The Caldwell Partners – update at fiscal year end 2020

Caldwell released full year financials on November 12th, 2020. Results were better than expected (given COVID) and the market response was generally positive. After COVID was in full swing, the shares typically traded around $0.75, so their current price ($0.78 as of November 18th) isn’t a departure from the normal trading range. However, the fact that the financial results are as healthy as they are is a good sign, which is why we believe Caldwell is still an interesting opportunity. For those that are new to Caldwell (and want a bit more background), the initial Caldwell post can be found here. As always, I use a green, amber and red format to indicate areas which are thought to be bullish, neutral, or bearish.

The typical “COVID” chart. Returning readers will know that I favor an entry point when a chart has “flattened out”, which was consistent with my entry into Caldwell. My initial investment was made prior to COVID, and I was happy to collect the dividend while the business continued to grow. With the onset of COVID, the wheels came off the proverbial bus for just about everyone (and every business), and Caldwell was no exception. As one can see from the chart below, Caldwell has taken the typical COVID nosedive, but more recent price action does appear to suggest a new bottom. It does appear that the MAVGs are converging, but for the meantime, we continue to regard the chart as being neutral.

Despite economic woes, the balance sheet remains solid. Despite all the hurdles that COVID presented, Caldwell managed to wade through the remainder of the fiscal year without compromising the balance sheet. Overall, there are no red flags. While current assets have fallen (compared to last year), current liabilities have done so in a similar fashion. Some might argue that this is due to the cancellation of the dividend, but even if one were to adjust for dividends that would have been payable, the current ratio is still an improvement over the prior year. It is also noteworthy to point out that both assets and liabilities have increased as a result of the adoption of IFRS 16 (change in accounting for leases), and the fact that Caldwell did take on some new leases in 2020. However, these do not materially alter the picture – the company managed to navigate a period of significantly reduced revenues while at the same time remaining fiscally prudent. Given all that’s happened, the balance sheet provides solid footing for Caldwell as it moves into 2021.

Revenues are down 20% – but Caldwell reports its highest earnings in 10 years. Those two statements generally don’t go together, but nonetheless, there they are. As expected, revenues were down significantly, but since so much of the cost structure is aligned with achieving revenue targets, costs went down as well. Add to this the fact that Caldwell was eligible for both Canadian and US COVID assistance (which offset cost of sales), and you end up with the highest net earnings in the last decade. To be fair, if one removes the full impact of COVID stimulus amounts ($2.839 MM), operating profit would be reduced to $927,000, and pre-tax net income would be reduced to $134,000. Clearly, without the COVID assistance, it would have been a marginal year at best. Regardless, given that 1/2 the fiscal year (March – August) was arguably compromised, maintaining profitability is no small feat.

…and cash flow remains solid. Lastly, it’s always a bit disconcerting when earnings are positive, but cash flow remains stubbornly negative. In this particular case, we need not be concerned. Cash flow after changes in working capital clocks in at $1.389 MM ($0.07/share). If one prefers to look at cash flow before changes in working capital, it becomes that much better, at $6.491 MM ($0.32/share). Depending on ones preference, Caldwell is currently trading at an unattractive 11x cash flow or a very compelling 2.4x cash flow. Valuation aside, the cash flow statement tells a solid story.

The Insider story remains unchanged. Nothing has changed since the prior Caldwell post (October 9th 2020), as no insider selling is evident. Significant insiders continue to hold 41% of the total outstanding shares. A breakdown of these insider holdings can be found in the October 9th Caldwell post.

The price has strengthened, but the valuation is still attractive. Since October, the price has improved somewhat, peaking at $0.86 recently. That being said, this comes on the heels of better than expected results and general market optimism that a COVID vaccine is just around the corner. Earlier in November, Caldwell traded as low $0.68, so it would be fair to say that deterioration of the price (back to $0.75 or under) is just one bad headline away. At the date of writing this (November 19th), Caldwell is trading at $0.78, which is still reasonable in the context of various metrics:

