2018 in review….

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:

  • Pioneering Technologies
  • Titan Logix
  • Reliq Health Technologies
  • Total Telcom

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….

 

PTE logo

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”:

  • The balance sheet (as of June 2018) remains debt free, with $5.7 MM of cash and short term investments.
  • Assuming that sales are still slow to materialize, and cash is still being burned up at the same rate, PTE could be consuming between $225,000 and $360,000 per month, or cash burn of $1.575 MM to $2.52 MM for the 7 months from July – Dec 2018.
  • If this is indeed occurring, then cash and short term investments, as of December 2018,  could be as low as $3.2 MM to $4.1 MM.
  • This in turn means that net equity per share (using the fully diluted share count) could be as low as $0.13 to $0.15 per share, after adjusting for cash consumed.
  • If one eliminates all long term assets, then the Net-Net book value per share (using the fully diluted share count) falls between $0.11 and $0.12 per share.
  • Lastly, if one adjusts for potential cash consumed, the adjusted Enterprise value (using the fully diluted share count)  is between $2.35 MM and $3.25 MM.

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.

 

Titan Logix

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:

  • Revenue up 28% vs prior year.
  • Cost of goods down 3% vs prior year.
  • Gross margin up 90% vs prior year.
  • All other cash costs up 8% vs prior year.
  • EBITDA is still negative but is significantly improved at  -$0.256 MM vs -1.11 MM.
  • The company remains debt free.
  • Book value is $0.51/share, and net-net value is $0.35 per share.
  • Cash & short term investments of $8.27 MM, or $0.29 per share.

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.

 

RHT image

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:

Reliq valuation at Dec 14 2018

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.

 

Total telcom logo

 

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:

  • Q1 revenues essentially flat at $346K vs $345K prior year .
  • Cost of goods up 12% vs prior year Q1.
  • Gross margins down 5% vs prior year Q1, at 53% vs 58%.
  • All other cash costs down 6% vs prior year Q1.
  • EBITDA down 11% at $72K vs $81K vs prior year
  • Net earnings of $50 K flat vs prior year Q1.
  • The company remains debt free.
  • Cash on hand of $1.4MM, or $0.057 per share.

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:

TTZ comparative Q1 since 2015.PNG

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 greyswan2@gmail.com.

 

 

 

 

Total Telcom – a micro-cap opportunity

Rom communication screenshot.PNG

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.

TTZ 3yr chart at Oct 29 2018.PNG

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, redor 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.

Total yr end 2018 bal sheet

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.

Total yr end 2018 cashf flow.PNG

 

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.Total yr end 2018 inc st

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 revenuesNormally 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: 

TTZ full yr MDA rev decline

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:

TTZ full yr MDA breakeven

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:

  • Neil Magrath, CEO:                                  3,045,606 shares, or about 12.2 % 
  • Scott Allen, CFO:                                       1,986,475 shares, or about  7.95%
  • David Hammermeister, Director:         2,259,133 shares, or about 9.05%

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 ownershipGiven 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 technologyBoth 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:

  • Book value: At a book value of $0.085, this suggests we are trading at 1.8x book value. Not cheap, but not extravagant either.
  • PE multiple: With EPS coming in at $0.019, this suggests a multiple of 8.15x, which I would argue is attractive.
  • EV/EBITDA multiple: Because Total has lots of cash and no debt, their EV/EBITDA multiple is a very attractive 5.1x, given an Enterprise value of $2.36 MM and EBITDA of ~ $461,000.
  • Cash flow yield: Assuming that we use the lower of the two  cash flow values ($592,313, or $0.024/share), this gives us a very respectable cash flow yield of 15.5%.

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:

  • Book value: Applying the average multiple of 2.08x to book value of $0.085 gives us a price of $0.175, a 13% gain over our hypothetical price of $0.155.
  • PE multiple: Applying the average multiple of 12.96x to earnings of  $0.019 gives us a price of $0.245, a gain of 58%.
  • EV/EBITDA multiple: Applying the average EV/EBITDA multiple of 7.83x to EBITDA gives us a price of $0.205, a gain of 32%.
  • Cash flow yield: Applying the average cash flow yield of 11.12% to cash flow of $0.024/share gives us a price of $0.215, a gain of 39%.

