Our latest update on Pioneering Technologies can be found here:
Our latest update on Pioneering Technologies can be found here:
I should probably preface this post by saying that a company such as Reitmans (RET.A, RET) is not my usual territory. However, before you throw the baby out with the bathwater, hear me out. There is a method to my madness…
Anyone that was invested in equities this year would have been impacted by (or was at least watching) the December selloff. The Dow, TSX, and TSX venture are all (currently) looking significantly uglier, and many investors have felt the pain, me included. To add insult to injury, tax loss selling came into full swing in December, causing further weakness in share prices. I suspect many people rounded out the year with marginal gains at best, or were simply in the red.
Which is where the rather unsexy story of Reitmans comes into play. While I watched the markets, I realized that many companies were taking a beating, and that there was sure to be some opportunities. Initially, I started looking at another Canadian retailer (Le Chateau) ,as I noticed the shares trading at historic lows. However, despite having made a very significant return off of Le Chateau (a long time ago…), I gave it a pass, as unlike Reitmans, it has neither a compelling balance sheet or positive cash flow. That being said, I’m not suggesting that Reitmans was one of the only opportunities (there were many), but it simply provides a mechanism to demonstrate how reversion to the mean can sometimes provide reasonable, short term, low risk opportunities. Lastly, before we get into the details, I should be clear that while many of the markers that I typically look for (low debt, good cash flow) are present in this analysis, others are not. Unlike some of the other companies I have written about, which tend to be very small, Reitmans is significantly larger. This being the case, the way I view this investment is somewhat different than how I might view an investment in a much smaller micro or nano-cap.
So what exactly does that mean – “reversion to the mean” ? I’m sure you’ve probably heard the term bandied about by either some talking heads on BNN, or someone with a mathematical bent. In the context of a companies share price, it simply means that over the long term, shares will tend to trade around a long term average of a particular valuation parameter, or parameters. The one that is spouted most frequently is the PE ratio. Quite often, you will hear a market prognosticator state that “ABC corporation typically trades at 11 times earnings, and right now, at 8 times earnings, we believe it provides compelling value”. What that guy (or gal) is essentially saying is that, all things being equal, the price of ABC will move back back to the long term average of 11 times earnings, and anyone buying today is getting a bargain.
So what made Reitmans appealing ? Well, since the PE ratio is so well ingrained in our collective psyche, it makes sense to start there. If we take a look at the past 10 years, we see the following:
The astute reader will notice that I have included two sets of “averages”, 10 year averages from 2009-2018, and a shorter time frame of 4 year averages from 2015-2018. The reason for this is that Reitmans today is not the same Reitmans of yesterday. In late 2014, Reitmans decided that it was bleeding cash too heavily, and slashed the dividend quite significantly. So, I think it’s fair to say that you probably have a different group of investors holding shares today than you did prior to the dividend cut. Because of this, we show the full 10 year averages to get a sense of where things could go, but we only use the more recent averages to drive out where we think the shares probably will go. The more recent 2015-2018 averages are more conservative, and are therefore more realistic.
One can see that the PE ratio at the time of our analysis (10.9 x), at a price of $3.60, is well below the average high, low, and absolute average PE ratios. Essentially, although I can’t state what the exact probability of a loss might be, we can make the inference that it’s low. Even if one assumes reversion to the low end of the spectrum , the result (average PE multiple of 12.08 x estimated earnings of $0.33) results in a gain of almost 11%, excluding any dividends.
But using a single criteria to buy or sell is foolish! If you finished reading that last paragraph with this thought on your lips, I would wholeheartedly agree with you. In the case of Reitmans, it’s even more appropriate, as earnings have been negative in 2 of the last 4 fiscal years. In this case, it’s even more appropriate to bring in other valuation metrics. Since many folks who consider themselves value investors focus on book value, I thought that might be a logical next stop:
Our snapshot of the price/book ratios tells a similar story – it would be unlikely that one would lose money, and even at the low end, one could end up with a double-digit return. Additionally, our snapshot of the price/book ratios also gives us another signal, in that over the last few years (2017 – today) book value has actually been increasing, which is a good sign.
In fact, this same story plays out if one looks at operating cash flow yield…
..and when one looks at the dividend yield…
In the context of the dividend yield, it should be noted that 2014 was excluded, as the dividend cut (late in that year) skewed results. With the current dividend significantly reduced, and as a much smaller percentage of cash flow, it would take some very bad business decisions (or situations) to result in another dividend cut.
At this point, I could go on with more of the same, but I’m guessing you’ve seen enough. While I could have drowned this post in charts & other stats, suffice to say that when I review a company I typically look at and maintain a 10 year history of:
I may have missed something in that list, but you are probably glad that I didn’t decide to flood this post with all of this information, as it’s a lot to sift through. That being said, it is an invaluable tool when analyzing companies like Reitmans , as companies such as this have a history long enough that one can derive long term valuation metrics, but small enough that coverage is often very limited. While there is an army of analysts providing opinion (and valuation metrics) around Apple & Google, the fact is that this sort of activity makes the prices of those companies reasonably efficient. As I’ve said before, price inefficiency lives in the weeds where small companies are, which is why data such as this can be so useful.
So if one were to buy at this price, what is a reasonable expectation ? While the data suggests that one could make a tidy profit, one also has to include a few other factors, namely dividends and tax impacts. Before buying into a position, this is something I always assess, as I’m really interested in what the real, after tax, return will look like. For the sake of this exercise I have made a number of assumptions, as follows:
So, after holding for one year, and with all tax impacts included, it would not be unreasonable to expect an after tax return of ~ 13% at the low end of the spectrum. Of course, if you are in a lower tax bracket (or tax sheltered) ,the returns would be better, and one does not necessarily have to hold for a 12 month period.
In summary, an investment in something like Reitmans is significantly different than an investment in the other companies I have profiled. Those companies (Pioneering Technologies, Titan Logix, Total Telecom) provide exposure to large movement in share price for a relatively low “ticket price”. A movement in share price for these companies of 100% or more would not be unheard of. While their balance sheets are clean, one must be able to stomach significant volatility in the interim, as results rarely occur overnight. However, in a portfolio of these, those that do spectacularly well will make up for those that either muddle along or never recover.
By comparison, an investment in a company like Reitmans provides for much more muted returns, but given that one is purchasing at the low end of a valuation spectrum, the probability of a very reasonable return in a relatively short period of time is quite high. A purchase of these shares is simply a way to put idle money to work – it is unlikely to fail catastrophically, you are paid to wait, and there is a high probability of a solid return. At such time when a price target is reached, it’s probably not a bad idea to sell, as I’d suggest that something like Reitmans isn’t a “hold forever” type of investment, nor is it something likely to provide spectacular micro-cap returns. Once the share price has “reverted to the mean”, the easy money is gone, and it may be time to move on.
As always, these are only my thoughts & opinions. In writing this post, I was hoping to elicit some feedback, specifically:
If you have comments on these points, or if you have other questions, I can be reached at email@example.com.
Given that we are closing in on the end of the year, I thought I would publish a quick recap on those positions that I previously wrote about, namely:
Unfortunately, like most of the Canadian small cap market, all of these are either in the toilet or treading water. However, each of these has its own particular story. Without further ado, I’ll launch into it….
Pioneering has been perhaps the biggest disappointment of 2018, as not only did it fail to meet revenue targets, it’s share price also cratered catastrophically. As of today (December 12th 2018), Pioneering is trading at $0.10, roughly a 90% drop from its price back in late 2017. The short & not-so-sweet reason for this skid is “over promise and under deliver”. Given the attention and buzz that was created around Pioneering in 2016 and 2017, investor expectations became inflated, and when increased sales didn’t show up, the bottom dropped out of the share price.
For those of you that have been following this story, this is all old news. The real question is “what now” ? Now that the market cap is a shadow of it’s former self, is this company on the scrap heap, or does it have a future ?