• Book value: Caldwell is trading well below it’s 5 year average (2015-2019) price/book multiple (2.4x) and even below the average price to book multiple if one takes the lowest prices for each of those years ( ~ 2x). At a year end book value of $0.76/share, Caldwell is trading well below the norm, and simple reversion to something more reasonable would provide very significant upside.
• PE multiple: While earnings were strong, one has to be aware of the fact that this year is not representative of a “normal” year, and the implied 6x PE, while low, must be taken with a grain of salt. While we believe Caldwell still offers compelling value, we would defer to other metrics other than PE, given how earnings this year have been skewed by both negative and positive COVID impacts.
• EV/EBITDA multiple: At an EV/EBITDA multiple of less than 1.0, Caldwell continues to trade in depressed territory, despite the fact that it has no debt, significant cash, and is both earnings and cash flow positive. Historically, the EV/EBITDA multiple has exceeded 4x, suggesting there is significant room for share price improvement.
• Cash flow yield: As noted in the October 9th post, this depends on how one tends to view cash flow, either before or after changes in working capital. If one prefers cash flow prior to working capital changes, the full year cash flow yield is an astronomical 41% ($0.32/$0.78). If one prefers cash flow after working capital changes, the full year cash flow yield is a more “normal” 9% ($0.07/$0.78).

The dividend is still gone – for now. Yes, the dividend is still MIA, but the following excerpt from the Caldwell MD&A states that “…payment of regular dividends can be in the best interest of the Company and its shareholders”. The short story is that Caldwell has a history of paying dividends, and the Senior management of Caldwell are very aware that without a dividend, the share price will remain depressed. At the current price, there is also the risk that someone larger (and with deeper pockets) is looking at Caldwell and wondering if it would make a nice acquisition. Unless the current executives of Caldwell all despise their jobs, they probably have an interest in working for the “devil they know” as opposed to a new “devil they don’t”. Quite often, once a company is acquired, the acquirer is more interested in installing their own hand picked executive group – and handing pink slips to the executive team of the acquired company.

So, for now, the dividend is gone, but the ability to pay a dividend certainly is not. Even a reduced dividend would signal confidence, and would spark interest for income seeking investors, who would purchase shares after the certainty of such an announcement. In the meantime, without a dividend, the shares will remain likely remain “on sale”. Once a dividend reinstatement is announced, they will enjoy a nice bump. For an example of what that looks like, just take a look at Boston Pizza, whose share rallied 35% on the day of the announcement, and have since risen as much as 60%.

Lastly, the economy is still soft. As COVID continues to shake the global economies, it begs the question: when will normal return? The truth is that nobody really knows – but companies continue to operate, and cannot put hiring and growth plans on the shelf forever. While some industries continue to struggle (energy, transportation), others have seen a significant run as a result of COVID, as a recent Mckinsey study suggest that COVID has likely accelerated the move to digital commerce by as much as 4 years. Companies will continue to adapt, and some of those companies will need to search out the right executives to lead that charge. When they do, companies like Caldwell will be there to manage that process.

In closing, all the same points that were made on October 9th still hold true:

• The share price is slightly better, but still reflects (mostly) bad news: The share price has already been punished, and unless there is another COVID like pandemic waiting in the wings, a further fall is unlikely. Businesses have started to adjust to the “new normal”, and cannot shut down forever. Executives still have to be sought out and hired – even if they end up working from a home office.
• The shares are trading slightly over cash value: The share price has improved a bit in the last month, but the balance sheet is actually in better shape that it was at the end of Q3.
• Bankruptcy is still a non-issue: This is a common theme in the companies I tend to look at, and this is no different. Caldwell continues to be debt free.
• Reinstatement of the dividend will move the price: This is no secret, as I previously alluded to the significant bump that Boston Pizza received when it reinstated a dividend that was only 60% of its former payout.
• Keep an eye on insider sentiment – although selling is unlikely: Current insiders have remained steadfast in their resolve to hold Caldwell through this very difficult time. We believe this will continue to be the case, but we will also keep an eye on insider activity.
• If you are a buyer, buy in small portions: The shares do not trade on huge volume, so if one is anticipating a purchase, use smaller bid lots in order to not move the price too significantly.

As I indicated previously, I am already long on Caldwell, and have bought more at the current price ( ~ $0.75 CAD) and will likely continue to do so. As always, these are only my thoughts & opinions, and it will take some time for this thesis to bear fruit (or not). If you have questions or comments, I can always be reached at mark@grey-swan.com.