Reminiscences of a Stockblogger

A Little Less Bearish

Following up on my intention from mid-week, I took off some of my index shorts on Friday.  I also covered my oil stock shorts and some of my tech one’s.  I’m keeping the airlines.  Because the market fell so far (I did not expect the S&P to get all the way back to the mid-2,800s!), I decided to cut my short exposure by more than I had anticipated.  I now hold less than half the index shorts that I did.  I took the first of some small longs – in very large cap names – Google, Abbott Labs and MasterCard.

Mostly, I’m less bearish because the market has come down a lot.  But a couple of other things are playing into my thinking as well.

For one, as the market continues to decline a coordinated effort from the central banks seems more likely.  While I’m not sure that a whole bunch of money is really going to solve anything, I’m inclined to think that the market will go up on such an intervention, at least for a while.

Second, there seems to be a path out of this mess and that is important.  The thing the market really hates is uncertainty.  And while uncertainty about the coronavirus still abounds, we aren’t flying completely blind here.

First, China appears to have provided everyone else with a template for how to get through this.  Cases in China seem to be declining (if you believe their statistics that is – in itself is a reason to be cautious).

Now, in North America we can’t be as draconian as the Chinese, but we can shut down schools, stop gatherings, and businesses can close for a period in areas where the virus takes hold.  The experience of China suggests that seems to work.

Additionally, there is a vaccine in development and maybe it isn’t as far away as it appeared a few weeks ago.  It might only be a few weeks from being developed, which could mean as little as 3-6 months until it is available.

You put these things together and you can see how globally, we could get through this in maybe 6 months. You can envision a path to the other side.

While that path is not good for the global economy, the stock market always looks past the immediate bad things and asks what happens next – and you can see how what happens next doesn’t necessarily have to be all dark and grim.

This may not be a path to immediate new highs for the market, but I also don’t know if it is a path to a full-on 1987 or 2008 style panic.   I wasn’t around for 1987 but I was for 2008 and the collapse didn’t happen until the credit markets actually seized up, at which point no one saw a path out of it.  There was a real fear that things just wouldn’t come back – that there was no path out.

Contrast that with the beginning of September 2008, which was like 3 weeks before the world went completely on tilt – the market was down less than 10% and holding up okay-ish.  Maybe if the Fed had bailed out Lehman (and everyone else subsequently), we wouldn’t have had 2008 at all?

My point is that the market doesn’t collapse on the possibility that something bad might happen.  It teeters on that.  It collapses once that possibility becomes inevitable and especially when it doesn’t see a way out of that bad event.

I just don’t know if that is what we have here.

So those are the positives that cause me to be a little more bullish, to take off some shorts, and to buy some Google (Google!  Me – buying Google – Hah!).

The negatives that keep me from really diving in here, apart from the obvious uncertainty about the virus itself, is that I’m a little wary about what happens to the global economy as parts of it potentially shut down for a period.

Once we are through to the other side of this, will it just bounce back?  I know that is the consensus.  I’ve read a ton of brokerage reports and they are all like – one quarter or two quarters of drop and then everything bounces back to normal.

The assumption implicit in that prediction is that the economy works like a machine.  You can turn it off and on and it effectively goes back to behaving the same as it was.

I’ve never been entirely convinced of that.  I’m more of the Jane Jacobs school of thought that the economy is like a complex ecosystem.  And ecosystems don’t behave mechanically.  They are less predictable.

I mean, again using 2008 as an analogy, we turned the economy off for a month (maybe two?) and it seems like it took years for it to completely bounce back.

This is different of course but I’m still a little concerned that while the virus will pass, the ripple effects on the economy won’t pass as quickly.  That after the initial exuberance of containment, the aftershock of having shut so much down for months will have a lasting impact on businesses.

But I don’t know, I’m really not sure about this.  It is different; it’s likely not going to shut things down in the same way that a credit crisis or even a business cycle shuts it down.  I’m just a little wary, and why I’m still positioning myself more out of the market than in.

The other thing I did, and I’m not really sure this was a good idea, is I bought back a portion of the gold stocks I had sold.  I bought some Gran Colombia and some Wesdome.

I don’t know if I should have done this.  Gold is so bizarre.  You just never know.  Also, consider the following:

1. India and China make up the bulk of jewelry demand and the virus may make that take a hit – it already has to be hitting China and it seems inevitable that India gets hit with this virus at some point and I don’t see the same sort of containment strategies working there – it could be a real disaster in a place like India
2. Gold stops doing well if things really deteriorate.  Everything is rosy in gold as long as everyone still believes that its all going to be ok when central banks step in.  We saw a bit of this on Friday.  I learned in 2008 that if the shit really hits the fan gold is going to tank with everything else for a while.  It will be the first thing to come back, but you’d be better off out until that liquidity crunch ends.  I don’t know if this virus panic gets to that point, maybe not, but it gives me pause.

