea is straightening out. It feels like its been a year and the results at Prestea are getting worse if anything.  The stock price has held up really well since I sold and so I am left to wonder if maybe this is the quarter where that happens and I will be kicking myself in a couple of months.

HyreCar – I mentioned in my last post that I had bought and sold HyreCar.  The buying was a great idea, the selling not so much.  I don’t see any news to account for the rise.  I’m guessing that this $2 move since I sold (ugh) is because of the Lyft IPO?  You know I always underestimate things like that.   I mentioned the Lyft and Uber IPO’s as potential catalysts in my notes on HyreCar, but I didn’t really give that much weight to them.  Turns out its the overriding factor.

Superior Drilling – I sold a bit of this.  Nothing is really wrong with the stock but nothing is particularly exciting either.  If I had to give a single reason for reducing my position it would be that their OPEX spend in 2019 is going to be higher than I had thought, so the company will grow, but they won’t be delivering as much free cash as I had hope for.

Liqtech – I have continued to reduce my position in Liqtech, which may turn out to be a mistake.  Why sell the stock?  Well it was a pretty big position and it is also a binary one.  There still are a lot of assumptions in any of the calcs I run.  So its really just a matter of risk management.

Portfolio Composition

Click here for the last seven weeks of trades.  Note that I found a problem with my spreadsheet in the last update.  From December 12th 2018 until my January 2019 update I had double counted my Smith-Micro shares (6,000 instead of 3,000).  Therefore the totals for my portfolio during that time were roughly $7,000 (~1%) too high.  I corrected all my tables and charts in this update.

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A Bit of an Update and Kindred Biosciences

In the month since I last wrote I have mostly stayed the course that I laid out in my last portfolio update.  I took a couple of small positions which I have subsequently sold (HyreCar, which worked out, Graftech International, which didn’t).  I sold out of Gran Colombia, Atlantic Gold and Golden Star Resources, all of which had risen quite a bit over the last 2 months.  I sold out of C21 Investments just this week.  And I also reduced my position in Liqtech as it has appreciated.

Add it all up and I have an even larger cash position now than I had in the fall.  I have only a couple of positions that are more than 1% in size.  I’m close to net short in my account after including index shorts.

My plan is to mostly wait patiently in cash.  I’ve said it before a few times: if the market keeps going up for reasons that I don’t really understand, I’m okay with it doing it without me.

But I’m still on the look out for stocks that aren’t too economically sensitive and offer some upside.

I thought I had found a decent one with Kindred Biosciences.  But my timing was horrible.

I got the idea from @FBuschek who pointed me to this podcast where former hedge fund manager Steve Kuhn says he has 10% of his portfolio in the stock.

I took a 1% position in the stock early this week.  Then the company released earnings last night and the stock tanked today, down 15% at one point.  I’ll get into why, but first a brief overview of the company.

Kindred has a market capitalization of $370 million (39 million shares) and $125 million of cash.  They are mostly a clinical stage biotech – they are only starting to generate revenue from one approved product (Mirataz) and are burning cash at about a rate of $45 million a year.

The twist is that Kindred Biosciences focuses on animal pharmaceuticals.  They develop drugs for companion animals, which means house pets like cats and dogs but also horses.

The high level idea here is that Kindred says they can be much more efficient with capital than your run of the mill biotech.  The line they use at conference calls is that the addressable market for an animal drug is typically one-tenth that of a human drug, but the costs of development are one one-hundredth.

It’s a compelling catch line and I think there is some truth to it, though it remains to be seen whether the incremental value of an animal drug is to the extent Kindred suggests.  After all, Kindred is spending enough on their operating expenses ($53 million in 2018 including $26 million on R&D) that it’s clearly not free.

The other twist on the business is that veterinarians that prescribe the drugs are generally also effectively the pharmacists.  They sell the drugs they prescribe.  So they  have an economic interest in prescribing new drugs that they can sell to their patients.

Kindred’s first drug, Mirataz, was approved last spring and started selling in the third quarter.  Sales in Q3 were $600,000 and that rose to $1.4 million in the fourth quarter.