Clearly, if I knew the answer to this, I’d already be on my island somewhere. That being said, we can take a look at “what is” to determine “what might be”:
So, at todays price of $0.10, you are actually buying Pioneering on a “net-net” basis. Is this a good deal ? It depends – if the Pioneering Smartburner is no longer useful, or has become obsolete, then the value of the company is questionable no matter how low the price gets. However, what if sales do (eventually) show up ? Or better yet, what sort of sales have to show up to make a difference ?
If we take a look at the most recent PTE financials (9 months ending June 2018), PTE recorded about $4.5 MM in total costs. Note that we are excluding any gains / losses due to the derivative liability, as this appears to have worked itself off the balance sheet. If we adjust this $4.5 MM for non-cash costs (stock based compensation, amortization and depreciation), it’s reduced to $3.5 MM of cash costs, which suggest that full 12 month costs should land somewhere in the $4.7 MM range, which we will simply round to $5.0 MM. We also know that PTE has managed to maintain gross margins at 50%, so in order to break even on a cash cost basis, PTE needs to see $10 MM in revenue.
Is $10 MM in revenue a pipe dream ? Well, we know that for fiscal 2017, PTE did indeed record $10 MM in revenue at a 50% gross margin, so the answer is “no, it’s not a dream” – they have done it once, and I find it hard to believe that in fiscal 2017 they sold to every possible customer in North America.
Perhaps the better question is why anyone would buy a Smartburner to begin with. Lord knows I wouldn’t – I have a gas stove, and I like instant heat. However, we need to separate the idea of who has the purse strings from what people want. You’ll recall that at some point in your distant past, your parents told you to wear a helmet when you were biking, skiing, or doing most anything that suggested the potential for injury. You, being the disobedient child that you were, likely fought this edict, until such time that your parents reminded you that “while you live in this house, you live by our rules”. They controlled the purse strings, and regardless of your thoughts, you complied. The same is true here – the people that are going to be cooking on a Smartburner sometime in the future won’t be doing so because they want to – they’ll do so because the owner of that home said so. That owner believes that the “de-risking” of their rental unit is well worth the annoyance of getting used to a Smartburner, as tenants are now less able to burn down the house. With compliant UL858 stoves already in showrooms (I have seen them), the trend for safer coil top stoves is here to stay. Naysayers would suggest that if compliant stoves are on the market, the landlord will just buy one of those. Well, maybe – if you have the nicest landlord in the world. One thing about landlords is they like to control costs. The Association of Home Appliance Manufacturers (AHAM) suggests that a basic coil top stove lasts between 18 and 22 years. If I am a landlord, I’m not shelling out $400 for a new stove if I can make my existing stove (which has another 10 years of life) compliant for half that cost. While you might concede this point, you might also be saying that the vast majority of landlords simply won’t buy a Smartburner, because nobody says they have too – and you are right. Pioneering doesn’t need every coil top stove to be converted, they just need some. To be specific, with over 40 million rental households in the US, they just need a very small slice of some.
So, at the end of the day, I don’t believe Pioneering is heading for bankruptcy. I do believe it was overpromoted (which led to the run to $1.50), but the concept of kitchen fire safety, an aging population, and all those rental households in the US have not gone away. I believe that at the current price of $0.10, PTE may provide some significant upside (assuming sales materialize), and is suitable for very risk tolerant small cap investors. Of course, I may be wrong, and that may cause people to call me various names, some unflattering. That’s ok – I’ve been called many things, and have survived them all. I continue to be long, and have purchased at the current price.
Some of the things I end up going long on gets lots of press – and others don’t. Titan falls into this category, as despite consistent improvement, it keeps skipping along at basically the same price.
Titan year end numbers, released on November 29th, revealed the following:
While it is true that Titan is still EBITDA negative and burned a whopping $500,000 over the course of the year, this has to be viewed in the context of a recovering energy market. As we all know, commodities are cyclical – when prices are lousy, producers stop drilling, consumers keep consuming, and eventually prices start recovering. Around that time, producers decide to start drilling again, but since bringing new production on isn’t like flicking on the light switch, there tends to be a bit of a lag, at which time price really starts recovering – not exactly rocket science.
So Titan is managing to actually increase revenues (and gross margins) while keeping a lid on G&A costs – all in the context of an energy market that isn’t running on all cylinders. This begs the question – what will things look like once activity starts to pick up even more ? While I don’t know the answer to that, I do know that Titan remains a low risk play on the energy sector and has significant upside potential. At this point, the market is valuing a debt free company at slightly more than the assets on the balance sheet, suggesting that any future cash flows will be worth the square root of zero – a proposition which I don’t believe. While I don’t know when the market will notice, I’m glad to wait and potentially pick up more as the price drifts through the low ~ $0.50 range.
I had never actually intended to write about Reliq, but when they released their infamous “we have to restate revenues” press release, they provided a textbook case of a company that I try to avoid like the plague. Overvalued, overhyped, and with a balance sheet and an exploding share count that assault the senses.
To be fair, I should point out that I did indeed own Reliq at one point, as I indicated in my prior post. However, once the valuation of Reliq started to get beyond what I could understand, I sold for a tidy profit. I will freely admit that the company has never been a favorite of mine, and because of this I cannot profess to have the depth of knowledge that I might have with other positions. That being said, Reliq hasn’t given investors much to be happy about recently, so if you are bullish on Reliq, I’m guessing you’ve done your homework, or you are simply comfortable with the implied risk.
All of that aside, the question as always is “what to do today” ? The share price is obviously much lower, so perhaps this represents a reasonable entry point.
Whenever I’m about to take a position such as this, I try to map out where things are today versus where they might go tomorrow, which is not unlike how I view my position in Pioneering Technologies. For Reliq, I took the time to map out the numbers, as shown below:
This table shows us the value (in terms of Market Cap and Enterprise Value, or EV) as of the most recent financials, and what the EV of Reliq might be as of December 31st 2018 assuming a low cash burn rate of $427,000 per month, and what the EV might be assuming a high cash burn rate of $1.03 MM per month. Both of those cash burn rates tie back to the most recent financials, where it indicated that Reliq used $1.28 MM ($427,000 per month) after changes in working capital, or $3.1 MM ($1.03 MM per month) if you exclude changes in working capital.
Some of you may have noticed that I tend to focus on the EV/EBITDA multiple as a general yardstick for valuing a company, as this metric rolls market cap, debt, and cash into one ball of wax. As investors, we are always on the lookout for value, and a company that has high EBITDA and a low Enterprise Value is a reflection of that.
In the case of Reliq, I have shown what the EV could look like as of December 31st, and what sort of EBITDA an investor needs to expect in order to justify some sort of reasonable valuation. For instance, if you believe that Reliq will continue to burn cash at the “low” rate, then estimated year end EV of $23 MM suggests that you need to see EBITDA (at some future point in time) of $2.3 MM in order to justify a EV/EBITDA multiple of 10x.
What we can see is that Reliq needs to book somewhere between $5.75 MM of EBITDA for less aggressive investors who are willing to pay 4x EBITDA, and $1.77 MM of EBITDA for those investors who are very aggressive and are willing to pay 14x EBITDA. Which leads us to the question – is this possible ? The short answer is maybe – but I’m not holding my breath.
If one takes a quick look at the Reliq financials going back to the year ending June 2016, you can see two things pretty quickly. First , EBITDA has been negative for every year, and not a “little bit negative”, or “negative and trending up”. It has simply been negative every year, and has gotten worse each year. In fact, EBITDA in this last quarter at -3.1 MM is worse than each of the fiscal years ending June 2016, 2017, and 2018.
Secondly, one can see that the cash in the company coffers has arrived as a result of share issuance. So, if you work for one of the firms that underwrote one or more of those share offerings, I must commend you on a job well done, as you managed to raise no less than $18 MM since 2016.
So, while I generally don’t shy away from speculative companies, I will be keeping my distance from this one till further notice. Perhaps Reliq will turn things around – but they’ve got a deep hole to dig themselves out of before that happens.