On the other hand, I mean holy crap – Gran Colombia and Wesdome were down ~15% on the day when I bought them (!!) and gold is still well above where it was at even the beginning the year.  They are making a lot of money – Gran Colombia is trading at like less than 2x EBITDA and probably less than 4x free cash flow at these gold prices (I haven’t worked through the free cash flow numbers at $1,600 gold so don’t quote me on that, but its in that ballpark).

But it is gold, so expect the unexpected.  I might be backtracking on those purchases.  I’m staying nimble.  My underlying framework is that I don’t know much at all.

 

Continuing to Wait

I wrote a few weeks ago that I was sitting on the sidelines.  That continues to be (mostly) the case today.  It has not been without some pain however – the market went up for the first two weeks of February and I’ll be honest, it was getting very frustrating as it just didn’t make sense to me.  Fortunately I stuck to my resolve and stood mostly pat, watching stocks go up while my portfolio did a whole lot of nothing.

Now though, the tides have turned.  The market seems to be waking up to what this virus will mean for economic activity.  My portfolio has done well and is at a new high, up about 2% for the month, while the S&P has fallen 7-8%.

Though the market has fallen pretty far pretty fast, I’m still reluctant to do much other than make small trades here and there for a bounce.  I did take off some of my short positions – 20% of the index shorts (I think I will take off another 20% today or tomorrow as we can’t just keep going straight down) and roughly 1/2 of my airline and oil shorts.  I may regret reducing the oil and airline shorts if the market continues to fall given that they are obvious collateral damage of the virus spread.  I did take on a few small, big-cap tech shorts, like Apple and Skyworks when things seemed to be getting particularly silly.  But I’m wary of how oversold we are and wary of some sort of stimulus package that seems inevitable (there was a call for it in the WSJ this morning).

I did sell some stocks that had what I would call unappealing news.  When Smith-Micro came out and said that they had acquired a competing company that was a provider to T-Mobile I sold the stock, thinking that this probably meant that there would be no T-Mobile deal coming in the short run.  When Big Five Sports announced bad guidance for the first quarter (due to weather) I sold out of that stock as well, thinking that being a retail chain with poor guidance in the midst of this virus was probably not a good combination.

I also sold some stocks on good news – in this case mostly the gold ones.  It felt to me like gold was getting a little frothy earlier this week and so I have lightened up significantly on almost all of my gold positions – Gran Colombia, Wesdome and the like.  I’m also wary that there are headwinds here for gold – first that India and China make up the bulk of jewelry demand, which is going to get hit by the virus and B. that if the shit really hits the fan gold doesn’t tend to do that well.  The only gold stock I didn’t sell was Roxgold, which is simply because the damn stock won’t go up!  I also added a small position in a new miner – Teranga Gold.

The other thing that I have done is take positions in some bond indexes.  This seems like another way to play the virus and what is likely to be the inevitable slowdown that will materialize.  Unlike shorts, I’m not sure that bonds will drop as the central banks inevitably respond, so it might be a bit safer avenue.  I bought TLT, ZAG and XSB.

Two stocks that I have decided to keep positions in are Evolent Health and Digital Turbine.  Both had good quarters in my opinion.  With Digital Turbine I really like the acquisition of Mobile Posse and insiders have been buying stock since the release of the quarters results.  Evolent’s revenue guidance for 2020 was very good, and while their EBITDA guidance was light, that would seem to be because of the ramp in costs from the growth.  The stock is still held hostage to Passport though, which should resolve in the new couple of months.

Finally, Schmitt Industries had some (maybe?) good news when they announced the delay of their de-listing transaction as the evaluated a new opportunity.  I’m hopeful but guarded about what the opportunity might be.

Looking ahead, I’m of the mind that when I do get back into the market I will look for larger companies to buy.  It just seems like every time there is a big sell-off, its always the big companies hat recover fastest.  There are a lot of big-cap names that are beginning to get whacked but good.  So I’m trying to figure out some simple ideas here that will work once the turn begins.

Mostly Out of the Market for Now

Having so much uncertainty about the coronavirus in combination with a market that is at all-time highs, I made the decision Wednesday to get (mostly) out for now.  Over the last 2 days I sold down nearly all my positions.  I’ll wait this one out until I feel a bit more clear about where things are headed.