Mirataz is for managing weight loss in cats.  Preventing weight loss in cats, particularly old one’s, is necessary. Cats that lose 10% of their weight are at significant risk of liver failure and death.  “If you’ve owned a cat, often at the end of their life, what happens is they get sick for some reason, they stop eating and they get sicker and sicker and sicker.”  The trick is to find a way to get them to eat again.

Mirataz is based on a human generic drug called mirtazapine.  The problem with using mirtazapine directly in cats is that its sold in pill form.  The cat owner has to break up the little pill into 8 and then manage to get the cat to swallow it.  Compliance is low.

Mirataz puts mirtazapine into a transdermal delivery system, which means its an ointment, this case applied inside the cats ear, that seeps in through the skin.  Compliance is expected to be much higher. Mirataz was approved by the FDA in May 2018.

It’s a legitimate use case and the transdermal delivery system makes a lot of sense.

Where will sales go?  Well here is where we get into today’s collapse.

There are 9 million cats in the United States with this problem.  3 million of them are being treated right now.  About half of those are considered chronic and will need treatment for months or years.  A tube of Mirataz goes for $15. That is a 2 week supply.  The veterinarians are expected to mark it up to $30.

The big opportunity with Mirataz is on the chronic side – if the 1.5 million chronic cases require 6 months of supply every year that’s an addressable market of $585 million.  That’s a pretty big TAM.   If the other 1.5 million cats being currently treated require a 2 week treatment that is $22.5 million. So the 2-week treatment is much smaller.  The 6 million cats that aren’t being treated are additional upside if the owners bring them in now that there is an option with better compliance.

Putting this all together, the TAM looks quite large.  But how accurate that TAM is and how it translates into revenue remains to be seen.  It’s early. What we are seeing today in the share price is a consequence of that uncertainty.

The stock is selling off today because Lake Street reduced their target significantly (from $30 to $12), on concerns that Mirataz revenue will be lower than modeled.

Kindred Biosciences price target lowered to $12 from $30 at Lake Street Lake Street analyst Brooks O’Neil lowered his price target for Kindred Biosciences to $12 following the company’s Q4 results while affirming a Buy rating on the shares. The analyst says that while Mirataz, Kindred’s first approved drug, is off to a solid start, he now believes revenue from the drug will be lower than modeled previously. However, the company has a “deep pipeline of attractive drug candidates for the large and growing companion animal medicines space,” O’Neil tells investors in a research note.

I don’t have access to Lake Streets research so I don’t know how much they reduced their sales estimate by.

Reading over the conference call it looks like this was probably the key exchange that led to their reduced expectations (my italics):

Brooks Gregory O’Neil, Lake Street Capital Markets, LLC, Research Division – Senior Research Analyst [43]

Sure. It makes sense. In the past, you guys have talked about 9 million cats having inappetence and big percentage, perhaps as many as 50%, being chronic. What have you seen in the U.S. market so far in that regard? And can you say if you see any big differences between the international opportunity for Mirataz and what you’re seeing domestically?

Denise M. Bevers, Kindred Biosciences, Inc. – Co-Founder, President, COO & Director [44]

Sure, Brooks. So again, I’ll just reiterate that our product is labeled for 2 weeks, and that’s what we’re marketing toward. The challenge we have, of course, as I’m sure you understand, is getting down to patient-level data. The way to do this is through market research. We have ongoing market research initiative. What we do know is that unintended weight loss impacts many chronic conditions, cancer, chronic kidney disease, hypothyroidism, diabetes. How the veterinarian chooses to use the product is obviously up to his or her clinical discretion. So we will continue to collect market research and report on that accordingly. As far as opportunity, as I said, it’s about 2/3 typically is about the opportunity in Europe versus the U.S. And we suspect that veterinarians will be treating the same host of cats with these conditions, chronic and acute.

I’m thinking that Lake Street took the response to mean that Kindred was backing off of their expectations for the chronic market.  Is it also noteworthy that Lake Street was not part of the last financing?

So I don’t know.  I was thinking Mirataz could do $50 million of revenue once sales matured.  Is that too high?  Reading through a couple of the analysts I have managed to get research from, I was seeing peak numbers around the $75 million range.  This was prior to today’s call though.   What’s realistic?  Tough to say.  There’s really not a lot of information to go on here, which I guess is the problem.