Since my initial post on Total (November 02 2018), not much has really changed, so this will be perhaps my shortest “update”. Nonetheless, Total did issue Q1 financials on the 29th of November ,which were largely neutral:
As the cop on the street would say, “nothing to see here, move on”, which is what I expect most of the market did. However, there are a few points worth noting that are still interesting. Firstly, its only fairly recently that Total has managed to be EBITDA and cash flow positive (Q1 of 2015), and since hitting this milestone, this is the best Q1 TTZ has recorded since then:
With the exception of shares outstanding, which have risen by a measly 1% since 2015, every other metric is improved: the cash balance is consistently growing, and EBITDA, cash flow, and earnings are all the highest they have ever been for a Q1. While this doesn’t necessarily predict the future, it sure doesn’t hurt.
Additionally, overall results for Total last year were muted by the fact that they actually lost some customers in the Environmental services sector (in the US). In addition to this, the heater controller segment was impacted by a shortage of vehicle heaters, which dampened their overall sales in this segment. Despite this, Total exited the year with net income of $476K, or EPS of $0.019.
So, while Q1 numbers weren’t blockbuster, they certainly didn’t make us run for the hills either. Based on what we can see today, barring a major catastrophe, it would seem reasonable that Total can at least repeat last years results. If they do manage to do that, then the current price of $0.18 suggests that an investor might see a flat share price or decline to around $0.14. To be fair, Total has traded as low as $0.12 in the last 52 weeks, but it only traded at that level for less than a month. For the vast majority of its “cellar dwelling”, it has tended to trade around $0.14. So, one could see a worst case loss of 33%, or a more likely loss of 22%.
On the other hand, if Total sees expansion in any one of it’s revenue streams, a lot of that incremental revenue flows straight to the bottom line. In my prior post I highlighted how the company now covers all of its costs from its recurring revenue stream, which means that any increases in existing revenue streams (or any new revenue) is “gravy”. To put this in perspective, for the year ended June 2014, Total booked revenues of $765K, whereas for the year ended June 2018 they booked revenues of $1.78 MM – a CAGR of 23%, all while maintaining gross margins of 50% or more. While last years revenue growth was an anemic 2%, Total previously had revenue growth of 6%, 38%, and 54% for the years 2015, 2016, and 2017. The gist of the argument is that it they have managed very significant growth, and I can’t imagine they recently have thrown up their arms and said “that’s good enough”. With management owning almost 30% of the shares, I’m guessing they have a strong interest in growing the company some more.
With this in mind, we continue to hold our position in Total, given that our cost basis is somewhat lower than the current price, and the fact that liquidity is sometimes limited. Assuming that Total does manage to garner more incremental revenues, we believe this could provide upside of 50% or more.
As always, these are only my thoughts & opinions. If you have questions or comments, I can be reached at firstname.lastname@example.org.
You are probably looking at the above picture, wondering if I’ve gotten confused and started writing about the wrong company. Well, sometimes opportunities aren’t clearly marked like stop signs at an intersection. Total Telcom (TTZ – TSX Venture) is one of those opportunities. The company itself is so small, and so “underpromoted” that I actually couldn’t find a reasonably sized company logo on the web, so I went with the logo of their operating subsidiary. So, if a picture is worth a 1,000 words, this one says one thing – they are worried about getting stuff done and making money, not how shiny their website looks.
Full disclosure – I am long on Total shares: Before discussing the company itself, I believe it’s only fair that you should know that I hold shares of Total. The cynics among you have now made the observation that “this guy is just promoting this thing so he can sell to the sheep”. Without a doubt, this is an endemic problem in the small cap market. However, if we look at a 3 year chart of TTZ, you can see that if I do indeed hold TTZ, I may have bought at prices well below todays price – or well above. The short answer is that while I am indeed long on TTZ, I think there’s more value to be had than the current price today, which is bouncing around $0.15 as you read this.
What does Total Telcom do ? Traditionally, Total specialized in (and continues to specialize in) two way communication in very harsh & remote environments. We are all very familiar with instantaneous communication in this era, but in some places (the middle of the Atlantic ocean, the Mojave desert – you get my drift), this isn’t the case. If I break my ankle while falling down the stairs in my home, I can reach into my pocket and dial 911, and fairly soon someone will come and get me. On the other hand, if I am on top of some remote mountain and the same happens, things can get ugly quickly. This is where Total comes in.
For those of you that are already back country types, you are probably saying that there are already products and competitors in this market place, and you are right. One name that springs to mind immediately is Garmin. However, Total, has been aware of this for a while, and with this in mind has sought out very specialized niches where it can excel. In 2015, Total started providing communication equipment & services to the Baja racing circuit, and is now entrenched as the provider of communications for those races. Additionally, Total has recently found it’s way into a brand new business line – wireless heater controllers, which are used to remotely control secondary heaters for industrial equipment such as heavy haul trucks. The combination of growth in both of these segments and a pristine balance sheet creates a compelling story – the details of which I’ll now launch into. For those of you that are new here, I use a green, red, or amber format to indicate whether a particular factor is good, bad, or neutral. Here we go….
The chart isn’t necessarily screaming “buy me”: Looking at the 3 year chart (above), you can clearly see that Total has come off a significant high. Normally, I look for what I call a “saucer bottom” which suggests to me that interest is low. In this case, the situation isn’t as clear cut as I might like it to be. However, I believe the fundamental factors that I’ll discuss will provide more impetus for the share price to at least stay flat or move higher, rather than crater catastrophically. In the meantime, I’ll suggest that while the chart isn’t a falling knife, it provides an “ok” signal at best.
No debt & lots of cash. Not much explanation needed here. Total has about $0.06 per share in cash, no debt to speak of other than normal payables, and is worth about $0.085 per share on a book value basis. While Total would not be considered “deep value”, the balance sheet is pristine and presents no risk of insolvency.
Cash flow positive. Normally, with many of the companies I research, they are either coming out of a prolonged downturn (Titan Logix) or management has stumbled (Pioneering Technologies), which means they are usually burning cash. Not the case here – Total has been cash flow positive for the last 2 years, regardless of whether one looks at cash flow before or after working capital changes. Not only is cash flow positive, it has grown by 44% (cash flow before changes in working capital) or 61% (cash flow after working capital changes), depending on which cash flow metric you prefer.
Clean earnings. Unlike some companies I have written about, the income statement for Total is dead simple, and does not suggest that anything is particularly funky. The only items of particular interest are the sudden drop in R&D expense, which is explained in the notes to the financial statement, and the anemic revenue growth, which I address later.
In previous years, the R&D expense did not meet the guidelines for capitalization, whereas for 2018 it did. The net effect is a drop in R&D expense and capitalized product development costs appearing on the balance sheet. Some of you may make the astute observation that if one were not to capitalize the R&D costs, it would have been included as an expense, and therefore would have severely impacted earnings. While this is correct, I tend to keep a closer eye on cash flow, which is more representative of business health, as opposed to earnings, which are subject to the occasional “massaging of numbers”. As indicated earlier, despite the cash payment for $312,000 of R&D costs, Total still exited the year with more cash than it started with, despite almost no revenue growth – which brings me to my next point.
Flat revenues. Normally I don’t specifically address revenues, unless I believe there is something of particular interest worth mentioning. In this case, there is, and the way one views it is highly dependent on whether or not you are a “glass half full” kind of person or a “glass half empty” kind of person. Hence the peculiar coloring of this section – half amber, half green.
Revenues grew by a measly 2.2%, which doesn’t exactly create excitement. With that in mind, I took a closer look at the notes to the financials, and came up with a few interesting tidbits. First, the bad news:
This is analogous to a distance runner beating his prior years time in the Boston Marathon, despite the fact that he or she was hungover and was wearing flip flops. Perhaps it’s not that extreme, but the fact remains that Total exceeded prior years sales and cash flow numbers and kept costs in line, while one major customer basically “went away” and another emerging sector was met with supply constraints beyond their control. So, despite the fact that they were not firing on all cylinders, Total still managed to do better than last year. Now the good news:
The fact that the company is entirely self funding based on recurring revenues means that any incremental revenues from hardware sales (or further growth in existing sectors) filters right down to the bottom line, which is music to a shareholders ears.