I don’t have a clue whether the coronavirus scare is over or whether it is only in a lull brought on by the strict measures being enforced in China.  It seems to me that if 10+ cities are shutdown, we should expect to see the number of cases slow.  It is also possible that the number of cases have simply stopped being reported.  From what I have read of flu’s, they don’t really just disappear so it seems at least possible that this is not one and done.

But I’m also being influenced by the market.  When the market was down 70 points on Friday I was buying a few stocks, but after the move this week, in the wake of what I don’t really see as a resolved situation, it just doesn’t make sense to me.  Yes, I know – stimulus.  Whatevs.

As I’ve said on a few occasions, because I don’t run money for anyone, and therefore have no investors to answer to and no shareholder letter to write with returns to justify, I just have no reason to take risk when I don’t feel comfortable doing so.  The market is at an all-time high.  The risks seem to be plenty.  So I’ll just wait this out for a month or so and see what happens.  If I miss a 5% move, big deal.  I would think that most of the euphoria of a virus-nonevent has been already priced in over the last 4 days (but who really knows).

I still have a smaller position in Smith-Micro, a smaller position in Sonoma Pharmaceuticals, my position in Nuvectra and Schmitt Industries (which announce a voluntarily delisting – I mean come on!) and a couple other tiny 1% positions.  I have two new positions that I have kept for now, Rada and Sharps Compliance, neither of which is particularly tied to this virus and Sharps should be positively correlated to it.  I also continue to own my gold stocks and I did add a bit to Wesdome this week when it got into the low $8’s.

My positions remain hedged with index shorts.  Though not in the practice portfolio where I cannot short, in my actual portfolio I’m still short some shale names, a couple of airlines and a couple cannabis names.  All very small as I really hate losing anything material on shorts.

 

Week 432: Coal for Christmas!

Portfolio Performance

Thoughts and Review

I have been wrong about the market.  My cautious approach has turned out to be unjustified and the market has soared to new highs.

As a consequence, my S&P and Russell shorts have performed poorly.  That has been a headwind.  But quite honestly, it hasn’t been the problem with my portfolio.

Instead, as I wrote about in my last post, the problem with my portfolio has been bad stock picking.  I’ve been smacked with 3 events, each of which whacked my portfolio and pulled it back a step.

First Nuvectra.  Then Evolent.  Then Mission Ready Solutions.  Three events that led to under-performance in November and December.

I’ve had dry spells before, and I can only hope that the worst of this one has passed.  This last week has helped, and even in these last couple days I’ve popped another couple percent from end of week levels.   So maybe the worst has passed.  I can hope!

On the topic of hedges, though the market is clearly in a bull run I have decided to keep them.  I’ll sleep better knowing that I have some protection to the downside.

This move in the market seems to be all about multiple expansion.  The S&P is at 20x this year’s earnings.  Earnings growth from 2018 to 2019 was minimal – Bank of America-Merrill Lynch has 2018 S&P earnings at 161 and the 2019 S&P earnings consensus at only 163.   That means that growth this year was basically nada.

While next years earnings are forecast to have a big jump (to 173), the trend has been for those estimates to come down so I would take the numbers with a grain of salt.

It is just not an environment where I want to go out on the limb.  So I will hold onto my hedges and hope that my stock picking (and luck!) improves.

Evolent Health

After having played out contrary to my expectations early in December, Evolent has since worked out much more favorably – events have been back inline with my original expectations.

The whole process has been a gong show.   I don’t like gong shows – they cost me profits as I get whipsawed.  That happened here as I did sell the stock after the original decision by former Governor Bevins to not include Passport Health Plan in the new Medicaid awards.   Then I bought back my stock somewhat higher after realizing that Bevins may be overturned and this was unlikely the end of the saga.

Newly elected Governor Beshear came into office December 10^th.  Six days later he pulled the plug on Bevins plan to overhaul Kentucky Medicaid.

The Bevins contracts were awarded on the basis of the Bevins overhaul.  Not surprisingly, Beshear followed up with an announcement on the 23^rd of December that he would cancel the managed care contracts that Bevins had awarded.

Honestly, if I had a bit more confidence, I would have gone all in on Evolent in anticipation.  With the Bevins overhaul scrapped, Beshear had plenty of reason (and cover) to re-award the contracts.

I think it is likely, but not a certainty (after this last debacle I cannot use the word certainty!), that Passport gets awarded the new contract when it is announced some time this spring.

Beshear has been pro-Passport so far.  He was the one that approved the Evolent take-over in the first place.  I go back to his comments pre-election about wanting to get Passport’s new health campus built.  There was also another community voice that was recently speaking in favor of Passport, Steve Trager, president & CEO of Republic Bank & Trust Company.