But I’m still pretty interested in the idea, which is why I didn’t just cut and run this morning (I did do a whole lot of waffling however).  The pipeline is big.  In addition to Mirataz, Kindred Biosciences expects 2 drug approvals and 3 more pivotal studies in 2019.

The nearest term opportunity is with a drug called Zimeta.  It controls fever in horses.  Kindred showed positive results in a pivotal study of 139 horses.  The FDA has done most of its due diligence and all that seems to be left is a last manufacturing inspection before it is approved.  The market for fever in horses isn’t huge, but it looks like the drug should be able to get $10-$20 million of revenue once it ramps up.

Kindred announced positive data on its pilot field effectiveness study for the drug epoCat in January.  epoCat is intended to control anemia in cats.  The results from the study looked to be very good (albeit to my untrained eye).  The next step is a more extensive pivotal study that will take place in 2019 with a read out either in late 2019 or early 2020.  If successful the drug could launch late in 2020.  Based on the analyst estimates I’ve seen the revenue from epoCat could be in the $75-$100 million range.

Stepping even further out Kindred has a couple of drug candidates for atopic dermatitis in dogs.  This is a big problem in dogs and there are already a few other drugs on the market.  There are two drugs sold (Apoquel and Cytopoint) by the very large animal health company Zoetis.  The market size of atopic dermatitis is $500 million plus and growing so there is a lot of opportunity.  It’s possible these candidates, if successful and if they prove more effective than the atopic dermatitis options available right now, the estimates I’ve seen suggest the revenue opportunity is over $100 million.

So there appears to be lots of ways for Kindred to win.  Nevertheless, getting smacked on my purchase only a couple days after I bought makes me wonder if there is too much I don’t know here.  One of the things Kindred has said themselves is that animal health is not very well followed or understood – the research on market potential and on chances of success are not as well defined as in human biosciences.  So we are all kind of flying in the dark.

Looking at the competitive landscape, these animal health companies get big multiples.  Zoetis trades at 8.1x EV/Sales.  Idexx Laboratories trades at 8x EV/Sales.  Elanco, which is not really growing, still trades at 4.3x EV/Sales.

So if I spit-ball it and say that Kindred should trade at 7x EV/sales, then the current stock level is pricing in about $50 million of sales (I’m ignoring the cash which I assume they’ll burn through to get there).  Sales at that level are probably 3-4 years out so maybe I am too optmistic.   But even so it doesn’t seem like a high bar to pass given the pipeline of opportunities they have.

But this is a case where I can truly say – but what do I know?  I’ll keep my position small and wait out more information.  We’ll see how the data comes out with Mirataz and I’ll maybe look at adding if it appears Lake Street is wrong and the chronic market for Mirataz is there.

 

Some thoughts on the CNX Midstream guide down

So this isn’t a stock that I own right now.  I have owned it though.  I’ve been following it and some other midstream plays fairly closely since early December.

Up until recently these midstream stocks weren’t performing all that well.  They were getting beaten up with oil even though some of these companies have absolutely nothing to do with crude.

CNX Midstream for example.  100% natural gas and liquids.  They are the child of the old Consol – basically a situation where the E&P assets went into one company (now called CNX Resources) and the midstream assets, so pipelines, compressors, and facilities, went into another.

CNX Resources is a fairly large Marcellus/Utica producer, wet/dry natural gas, 1.4 bcf/d.

CNX Midstream operates all the pipelines for them.  They basically handle gas for CNX Resources and one other customer (HG Energy, which is private) so they are very concentrated.

Most importantly, CNX Resources owns 33% of CNX Midstream.  They are also the general partner, which means they manage and operate CNX Midstream.

On their fourth quarter call CNX Midstream surprised the market.  EBITDA guidance was $200 million to $220 million.  Distributable cash flow guidance was from $150 million to $170 million.

Up until that point analysts had been expecting an EBITDA guide of around $245 million and the floor on DCF was thought to be $170 million.  So this was a significant guide down.  Below is from their analyst day forecast back in March of last year:

So what happened?