So, even though revenue growth is flat, it is still a story that has good news buried in it. I will leave it up to you as to whether this is a good news story, or just a neutral story at best.
High Insider ownership. Three insiders own approximately 29% of the total shares outstanding, as follows:
Other insiders also have ownership stakes, but these three are the largest, and the fact that the CEO and CFO both own such significant amounts indicates that management is clearly aligned with outside shareholders, so the insider story is clearly a “green light”.
No analyst coverage or institutional ownership. Given that Total generates enough cash to fund operations, and the fact that management is incredibly quiet, the company is virtually unknown by both investment bankers and the general public, as it hasn’t needed to raise capital. In the interim, this means that the shares shouldn’t be pushed to ridiculous heights anytime soon, nor should there be a mass selloff (see:RHT) if things go sideways. Assuming that Total continues to generate profits, the market will eventually re-price the company given their cash flow generation ability and the cash heavy balance sheet.
No self promotion. Total has issued precious few press releases over the years, and the bulk of them relate to standard news items, such as quarterly earnings. If anything, they could be accused of not promoting the company enough. In any case, lack of self promotion means that the share price hasn’t been artificially propped up by the overly optimistic words of management.
No share buyback – but total shares have been static. If a company is buying back shares, this section would typically get a “green light”, and if a company has seen total shares expand slowly over time, then I might suggest that an “amber light” is more appropriate. In this case, the fact that shares outstanding have increased by only 1% over the last decade suggests to me that Total is keeping a tight lid on things, so this section is green.
Easily understood business. I have to admit that while I could easily understand the value proposition for their two-way communication segment, I was at first a bit unclear about the wireless heater controller segment – I wasn’t quite sure why anyone would want a wireless heater controller, which prompted me to ask some questions.
For those of you that are also wondering exactly why one might want a wireless heater controller, the explanation is pretty simple, and should have been intuitive for me. I live in a part of Canada that gets fairly cold in the winter, so many people end up running their vehicles in order to warm them up before they get on the road. Because they are running the engine, this creates extra emissions, wastes gas, and poses a theft risk. A small secondary heater, equipped with a wireless controller, allows people to warm up a vehicle remotely (whether it’s a semi tractor or a pick up truck) without running the engine, such that the interior of the vehicle is warm, the windshield is free of frost, the engine oil is warm, emissions are significantly reduced, and money is saved because the engine isn’t burning gas or diesel. Once I heard this, the value proposition became clear. I have gone outside (more than once) in -35 degree weather simply to start a car and scrape the windshield – and it sucks.
Potentially disruptive technology. Both of the business lines occupy very specific niches, but I’m not sure these are “disruptive technologies”. The products offer significant improvements, but I can’t say that they impact the existing status quo the same way streaming video eventually killed Blockbuster.
Current valuation is attractive. All of the above factors paint a good picture. However, valuation is usually where the rubber hits the road. At any time of the day, you can go to the market and buy Facebook, Google, and Amazon – all of them very good companies, but also very expensive. While I’m not here to argue the merits of the various FANG stocks, the point is that it’s easy to buy something “good”, it’s not always easy to pay a price that doesn’t break your wallet.
Currently, the price of Total is trending somewhere around $0.14 – $0.17, with recent price action likely falling at the lower end. In order to discuss valuation, we will use an average price of $0.155, and based on the most recent financials, this suggests various valuation metrics:
With the exception of book value, all of these multiples suggest that the current valuation of Total is reasonable, and even better, that reverting to a more average multiple could provide a bump in price.
With that in mind, we took a look at the price of Total during the period from May 29 2018, when 9 month financial were released, to October 24 2018, the day before full year financials were released. We use this period because it (a) provides us with 9 months of financial data, which is the next best thing to a full year, and (b) it eliminates the higher prices of Q1 which would skew the ratios upwards. During this period, Total traded between $0.12 and $0.215. If we apply the average multiples during this period for Book value, PE, EV/EBITDA, and Cash flow yield we get the following:
So, for those of you that are “short term traders” , there is a potential opportunity as Total reverts back to a more normalized valuation. For others, you might have a longer hold period in mind, which is where I believe the real opportunity is.
The current price isn’t suggesting any growth. Back in Q4 of 2017 and Q1 of 2018, the share price of Total was well beyond where it is today, precisely because of this reason – because too much growth was built into the share price. As such, the share price traded as high as $0.55, only to come back down to earth.
This is not to say that that, in the future, the price could trade beyond these levels. However, at that time, someone decided to “pay early” for significant revenue and earnings growth that has yet to occur. By comparison, todays share price suggests little or no growth. With that in mind, what sort of real revenue growth would be needed to move the share price ? This is where I believe things get interesting.
One of the nice things about a company like Total is their remarkable consistency, which makes it easier to model future outcomes. Consider the following:
Using these parameters to forecast what the next fiscal year might look like gives us the following outcomes:
The key point to takeaway from all of this is that a significantly higher share price isn’t that difficult to achieve. Currently, the valuation of Total is arguably at the lower end of the spectrum, as it trades at ~ 8.5x earnings. Even with nominal growth in revenues and a more “normalized” earnings multiple, returns on todays share price can exceed 50% or more. If one is more bullish, and assumes that Total can grow revenues a bit faster, one can see returns well in excess of 100%. On the other hand, if earnings stay flat, then the downside is likely limited to the low teens, given that the company has a hard book value of $0.085, and insolvency (barring an unforeseen disaster) is out of the question.
As I indicated previously, I am already long on Total shares, and have been a recent buyer at these levels. I believe the risk / reward tradeoff is compelling, and that total returns over the long term could exceed 15%-20% annually. Of course, these are only my thoughts & opinions – if you have questions or comments, I can always be reached at email@example.com.
After publishing Part 1 of this analysis, I received a few more emails than I usually do, most of them negative. Most of them said something like “you are an idiot”, and while I can’t necessarily dissuade anyone of their opinion, I can say this: those readers probably misunderstood my intent. My intent was not to say that “Reliq is a bad company”, rather it was to communicate the idea that “mispricing and overvaluation happen more often than not, and here’s how to avoid getting sucked in”. Simply put, through my own experience, I’m hoping to show some folks what to look for so that they can avoid the next such debacle. For others, who have more experience and wisdom than myself, I will admit that I probably won’t be able to enlighten you. In that case, you need read no further.
In Part 1, I detailed the signs and signals that I used to exit my position, which although it was well into the money, could have been much more into the money had I waited longer . For those of you that might have bought in when I was selling, or even later, you might be asking a similar question. Specifically, while I might be wondering “why didn’t I sell later ?” , you might be asking “why did I buy when it was so expensive ?”, or “why did I wait so long to sell ?”. Ultimately, I can’t answer all of these, but I can provide some insight into how one might have read the signals a little better.
When I exited my position in Reliq, the three year chart looked like this:
Obviously, with my crystal ball being out of order, I left a lot of money on the table. However, many investors started piling in after this point, which brings us to the why – or more specifically, why did other investors buy in ?
The typical financing process of a small cap company: To answer why others are buying when some are selling, it’s probably useful to explore the typical financing process of a small cap company. Unlike large companies, small caps are for the most part “undiscovered”. They are undiscovered and ignored for a number of reasons, primarily:
All of these factors are barriers to large amounts of money flowing into small caps, but the last point is perhaps the most important, and in the case of Reliq, the biggest reason why you (or someone you know) bought Reliq.
When a small company starts out, they obviously have to raise money, some of which comes from founders. However, they may go out to the public market to do a small initial raise. As I mentioned in my first post, this is how I got involved with Reliq. The investors that participate in this raise are typically very risk tolerant, and understand that they may lose their entire investment. In turn, these initial shares are usually relatively inexpensive (usually under $0.50), which gives these early investors leverage – if things work out.
As the company starts operating, it will end up following one of two potential paths:
For many of you, I am willing to bet more than a $1.00 that you found Reliq via the first path, not the 2nd. From the emails that I have received, most investors have suggested that they are “down significantly”, which means they acquired Reliq at prices north of the current (October 22nd) price of ~ $0.60.