There is still lots of reason to be skeptical Evolent.  They are only borderline cash flow positive and their position as a service provider to smaller health plan entities like Passport means there is the risk that in the long run these smaller players will be un-competitive with their larger competition.  The Passport exclusion was seen by at least one brokerage as evidence of that.  In my opinion it is all politics.  But with the politics now working as a tailwind, I am inclined to stick with Evolent for now.

Nuvectra

Nuvectra is also playing out in a way that I would interpret as positively, though you would not know it from the stock price.

I’m probably missing something.   There is probably some “gotcha” in the bankruptcy process that I simply am not discounting.   If so, it will be a learning experience.  If I’m not, it would seem that the probabilities are that Nuvectra’s net assets, on liquidation, should exceed its debt by more than $2 million (which is what the equity is currently valued at).

But we’ll see.  At the very least this will be a learning experience.

The company produced their November financial statements and a schedule of assets and liabilities.  Cash levels are at the expected level.  Expenses have dropped to a trickle.  Most importantly, the amount that creditors are owned is in line with what I was expecting.

Amounts owned to secured and unsecured creditors total around $20 million.  This isn’t too far off of the value of the assets, even before considering the IP.

The definition of what is secured debt and what is unsecured debt seems to vary.  I’m not sure I understand exactly why.  I’ve seen an amount of $13.5 million, $10 million or $16 million.  That part is a little confusing but the overall amount of debt always seems to add up to around $20 million.

As you can see from the balance sheet, on the surface, Nuvectra’s assets far exceed the liabilities.  But this is because of net-operating losses (NOLs).

I have no answer as to whether there is a chance that these net-operating-losses have some value when the company exits bankruptcy.

I did notice that Sears struck a deal whereby their NOLs were preserved upon exit.  Maybe it is just wishful thinking to believe that the shell that exits bankruptcy might preserve at least some of them?

Anyway, that is not the bet here.  While I’m sure that in a 363 bankruptcy auction Nuvectra’s assets will fetch less than the book value, I can’t help but think that together with the Agovita and Virtis IP the overall value should be able to exceed $20 million.

In fact, in an argument filed by the unsecured creditors, the idea was pushed that assets far exceeded debt (thanks to @Fbushek for pointing out this excerpt as well as a couple of others):

Now it must be said that the unsecured creditors were making an objection about whether the secured creditors cash collateral lien should include IP.  So they were trying to paint a rosy picture.

Another consideration is that a lot of the “value” is inventory.  I’m not sure what value that inventory is going to have in the 363 sale – though if the sale is what I expect – that of the Algovita product line in concert with a restructuring of the Integer manufacturing contract – meaning the product supply chain is intact, then it might be worth quite a bit.

The final consideration is that, of course, these numbers assign nothing to Algovita and Virtis, which are the primary assets of the company.

With the stock pricing in so little at this level it seems like a reasonable risk for the potential reward.  I only wish I had been more patient and bought my shares here rather than up when the stock was 20c to 25c.

One other interesting point is that Nuvectra came out with their list of executory contracts they wanted to reject.   Integer/Greatbatch wasn’t among them.  Also, in a separate document intended to list the contracts to be retained, there was no mention of Integer/Greatbatch either.

My guess is that Nuvectra is keeping their options open for the auction.  Rather than eliminate the contract, they will leave it up to each bidder to decide if they want to carry on the relationship with Integer/Greatbatch, which I would presume would mean a negotiation of some sort of new agreement (and the proposed cure costs).

Apart from these disclosures, most of the rest of the documents (and there is a lot of them) is a lot of noise.  There has been back and forth between the secured and unsecured creditors arguing whether IP should be part of the secured creditors claims, back and forth about conflicts of the law firms hired to represent the parties involved, and amendments to this or that document.

The only other point worth mentioning is something called “avoidance actions” and what that might mean.  I’m still fuzzy on how this might work but it appears that avoidance actions could clawback some of the dollars paid in this contract.  For example, the unsecured creditors make the following point:

Just by the fact that the assets are in bankruptcy, this contract no longer is a lead weight on the Algovita asset.  As a consequence, Algovita may be worth more in bankruptcy than it was pre-bankruptcy.

The point the unsecured creditors are making is that this additional “value” that occurred due to the avoidance of the contract with Greatbatch/Integer should not necessarily be the first lien of the secured creditors.  Because that value didn’t exist when these creditors signed their debt agreement with Nuvectra.

I’m not sure how meaningful the discussion is for an equity holder.  At the end of the day either everyone gets paid and there is something left over for equity, or not.   So how the assets are allocated between secured and unsecured creditors is an interesting intellectual exercise but maybe not so relevant to the investment case.