Well part of it was that their E&P partner CNX Resources reduced their activity in 2019.  They phrased it as “minimum activity levels” and stressed that they would be “flexible” and add capital depending on prices and returns, but bottom line is that they are budgeting less than was anticipated.

So there’s that.  What can you do – your customer is worried about prices or returns or whatever else and they decide to reduce activity.   That means reduced through-put for CNX Midstream, or at least less growth than the analyst community was expecting.

But that’s only part of the story.  One analyst, I believe his name was Matt Niblack (?) pointed out that there was still something that didn’t quite compute:

…the minimum [DCF] has been adjusted down from $170 million to kind of $150 million to $170 million due to timing and other factors. But there’s still upside to that, and we just have to see how that goes. I guess my only other question here then is, in the minimum guidance range, if that seems — and also, I think implied in CNX’s production growth range, you’re looking at kind of roughly flat economics relative to Q4, right? And I’m just taking your EBITDA in Q4 and multiplying it by 4. I realize there will be some seasonality associated with that, so that will vary quarter to quarter. But for the full year, that’s what you’re looking at. And yet, there’s significant growth CapEx…

So the question is, why are you spending the same amount of growth capital if you aren’t growing as much?

I read the transcripts a couple times and while the company is a bit vague about it I think the hint they give is when they start talking about de-bottlenecking:

“So a significant portion of the capital that we’re spending in 2019 is associated with de-bottlenecking projects”

So CNX Midstream spends money de-bottlenecking.  That’s either compression, looping, twinning… it’s something that is going to lower pressure in an existing line.  Lower pressure of course means more gas.

But it’s more gas on the back of Midstream’s capital.

This brings up the point about the competing interests of the E&P and midstream.  Particularly when the midstream is controlled by the E&P.  Whose best interests is the de-bottlenecking in?

I would argue that the E&P, so CNX Resources, benefits more from de-bottlenecking.   If it was all one company the capital decision would be based on whether we get more bang (ie production/NAV/cash flow per dollar spent) from drilling a new well or from adding compression/looping an existing line and getting uplift from existing wells.

In this case it’s not all one company.  CNX Midstream pays for the de-bottlenecking.  So its a bit of a free-bee for CNX Resources.

Yes, CNX Midstream gets the volumes as well.  But they just get a toll, and they could have gotten those volumes anyway if the E&P had used its own capital and drilled some more wells.  Now I realize that drilling more wells in an area that could use some de-bottlenecking is likely going to back out other production.  Sure. So drill them somewhere else, where there is capacity.  Volumes are volumes for the midstream.  My point here is that the uplift is paid for by the midstream but they aren’t getting the full benefit.

Of course CNX Midstream says that its a good rate of return. From the call: “I mean, we could follow up with those specifics. I mean, those are good rate of return projects. Otherwise, we wouldn’t do those on a standalone basis. It’s sort of like core, like baseload, sort of like easy low-hanging fruit stuff to do.”  And it does give CNX Resources the ability to ramp production more at some point, now that pressures are lower.  So there’s that.

One thing de-bottlenecking definitely does is it helps an asset look better, at least for a while.  Not saying that’s the case here, I really don’t know.  But type curves never talk about pressure.  It’s rate vs. time.  Nevertheless, you lower the pressure and rates go up.  There is a reason engineers do a bunch of crazy math on their wells and introduce concepts like material balance time and pseudo-time.  Its because its pretty easy to get the wrong impression from a rate vs. time graph.

It all just makes you wonder if CNX Midstream might be taking one for the team here?  CNX Midstream spends some money on de-bottlenecking.  It’s not really a big deal in the grand scheme of things, the stock takes a bit of a hit but it bounces because it doesn’t affect the dividend or anything.  CNX Resources gets some free uplift from it.  That helps their guidance.  Everything looks a bit better. No one gets hurt.

Who knows!  Maybe it’s all just efficient capital allocation.  Nevertheless I think the thought exercise is worthy of contemplation: that there is at least the potential of misalignment with these E&P-midstream separations in the United States.