So the First Red Flag I’m trying to highlight here is excessive press. You may recall that in my first post, I started to think about unloading Reliq in the latter part of 2017. Not surprisingly, Reliq had lots of coverage from the investment community at that time (and later), as one can see from this snapshot of the BNN website.
At the same time that institutions are starting to sing the Reliq song, retail stock message boards start going bananas. The screenshot below shows a flurry of activity on the Reliq message board in late 2017, which likely only became more intense as time wore on.
This kind of coverage & discussion is great for momentum, as retail investors pile on while the broader investment community provides the impetus that the retail investor needs. A retail investor at this time would have been looking at the chart, and would likely have been gripped with the thought that “I’m going to miss this one”, which is only driven home by the voice of brokerages and institutional investors. Those institutional investors may or may not have interest in the long term story, but they can finally participate in the action as the market cap is getting bigger (which is what they need) and increased liquidity allows them to move in or out more easily. Lastly, the increased number of eyeballs on Reliq also provides for an opportunity to raise capital, which is exactly what happened:
So, for many of you, the coverage from analysts and/or retail investors was likely the “push” that got you to buy into the Reliq story, and the takeaway from all of this is a lesson your parents might have imparted upon you as a child: be wary of that kid that’s always telling you how awesome they are. That being said, many of you are frowning right now, wondering if maybe I’m throwing out the baby with the bathwater. Which is why we’ll move on to our Second Red Flag, which will require that we look behind the scenes.
So let’s assume that you, like many, thought that Reliq offered compelling value, and you bought in at $1.00 in late 2017, approximately the same time that analysts were covering it. At this point you wouldn’t have known it, but you could have done quite well. In fact, you would have had no less than nine months during which you could have unloaded Reliq for prices well over the (assumed) $1.00 purchase price. During this time an investor would have had no less than four distinct sets of financial statements to guide their decision – and in those financials, he or she could have seen the writing on the wall.
Below I have taken data from the four sets of financials issued, starting with year end financials for 2017 (released on October 30th 2017), to the most recent 9 months released on May 30th 2018. Rather than show each of the financials in detail, I am simply showing key data that I believe communicates the story. Additionally, one should be aware that all income statement and cash flow information for quarterly financials has been annualized. So, when you see revenue of $2,274,622 for the period ending December 31 2017, this is actually the total for the 6 months of $1,137,311 x 2, which provides us with a rough forecast for what we might expect over the full year. While this is imperfect, it provides us with something directional.
Investors who were doing their homework noticed the following:
Revenue is growing: Absolutely. Revenue continued to trend up each quarter, which every investor loves. Nothing to complain about here.
Cost of goods & gross margins are staying healthy: COGS, after strangely disappearing in Q1, resurfaced, but managed to stay fairly constant at ~ 20% – 25%.
Expenses are out of control: This is where the train starts to come off the tracks. Some investors apparently didn’t notice that while revenues were growing each quarter, expenses were growing even faster – and every passing quarter was looking worse.
Net income is getting worse with each passing quarter: This is probably redundant, given our statement about expenses, but if some investors didn’t look at the expenses in detail, they should have noticed that net income wasn’t improving.
So with the income statement firmly in the penalty box, one might have turned to the balance sheet, which actually stayed quite clean. On the balance sheet, all the action happens on the asset side of the ledger.
Cash is growing – for the wrong reasons: Without a doubt, Reliq managed to grow its cash balances, but only because of capital raises. Each new round of capital diluted previous shareholders, but did provide some de-risking to the balance sheet. Investors that bought in to Reliq were getting the signal that “you are being diluted, and the company has to perform that much better in the future”.
Accounts receivable start ballooning: As we all know, this is what popped the bubble recently. While growing receivables by themselves are not necessarily an issue, they have to be viewed in the context of total sales. In the case of Reliq, this issue first shows up on the statements issued February 2018. At that time, Reliq had billed a total of $1.1 MM in the six months of operations ending December 31 2017, or approximately $2.2 MM if one were to forecast for the full year. Of the total $1.1 MM billed, approximately 75% was waiting to be collected. By the time the next quarterly statements were issued, this percentage had increased to 87%, as receivables totalled $1.99 MM on total sales of $2.27 MM. Not good.
With the balance sheet offering up little comfort, other than a large cash balance, an investor could have turned to the cash flow statement in hopes that something positive might turn up. Unfortunately, that was not the case.
Operating cash flows, including and excluding working capital, are negative: The only saving grace is that on the final statements released May 2018, total cash burn suggests that Reliq could operate for somewhere between 2 and 6 years, if it continues to burn cash at the same rate, which is why this section is amber instead of red.
Valuation continues to climb: Lastly, under the cash flow information, I inserted a table to show how the increasing share count of Reliq and the increasing price continued to signal a risky proposition. For example, by the time Q2 financials had been issued, investors had the opportunity to sell Reliq (in March of 2018) at prices between $1.63 and $2.62. Even at the much lower average price of $1.44 during the preceding months, the valuation of Reliq suggested that it had to hit approximately $4.4 MM of EBITDA for the year to be valued at a very rich EV/EBITDA multiple of 30x EBITDA. Given the actual state of the six month financials, this would require an astronomical jump in revenues.
So, while I started this section saying we would investigate what I considered to be the Second Red Flag, I guess in actuality it was one big flag made up of lots of little ones. That being said, there are some among you that might be thinking that the financial statement information is a lot – an awful lot – to go through. So, with that in mind, I’d suggest that there was a Third Red Flag that was probably easier to read.
Back to the chart: I have stated before that I am not really a technical kind of guy. However, I still do pay attention to technical factors, as I believe there’s information to be found both in the technical and fundamental information.
The problem with charts is that most of us only have the chart today, when we really need the chart from yesterday. What I mean is that if we look at a chart of Reliq today, hindsight tells us that we should have sold. The trick is interpreting the signals when they are happening, not after. With this in mind, I have re-created what the chart of Reliq would look like at four different intervals. Please note that since I am not a “hard-core” technician, the charts I show provide only high and low price, volume, and the 10 and 30 week moving averages.
December of 2017: Congratulations! You are now a Reliq shareholder, at the bargain price of $1.00. Like many of us, you are a busy guy (or gal), so you don’t have the time to poke through financial statements. With this in mind, you decide to take a look at the 1 year chart of Reliq, which looks like this:
All the action is off to the right side of the chart, and there are three key things that I would takeaway from this chart:
This chart says good things, and if I see a chart that looks like this and the company has reasonable fundamentals, I typically try and buy as much as I can. So at this time (December of 2017), this chart is what I would call all green.
March of 2018: Wow – this thing keeps on going. You may want to think of taking some money off the table, as you have now doubled your original investment. The chart is basically a stronger version of the previous one – all systems are go.
Key points that are worth mentioning here (as of March of 2018) are as follows:
June of 2018: Storm clouds are on the horizon, as price has slipped, and things are not looking quite as rosy. If you haven’t taken any profits, you may want to consider doing so, as this chart is flashing red.
Unlike the previous two charts, you are now seeing a different story play out:
October of 2018: You will notice that this chart only goes up to October 1st 2018, not the 16th, where the real action happens. However, this chart, like the previous one, is telling you to move on.
While there is a short recovery in late June / early July, the bulk of this chart communicates the following:
This chart, which preceded the October 16th announcement, is telling you to “sell” in no uncertain terms.
So even if all the other signals escaped ones attention, the story told by the charts, the Third Red Flag, was there to see without looking at press releases or financial statements. The key, as always, was to be paying attention and to not let hope guide ones investment decisions.
When I started this series, I indicated that Part 1 would be about how I determined to sell Reliq (unfortunately, too early), and that Part 2 would be about how others might have read market signals to avoid the significant decline in share price. After posting Part 1, not only did I receive emails telling me how abhorrently stupid I was (that’s ok, I have thick skin), but some emails asking should I sell ?
If you are still holding Reliq shares, and are wondering what to do with them, I would say this. Bear in mind that I’m compelled to issue the usual caveat that I am not an investment advisor, simply an independent investor. That being said, what would I do ?