The one other thing relevant thing that has been settled is the schedule.  It looks like the process will take place quickly.  The plan is to have bidding procedures approved by January 9^th.   The auction should be complete by March 18^th:

Finally, after market close on the 31st, Nuvectra released news (and they do not release much news these days) that Algovita had received full-body magnetic resonance (MR)-conditional approval from the FDA.  I’ll need to dig into this a bit more to quantify just how important this is (this is a good paper describing that ~80% of SCS patients will require MRI’s within 5 years, so the approval addresses a significant untapped population), but it is reasonably important, as it means that Algovita can be applied to a wider range of pain issues and therefore the asset is presumably worth more to a buyer today than it was last year.

Gold and Oil Stocks

Gold stocks are making a move.  I’m holding the same one’s I have been for a while and added a couple of others.  I added smaller positions in Golden Star Resources and Leagold as it became more likely that gold was finishing its consolidation.  I also bought back Wesdome (which I never should have sold).

My largest gold stock position is Gran Columbia.  It still seems to be the cheapest of the bunch if you ask me.

On the topic of oil, I added another name to my basket of Crescent Point and Whitecap this week with Gear Energy.  There is nothing fancy here.  You can go onto SeekingAlpha and read all the articles about whether or not it is undervalued or overvalued compared to peers.  I’m playing this at a dumber level – invest in relatively liquid names that aren’t likely to screw anything up and that therefore will participate if the sector move in Canadian oil stocks continues.  I’ll get “cute” with my ideas if the move looks to be sustainable, but for now, if it is, these names will move just fine.

New Positions

I took a few new positions in the last couple months that are worth mentioning.

One of them is Velan.  I started writing this up for this post but it quickly became a post in and of itself so I will be posting a write-up on the name shortly.

Two others are past names I am revisiting – Digital Turbine and Intelligent Systems (da-dum!).

The fourth is SMTC, which I bought in December.  I have been watching the company for a while and the stock briefly fell below $3, which is where I took my position.

SMTC provides contract manufacturing for semi-conductors.  These are typical EMS tasks like PCB assembly, enclosure fabrication, system integration and testing.  They operate out of Mexico and the United States.

SMTC competes against companies like Keytronics, Sigmatron, Benchmark, as well as the larger, well known names like Flex, and Plexis.

SMTC made a major acquisition last November.  They acquired MC Assembly for $65 million.  The acquisition doubled the size of SMTC.  The company said they expected to realize $6 million of cost synergies once the acquisition was complete.  But honestly, I do not see those synergies in this year’s financials so far.  Costs appear to be up in the aggregate.  I’m wondering whether this is related to integration of the two companies and 2020 will show the synergies materialize.

Their business tends to be higher end, lower run rate manufacturing where quality, flexibility and a willingness to handle lower volume orders is important.

To compensate them, SMTC gets margins that are double of what tier 1 guys are getting – 12% while industry margins are in the 6-7% range.

SMTC has a large footprint in Mexico.  They had a far smaller one in China, but they exited China completely as of year-end.

The stock got hit in September after they guided down their 2019 numbers.

“In addition to the China closure, we are seeing softness in certain end-markets across semiconductor and data center expansions. Accordingly, we are updating full year 2019 revenue to range between $354 and $362 million, which excludes $16 million of revenues in 2019 attributable to SMTC’s operations in China, and Adjusted EBITDA to $25.0 and $26.0 million,” said Smith.

Admittedly, I’m not convinced about this one.  My bet here was partly on valuation and partly on a bottoming of the business.  If a trade truce does market a manufacturing bottom and 2020 is better than 2019, then SMTC looked like a cheap bet in an expensive market.

FWIW, SMTC guided to decent topline and bottom line growth in 2020:

We expect our 2020 revenue and Adjusted EBITDA, which will exclude any operations in China, to range between $390 and $410 million and $29.0 to $31.0 million, respectively

The midpoint of guidance puts the company at 5x EBITDA on next years numbers.  This compares favorably to their closest competitors but since I bought the stock I looked at larger competitors like Flex and Sanmina and they trade at similar or even lower multiples (Flex trades at 4.2x EV/EBITDA on 2019 numbers and 5.5x on 2020 estimates).

I might have been too quick to pull the trigger on this one.  It is not as cheap as I originally thought and the benefits of the acquisition have yet to materialize. Nevertheless I’m sticking with my small position for the moment.  It seems like the company should have economic tailwinds if trade is bottoming and they should be past any acquisition integration hiccups.  2020 might be a better year for the stock.

Portfolio Composition

Click here for the last ten weeks of trades.