Copper stars not quite aligned

Sometimes all the stars align for a trade.  And sometimes there is one star that is way off in its own orbit, throwing off the whole picture.

That’s what I’m thinking about copper right now.

There is a lot I really like about this idea:

  1. The demand picture is premised on what seems like the inevitable adoption of electric vehicles and increasing electrical infrastructure
  2. The supply picture paints a scene of depleted reserves and an empty pipeline that will lead to significant deficits for years to come
  3. The prices of copper equities are reasonable, if not downright cheap, and certainly not pricing in the upside of a rising copper price

It all fits.  Except for one thing.  These damn tariffs.

In my opinion there are reasonable odds that what is to come is more brinkmanship, more anti-ups, and maybe even some sort of climatic event ala Nixon in 1971 that changes the way the world operates for good.

Of course maybe not.  The market is certainly saying its all good.  But the market also rose right after Nixon put a 10% surcharge on imports and pulled the rug out from under Bretton Woods.

The 70s didn’t really go all that well.

I don’t know what is going to happen.  But it’s uncharted territory and it wouldn’t surprise me if the market is as clueless as I am.

Consider the following:

  1. We have a President that was elected, in part, by folks who lost their jobs or had their communities disrupted by the relocation of industries that were allowed to leave because of free trade (yes its complicated and there were other causes, but free trade was definitely part of it).
  2. The President has made it clear he will do whatever it takes to make good on his promise to fight for these people and communities and get those jobs back (whether or not what he is doing is actually going to be in their best interests is not clear but also not really relevant to the line of reasoning here)
  3. It’s not really clear if anything can be done to turn back the clock on these cities, counties and communities that have had the industries they were built on stripped from them, so perhaps regardless of what the President does, the outcome will disappoint

Those 3 points suggest that it is at least possible that we spiral into a vicious circle of escalating actions that don’t have the intended effect and therefore lead to even more escalation.

I’m just not sure I want to own a lot of copper in that environment.

With that all said, the picture for copper supply and demand assuming a “steady as she goes” economy is pretty enticing.

BMO put together a long and very interesting research piece describing the supply and demand dynamics of copper over the next number of years.

The demand side is being driven by electric vehicle demand and the grid infrastructure required to move to a higher amount of renewables.

The simplest explanation of why this will increase the demand for copper is this: An internal combustion engine contains 23kg of copper for wiring, whereas a battery electric vehicle and plug-in hybrid contain between 60-83kg of copper.  On top of that another 20kg of copper is needed for grid capacity and 6.5kg for the charging point.

On the supply side, a combination of declining grade, rising capital costs and a number of years of depressed copper prices have left us with a depleted pipeline of projects.

The conclusion, which is hard to find fault with, is that there is a significant shortage of copper projects in the development pipeline and projects will only be added if the price of copper rises enough to incentivize them.

So how do you play this?  Well maybe you don’t because there is just so much risk in the world.  I’m still trying to figure that out.  But if you do, I certianly think the copper stocks are reasonably priced for it.  Below is a comparison of a few that I have dug into where I just took analyst EBITDA estimates and averaged them to get a rough idea of the EV/EBITDA multiple these companies trade at (note that because Amerigo isn’t followed by any brokerages I have reports for I used the companies own estimates that I found in their presentations).

At the moment I have taken positions in a couple: Copper Mountain and Capstone.  But these positions are really, really small (<<1% each).

For now they are going to stay that way.  I’m just too uneasy about where all this trade stuff is going.

Q1 Earnings: Radcom

I’ve fallen behind writing about the earnings reports so far this season.  In the next few posts I am going to catch up with a few brief thoughts on a number of the reports that came out over the last week and a half.  Starting with…

Radcom

I’m surprised the stock has moved so much after the company reported first quarter results on Thursday.  I didn’t think there was a lot of new information provided.  Revenues ($8 million) were in-line with expectations, guidance was maintained, the trials are progressing.  On this the stock has jumped almost 20%.  Go figure.