Very simply, based on my investment style, all the information that is available to me today, and my experience, I would not be a buyer of Reliq today. In it’s current state, it does not fit my investment philosophy. That being said, I will continue to watch it. For you, your decision to hold, buy, or sell should be based on:
The bottom line is that Reliq is now firmly in the penalty box, and will find it more difficult to raise capital, so it very much needs to remedy its problems. If it does make a dramatic turnaround, meaning that it significantly increases revenues and actually collects on those revenues, then we will see a dramatic run up in share price. However, if Reliq simply “muddles along”, and there is no significant uptick in revenues and cash flow, then the share price is likely to stay flat or drift lower.
As always, these are only my thoughts and opinions. Let me know if you found this post informative, or if you just have questions or comments. I can be reached at: firstname.lastname@example.org
On October 16th, 2018, Reliq Health Technologies (RHT – TSX Venture) issued a press release indicating that the company would be “restating financials due to revenue collection issues.” Anyone that was long on Reliq immediately got the cold sweats, as the shares tanked on massive volume. As they say, a picture is worth a thousand words, and a 5 day chart as of 11:00 EST on the 16th serves up a lot of words, most of them nasty:
Those of you reading this that are (or were) long on Reliq have either sold, are contemplating selling, or are perhaps even doubling down, as the company still has cash in the bank. That being said, the question that all of you are likely asking is how could I have avoided this train wreck ? In Part 1 of this series I want to discuss how I avoided it in late 2017, and in Part 2, how you (or other investors) could have done the same throughout 2018. Similar to prior posts, I use green, amber and red headings to simply indicate those issues that are good, neutral, or bad.
My involvement with Reliq: Before delving into the nitty-gritty, I always like to provide the background as to how (or why) a particular company was brought to my attention. In this case, the story is actually not that interesting. I participated in the private placement that preceded Reliq, and held “dead money” for a number of years. Occasionally I will participate in private placements, knowing full well that there is the possibility of losing 100%. In this case, I held various illiquid companies until one of them (Moseda Technologies) changed its name to what we now know as Reliq Health Technologies.
What does Reliq Health Technologies do ? As per their website, Reliq states that they “specialize in developing innovative software as a service solutions for the $30 Billion community care market. Reliq’s IUGO care technology platform is a comprehensive SaaS solution that allows complex chronic disease patients to receive high quality care in the home or other community based setting, improving health outcomes, enhancing quality of life for patients & families and reducing the cost of care delivery”.
In plain English, I would translate this to mean that Reliq is introducing technology into the health care market to achieve the same or better outcomes while at the same time reducing costs. On the surface, this is an easy investment concept to grasp, and there is a clear value proposition. Clearly, the idea sounds like “a better mousetrap”.
I had been ignoring Reliq. But then, their chart got my attention: As I had indicated previously, my ownership in Reliq was simply a function of having participated in a private placement. Knowing that this wasn’t going anywhere for a while, I didn’t pay a lot of attention, until I noticed some life in the chart:
Having been “skipping along the bottom” for some time, Reliq started picking up in Q2-Q3 of 2017, and from a technical perspective, it didn’t look it was going to stop. So at this point, I started looking a bit deeper.
No cash on hand & lots of cash burn. At the time the chart was looking interesting, the most recent financials were those for the nine (9) months ended at March 2017. A quick look was all that was necessary – the balance sheet told me that Reliq had little money in the bank, and that it was theoretically insolvent.
However, a company can still get by if it’s not burning through it’s cash. A look at the cash flow statement killed that thought: Reliq had been burning through cash and raising capital via share issuance for some time already.
Based on this information, it was clear to me that this wasn’t a fundamental story, at least not right now. Given that the fundamental story wasn’t compelling in any way, I resolved to take a look at the holdings of insiders.
Significant insider holdings: A quick look at SEDI indicated that insiders did indeed own a significant amount of shares, approximately 11 MM of the 58 MM outstanding, or roughly 19%. So while the company clearly needed a capital infusion, insiders were at least going to feel the pain along with other shareholders.
Lots of coverage by analysts: Given that Reliq had raised capital by the time I was looking at them (Q2-Q3 of 2017), and clearly would need more, it was already a foregone conclusion that this story had been pitched to various investment firms looking for some work. What I did not know at this time was that as the Reliq share price picked up steam, one would eventually be able to find a total of 10 distinct interviews on BNN where Reliq was discussed, usually in bullish tones. For those of you that have some time, and enjoy the free entertainment, I’ve included the BNN link below.
Lots of self promotion: As if Reliq didn’t have enough eyeballs on it already, it wasn’t shy when it came to issuing press releases. From August 1st 2017 through to December 31st 2017, Reliq issued ~ 20 press releases, more than enough to incent investor interest. For instance, the screenshot below shows a total of 9 press releases in a span of a little over 1 month. Arguably, 2 of the releases are IIROC related, and therefore are beyond the control of Reliq. Regardless, all of these press releases, in conjunction with analyst coverage, acted like a giant magnet – attracting investor eyeballs, and with them, more money to chase the Reliq story.
No share buyback & rapidly increasing share count: This is fairly self explanatory. With no excess cash available to buy back shares, and a desperate need for cash to begin with, Reliq was ripe for dilution. At the time I was looking at them, total shares outstanding were ~ 58.4 MM, up from 49.4 MM the year before.
Easily understood business: As I indicated previously, the concept that Reliq was pitching was easy enough to understand – the use of technology to make the delivery of health care more accessible, more efficient, and less costly. While I didn’t have the ability to describe the details of how the technology was deployed, I could grasp the concept.
Potentially disruptive technology: Again, it was fairly clear that Reliq could significantly change the health care marketplace – if they could execute. Their ability to execute their plan was key, as without it, the story was simply one of hope. With that in mind, I decided to determine a “back of the envelope” valuation. Specifically, what sort of sales growth would they have to achieve in order for the current valuation to make sense ?
Valuation – off the charts: Valuing an early stage company is always difficult. However, even if one can’t land on what the exact value might be (or should be), one can still try and understand the implied value of the firm, to see if it make any sense at all. This is what I determined to do with Reliq.
Some time had passed since I had first started to look into Reliq, and at this point it was November of 2017, which meant I now had year end financials (year ending June 2017) to work with. Since I had no way to forecast what actual revenue and expense numbers might be, I made a number of assumptions for what I considered to be a “best case scenario”, as follows:
Once I had all this information in hand, I had a handle on whether or not the valuation of RHT made any sense or not:
To be painfully clear, Reliq had to increase revenue from $183,652 in fiscal 2017 to at least $9.0 MM, maintain gross margins of 42%, and have zero increase in all other expenses in order for the value of the company (at $0.65) to make any sense. Anything less than perfection meant that the company was likely too hyped, and the valuation made no sense. With this in mind, and given that I was well into the money at this price, I sold between $0.76 and $0.82 and redeployed the capital into other opportunities.
However, as you well know, the Reliq story doesn’t end there. Having washed my hands of Reliq and redeployed the capital, I watched the share price climb as the market made a fool out of me (as it sometimes does). I was curious as to how high the price would go, and would occasionally take a look at the financials to see if the dizzying heights of the Reliq share price were somehow fundamentally driven. Given what I could see, I believed this was not the case, and I believe the information was there for investors to see the same. This is what I’ll discuss in Part 2, as I believe that many investors could have avoided the Reliq debacle, and the associated loss of capital.
As always, these are only my thoughts and opinions. Let me know if you found this post informative, or if you just have questions or comments. I can be reached at: email@example.com
Following my original post about Titan Logix, I received an email that questioned the thesis of the post. I’ve extracted an excerpt from the email, as follows:
“…sure the company is cheap, but aside from book value, what makes you so sure the price will go up ?”
That is a totally valid question, and I’ll try & address the “whys” here. To (very quickly) recap the original post, there were a number of things that indicated to me that Titan was a relatively low risk buy. Note that I use the same green, amber, & red format, and that I simply list the points rather than going into a detailed explanation. Anyone that wants to review the original post can simply take a look at the prior Titan post to get the details. The distinct areas that I highlighted were as follows:
One can quickly see that the positives outweigh the negatives. However, not every investor is the same, and not every reader of this blog will have the same understanding of investing, or of this particular sector. This is where I may have come up short in my last post, so I’ll try to flesh things out a bit more here.