I guess investors have focused on the progress.  The four trials are wrapping up, and within the next 6-9 months they expect so be able to announce wins, though nothing specific was provided.  Ravkaie (the CEO) gave positive color around the potential for wins, but that isn’t anything new, he’s been saying that since the trials were announced last summer.  They indicated discussions with new carriers that will begin trials in the third and fourth quarter. And some of the tenders that are now coming in are for pure NFV solutions, which is a new development (most of their engagements were for hybrid deployments as carriers transitioned slowly to NFV) and one that should play right into their wheelhouse.

I unfortunately got shaken out of about 25% of my position the day before earnings.  Doesn’t it always happen that way.  Netscout, a competitor, announced a win with Vodafone that day, and my initial reaction was that maybe Radcom had lost that trial (though no one is sure who Radcom is in trials with, one of the companies that comes up in discussions is Vodafone).

On further reflection, that might be wrong.  It was pointed out to me that the Netscout press release refers to passive probes, which are not the same thing as the active probes that Radcom’s MaveriQ solution uses (passive probes are more akin to offline testing and measurement which would be like the sort of thing Exfo does).  Second, on the conference call, Ravkaie was specific about calling out Netscout as a competitor and saying that they do not have a comparable NFV ready solution to compete with Radcom.  So it seems more doubtful to me now that the Vodafone win is a loss for Radcom then it did at first glance.

Honestly, I think my move was driven as much by position size as the Netscout news.  Whenever I have a position that is big I get quick on the trigger with any rumor to the contrary.  The fact is that the morning of earnings I had the opportunity to add back at 18, but I didn’t.  I was not convinced the results were incrementally better to justify running back in.  That proved to be wrong, at least for now.  So I will just participate in the move with the shares I have and see whether it is for real.

Third Quarter Earnings Update: Empire Industries

I’m catching up on a few of the later quarterly results that came out.  Empire Industries was typically late with their results, which came out on November 29th.  They were mostly a non-event.

The company is in transition.  Up until this year the primary business unit of Empire, Dynamic Attractions, developed custom amusement park rides.  Their rides are high end, technologically complicated rides like the Harry Potter & the Forbidden Journey attraction.

In the last year they have transitioned their Dynamic Attractions business model from customer attractions to standard products that they can sell to multiple park operators.  The transition is expected to improve margins, as they focus on more of a manufacturing process than on one-off creations.  So far though it has not.

eilpost1

On the call CEO Guy Nelson said that they expect to be mostly through these growing pains by2017.  He pointed to the Flying Theatre, which I believe was the first standardized product.  They’ve sold 10 Flying Theatres so far, and the last nine have been at much better margins than the first.  As more products get over this hump, margins are expected to improve.

With the spin-off of the hydro-vac business (which I have written previously about here), the other remaining business unit for Empire has been steel fabrication.  Nelson said that they will be changing the direction of the steel fab business, exiting the contract manufacturing business and focusing it on producing parts for Dynamic Attractions.  This is probably a good idea; the Steel Fab business has not been profitable.

eilpost2

Nelson also gave an update on the SpacePark that was announced when Justin Trudeau visited China in the summer.  I mentioned the agreement in this prior post.  Unfortunately my optimism may have been misplaced.   Nelson was quite candid about the agreement, said that they hesitated with the new release, felt some pressure given that the agreement was attended by Trudeau, and that he felt that the Chinese counterpart only had about a 50/50 chance of securing the needed land for the park.

On August 9th Empire announced a $10 million contract for the design phase of the thirty meter telescope.  On the call they confirmed that this revenue will be seen in 2017.  It’s good to see the telescope, which has been held up by regulatory issues due to its Hawaii location.  Wikipedia describes the backstory well.  I’m not sure that the final location of the telescope has been decided.

The backlog seems to have stabilized after falling from its peak in early 2014.

eilpost3

The improved margins in 2017, the healthy backlog and the additional $10 million contract for the thirty meter telescope design should lead to an improved 2017.

But I want to see how successfully they can transition to this model before I take any more of a position.  Let’s see margins improve, and let’s see orders continue and hopefully increase.

Empire is a typical position.  A decent company, lots of ways to a positive outcome, but nothing has materialized yet.   So it remains a small position as I wait for a catalyst to justify increasing it. 

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.

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