The price of a commodity distracts us from what is really happening. We are bombarded by price information all the time, because people can easily identify with the concept of paying too much or getting a bargain. However, when it comes to investing in companies that produce commodities, or companies that are affected by the commodity price, it’s often better to look behind the scenes. The good folks at the U.S. Energy Information Administration must have anticipated my post, because they just updated their forecast for liquid fuel production & consumption, which is shown below.
The first thing that should become apparent here is that production and consumption are always dancing with each other – sometimes one gets ahead of the other, but not by much. The two lines are tightly interwoven, constantly moving in & out of synch. That being said, while consumption & production tend to be intertwined, price is the signal that screams at us that one of them is slightly out of whack. Or, to put it succinctly, the price of crude oil is very sensitive to slight changes in either production or consumption, and therefore can be very volatile.
We have all seen this, as anyone who watches the news is constantly told that WTI is either up or down, and only a few years ago we cursed high oil prices (and high gasoline prices), whereas now we are less likely to do so. To highlight this, a 2nd chart from the EIA illustrates my point:
If you look at the first chart, the difference between the production & consumption isn’t particularly striking. However, you can still see that the blue line (production) gets slightly ahead of the khaki line (consumption), and that this gap persists into early 2016. During this time, excess production was likely put into storage, to be slowly worked off later. However, the impact on price is far more volatile, as the 2nd chart indicates. Even though the excess production isn’t enormous, it eventually craters the price by ~ 50%.
So, while both production & consumption tend to move up over time, one is driven by millions of people who tend to consume at a fairly even pace every day, whereas the other is driven by exploration programs that take a long time to analyze & execute. For instance, if a major project is announced today, that production may not make it to the gas pump for a number of years. In essence, while consumption continues to slowly ticks upwards, producers may slow down or halt production entirely when prices are weak.
OK. So producers slow down or stop production. What does this mean for Titan ? A producer company is always trying to balance how much it produces and when. Although many companies employ hedging to get away from the price roller coaster, rarely are companies 100% hedged, and some can be totally unhedged. A quick look at the price cycle since the year 2000 allows us to walk through what happens with both producers and service companies.
So, to answer the question “…what does this mean for Titan ?”, the answer is that the slowing (or stopping) of crude oil production means three things for Titan:
So these are the reasons, in conjunction with those factors I indicated in the prior post, that make me reasonably certain that Titan will see increased business as the sector turns around, and that in turn will lead to an increase in share price.
As always, I can be reached at: firstname.lastname@example.org
Anyone that has visited this blog before knows that I’ve provided some detailed analysis on positions that I’m already long on, and my thoughts on why I might be staying long (or not). However, in this post I wanted to go through the process as to why I initiate a long position in a company at all, and what factors get me to that point. While I’m sure that many of you are seasoned investors, I thought that some of you might not have as many wrinkles as myself, and therefore might be interested in what I call “the weeding out” process.
That being said, I should probably issue a caveat, in that I have already been long on Titan for a while – specifically, I built my position in Q1 and Q2 of 2018. Therefore, depending on what type of investor you are, you may view this post as entirely educational, given that “the price has moved, and it’s too late to buy into this story”, or you may view it as an opportunity, since “the technical chart is better today than it was back then”. Whatever your perspective, my intent is not to convince you to buy into the Titan story, but rather to “show you the tools I use and how I use them”, for those that are interested. Note that once I start describing the detailed process, I color code the headings green, amber or red to indicate how a particular part of the data influences my decision.
With that out of the way, let’s get started….
Who is Titan Logix, and what do they do ? Titan, headquartered in Edmonton, Alberta, falls into the category of “oil & gas services”, so they don’t actually produce any oil or gas, they help the producers in that process. As per their website, their mission statement is “….to provide our customers with innovative, integrated, advanced technology solutions to enable them to more effectively manage their fluid assets in the field, on the road, and in the office.” Or, in really simple language, Titan provides state of the art technology (gauges & monitoring equipment) for producers of oil to accurately measure, store, transport, and safeguard their primary asset – the oil itself. While this doesn’t sound very sexy, producer companies face a lot of scrutiny in how safely they move oil from point A to point B, not only because of safety issues, but also because they want to make sure that every drop that’s in the tanker ends up in the storage tank, or pipeline, or refinery. Not only is spillage frowned upon from a safety & environmental perspective, it’s literally money that’s getting spilled on the ground. So, tracking, measuring, and moving it accurately is their primary service.
How did I find them ? I’m not sure when I first became aware of Titan, but since I allocated capital in Q1 of 2018, I’m guessing I probably found them by around Q2 of 2017. In this particular instance I found an article written by Bob Tattersall, a mutual fund manager who tends to focus on small caps. The article made a compelling case for Titan, so I wrote up a note to myself, and Titan was formally placed on my “watch list”. So, the “finding” process was simply a function of me doing what I usually do, which is reading – the paper, magazines, or online content. Most of the time the headlines (or articles) don’t result in any good ideas, but occasionally one will see something interesting, which is exactly what happened in this case.
OK. So you found them. How do you make the decision to allocate money ? I look at a number of different factors, which I’ll dissect here.
Attractive technical chart. OK, this is perhaps a bit misleading, because I’m not really a technical kind of guy. However, I have learned that when buying into a position, getting in at the “bottom of the saucer” is often a good place to start. The chart below illustrates what I’m talking about, and was what I was looking at in February of 2018. From this I could make a few observations, specifically:
So, at this point I established that Titan looked appealing from a very basic technical perspective. From here, I move on to fundamental analysis.
No debt, lots of cash. In most cases, my next stop is almost always the balance sheet. What I’m typically looking for is either no debt or manageable debt. Obviously, no debt is preferable, but if the company has debt, and it’s reasonable given their total cash available or their cash flow, then I’ll still consider them. In this case, the most recent financials available were for the 3 months ended November 2017. A quick look confirmed what I had already read in the prior article – that Titan was sitting on $6.4 MM of cash with no short or long-term debt.
On a book value basis, this was equivalent to about $0.22 per share in cash, and total book value (excluding intangibles) was $0.51 per share. At this point, I knew that Titan had potential, but I needed to find out how long this cash might last, as it was clear that they were still losing money. So, my next stop was the cash flow statement.
Reasonable cash burn. As I indicated, cash on the balance is nice, but if all of it is consumed within one or two quarters, it doesn’t do much good. In this instance I looked at not only the 3 month statements, but the years ended August 2017 and August 2016, as I wanted to get a range of what could happen. Cash burn from operations ranged from a low of $118,000 (fiscal 2017) to a high of $1.9 MM (fiscal 2016). The 3 month cash burn for Q1 2018 came in at $74,000, implying a full year value of approximately $300,000.
While I couldn’t predict where it would fall in the future, I could safely assume that even the worst of these ($1.9 MM) suggested that the company could operate for up to 3 years, during which time they would be looking for ways to not keep burning cash. This provided further “de-risking” information, as I was comfortable that the company couldn’t be called on outstanding debt, and was also unlikely to spend themselves to death. Additionally, the cash position and the reasonable cash burn gave me some comfort that there probably wouldn’t be a share issuance on the horizon that was going to dilute existing shareholders.
Clean earnings. Once I’m comfortable with the debt and cash situation, I take a look at the income statement to determine how “clean” the earnings are. What I’m looking for is either a lot of change in how revenues & expenses are classified on a year over year basis, or revenues & expenses that are difficult to understand. A quick look at the Titan income statement confirmed that things were pretty simple:
Nothing on this income statement screams “this is strange”. Costs are easily understood at a glance, and a deeper dive provides some glimmers of hope. While revenues are only up slightly, gross margins are significantly improved, & total expenses (excluding FX) are only up about 3% YoY. All in all, the income statement doesn’t offer up anything out of the ordinary, so at this point I can move on to qualitative factors.
High Insider ownership. After viewing insider holdings on SEDI, I came to the conclusion that the insider part of the puzzle was neutral for a number of reasons:
No analyst coverage or institutional ownership. I could find no evidence of any recent analyst coverage, or that any mutual funds held a position. The lack of analyst coverage is consistent with what I was expecting, as I would find it unlikely that a company as well capitalized as Titan would need to do a capital raise, which in turn would go hand in hand with analyst coverage. Additionally, the lack of any institutional holdings (outside of the Zucker estate) is a plus, as this means that there is no potential for a large block of shares to be sold off if a mutual fund manager decides to liquidate. The flip side of this is that there is the potential for the shares to get repriced if a mutual fund decides to buy in once results improve.
No “self promotion”. Quite often, a company will become aware that nobody is interested in them. Lack of interest usually means a depressed share price, which some companies can find understandably bothersome. So, in order to “create a buzz”, they may hire an IR firm to engage the public, or the company itself will start issuing press releases which sound exciting, but simply inflate normal events. A classic example would be “Widget corporation completes sale of widgets to Multi-national accounting firm”, which sounds great. However, at the end of the day, isn’t every company supposed to be trying to make big sales – isn’t that their job ? In the case of Titan, all I found were “business as usual” types of press releases, which confirmed that there wasn’t any artificial inflation of the share price.
No share buy back. I could find no evidence of any share buy backs, and the fact that total shares outstanding had remained fairly static confirmed this. This being said, a share buy back is a vote of confidence by management, but lack of a share buy back isn’t necessarily a lack of confidence. If that were the case, this would mean that the vast majority of firms listed publicly would be broadcasting a lack of confidence by virtue of the fact that there was not a share buy back in place. So, rather than being red, this section ends up amber.
Out of favor sector. I think this is fairly self-evident. The energy sector in Canada, and the associated service companies, had been out of favor for a while. One might argue that this is a redundant statement, given the flat chart of Titan. In any case, the fact that the sector was clearly out of favor meant less eyeballs (and money) to compete with.
The business is easily understood. Again, this is a fairly simple concept. If I was on a plane, and had to explain to the guy next to me what Titan did, could I ? I’m fairly confident I could. While I can’t say that I’m an expert in how their monitors (or gauges, or whatever) work, the concept is easily communicated.
Potentially disruptive technology. Lastly, I’m always on the lookout for something that will shake up the marketplace. In this case, I was not aware of anything that Titan was doing that could be called potentially disruptive. That being said, if this was a prerequisite for every investment, I wouldn’t be investing in anything. So this is amber rather than red.
The final verdict – A buy at an average price of $0.52. As I indicated, I ended up buying Titan. While some parts of my research turned up a few amber lights, there was nothing that screamed “run away”. Also, I should be clear about my expecations about Titan:
As always, these are only my thoughts and opinions. Let me know if you found this post informative, or if you just have questions or comments. I can be reached at: email@example.com
For those of you that have been following this story, you have either thrown in the towel, or are curious as to whether or not this company is alive (or not). Since publishing the initial four part series back in June of 2018, the share price of Pioneering has managed to shed even more value. Anyone that purchased in June of 2018 (or prior to Q3) has lost money, and in no small measure.
Recently I received an email which was basically a “what now” kind of query. Which is why I am following up with this post. For ease of reading, and so that readers can skip to those areas that are of particular interest to them, I’ve decided to follow a point form format. Here goes….
Are you (Grey Swan) still long on PTE, and have you purchased more ? Yes, I am still long, and I have (at these prices) purchased more.
OK. You are still long, and have bought more. Are you insane? That depends on how you view your investment horizon. I tend to have a long hold period (less than 2 years is very short for me), and have held things as long as 10+ years. My most successful investment spanned an 8 year period. During that time, depending on when I might have sold, I could have lost ~ 65%. When I did eventually sell, I ended with a 1200% gain on the entire position, and that was before the shares peaked. The final tranche of shares that I sold realized a gain of 2600%. All that is to say that I am “crazy” by the standards of those who have short investment horizons, but perhaps not crazy for those that have long time horizons.
Why did I buy more shares ? The company is, without a doubt, missing short term revenue targets, and the market is punishing it severely. However, a quick rundown of the Q3 financials provides the following information:
As always, these are only my thoughts and opinions. If you have questions or comments, I can be reached at: firstname.lastname@example.org
We closed Part 3 of our review with the belief that regulation changes to coil top stoves in 2019 would create safety awareness, and in turn, could drive increased sales of the Smart Burner product. Given the very large size of the US market (43.8 MM rental households), we decided that only a small fraction, 274,000, or about 6/10 of 1%, might install a Smart Burner once the regulation change takes effect.
What’s the impact of sales of 274,000 units: Now that we have determined what we believe sales could look like in 2019 (post “regulation change”), we can relatively easily determine what the economic impact (on the company) will look like.
From publicly available information, we can see that the Smart Burner sells for anywhere between $190.77 US and $221.99 US, as per information from both the Staples Supply and Interline Wilmar websites (below):
Source: https://www.staples.com/Smart Burner/directory_Smart Burner
Source: https://www.wilmar.com/Search?keywords=Smart Burner&filterByCustomizedProductOffering=False&previouslyOrdered=False
These prices are not reflective of what Pioneering might be receiving, as both Staples, Wilmar, and HD supply act as distributors. Therefore, this leaves us with an unknown: we know how much the distributor receives when the consumer buys a Smart Burner, but we do not know how much Pioneering is receiving from the distributors. However, we do know that the distributors apply their own mark up. If we can make a reasonable estimate as to how much distributors typically mark up an item, then we can effectively determine how much they are paying when they purchase it from Pioneering.
While I am no “supply chain” expert, some web research provides us with the following information:
“The average wholesale or distributor markup is 20%, although some go as high as 40%.”
This is validated via another source, as shown below:
Both of these data sources suggest that the distributor markup could be anywhere in the range of 20% to 40%. With this data in hand, we can then calculate what the revenue stream to Pioneering would be, using these ranges as bookends. With this information, we can extrapolate what the sale of 274,000 units could look like, under the following assumptions:
• We are only calculating sales of Smart Burners in the US market. Sales in the Canadian market would be incremental to this analysis.
• We are not attributing any value to any other Pioneering products, nor are we attributing any value to the partnership Pioneering has with Innohome.
• We use the lowest price we could find, $190.77 US.
• We assume that COGS (& gross margin) will come in at 50%.
• Because Pioneering is domiciled in Canada, we convert gross margin from US$ to CAD$.
• We use a conservative FX rate of $0.90 US$ = $1.00 CAD$. This is the weakest US$/CAD$ FX rate over the last 5 years, and the average FX rate (2014 to June 2018) has been approximately 0.80. A stronger US$ would improve these results.
• We apply the FX rate directly to the US$ gross margin, rather than attempting to model how the accounting for FX gains or losses would appear on the income statement. We realize that actual accounting gains/losses would be realized via currency hedging, etc.
• After converting gross margin to CAD$, we continue to use CAD$ for the rest of the analysis, as Pioneering G&A costs are denominated in CAD$.
• We assume G&A increases significantly, coming in at an annual amount of $12 MM CAD, double the current G&A costs which are forecast at ~ $6.0 MM CAD for fiscal 2018.
• We ignore non-cash charges such as DD&A, as they are not material (~ $30,000 CAD$ for fiscal 2017).
• We assume a corporate tax rate of 25%.
• We use the total diluted shares outstanding.
The outcomes of a sales volume of 274,000 Smart Burners under various distributor mark up percentages is shown below:
When we began this analysis, our thesis statement was that this was “a sales story”, and the key was whether or not Pioneering could increase sales. We believe that with pending regulation coming into effect in 2019, sales are likely to increase, and in doing so, will drive the profitability (and share price) of Pioneering. This being the case, we believe that todays share price weakness is a significant opportunity for those investors that are risk tolerant and have a longer time horizon.
Disclosure: The author of this analysis holds a long position in PTE. The author has received no compensation from Pioneering Technologies for the writing of this analysis.