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:

  • Revenue growth: From 2015 to 2018, they have managed to double revenue from ~ $800,000 to $1.78 MM today. We forecast various levels of growth from 5% to 35%.
  • Cost of goods: Since 2015, it has remained virtually static, ranging between 40% – 43%. We use an average of 42% for our forecast.
  • G&A: Despite the fact that revenues have doubled, G&A has only grown by about 8% over 2015 levels. We have increased G&A costs by 2.5% for our forecast.
  • R&D:  Because of the capitalization of R&D costs in 2018, this item has seen the most variability. We have used the average of R&D costs from 2015-2018.
  • Amortization: Although it has virtually no effect on the forecasted outcome, we have used the average amortization cost from 2015-2018.
  • Finance income / FX gains (losses): We exclude these, as we are trying to isolate growth in earnings from the core operations.
  • Taxes: Because Total has significant tax pools, earnings are tax exempt.

Using these parameters to forecast what the next fiscal year might look like gives us the following outcomes:

TTZ 2019 growth forecast

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 greyswan2@gmail.com. 

 

 

 

 

 

 

 

 

Reliq Health, Part 2: More symptoms…

RHT image

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:

RHT at Nov 27 2017

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:

  • Recently, indexing has become popular, which ignores very small companies.
  • In Canada in particular, small cap is synonymous with mining & energy, which many investors avoid.
  • Small companies have no name (or brand) recognition.
  • Institutional money tends to come in late, when the market cap has expanded.

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:

  • Things muddle along, or don’t go well: The company may still be trying to find out what it wants to do when it grows up, or it may have figured that out, but is just burning cash too quickly (this is likely where Reliq is). The company, recognizing the need for further capital, has an interest in raising that capital at the best possible prices. Good press means the price stays strong, and attracts investors. The “formula” is basically: New idea (or good idea) + good press = increasing investor interest = the ability to raise capital at higher prices. 

 

  • Things go well. The company starts becoming profitable relatively quickly, so much so that it becomes self financing. When this happens, it may or may not draw attention to itself through press releases, and the share price may (or may not) move significantly. If the share price does not move significantly, it may provide an attractive entry point, assuming there is a disconnect between price and perceived value. Mostly importantly, because the company does not require extra capital, it does not engage the investment banking community. It then typically disappears from investors radar, as only the most savvy retail investors find it, and institutions likely ignore it. Institutions ignore it because the market cap is likely too small, and trading is too illiquid. The next time it makes a significant splash in the press is usually when it is acquired at a significant premium to the normal trading price. 

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.

Reliq BNN shot

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.

RHT stockhouse

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:

RHT financing 2

RHT financing 1

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.

Reliq 4 statements.PNG

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:

RHT Dec 16 to Dec 17.PNG

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:

  • Both high and low prices (darker blue line and green line) are leading both of the moving averages, and have been since approximately August of 2017.
  • Both of the moving averages are nice smooth lines, which are starting to crest upwards, after having been basically flat for a year.
  • The 10 week moving average is leading the 30 week moving average, which simply confirms that recent prices have been strengthening.

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.

RHT Mar 17 to Mar 18

Key points that are worth mentioning here (as of March of 2018) are as follows:

  • High and low prices have continued to lead both moving averages, and there is only one instance where price threatens to break through the 10 week moving average.
  • As the price continues to climb, price volatility has increased a bit.
  • However, overall, the comments from the previous chart are still valid here. Things are still pretty green. 

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. 

RHT Jun 17 to Jun 18.PNG

Unlike the previous two charts, you are now seeing a different story play out:

  • Other investors have gone through the most recent statements, and are worried. Selling is starting to happen, and high and low prices have broken through both moving averages, which is usually bearish.
  • The 10 week moving average is pointing firmly downward, while the 30 week moving average still has bit of upward momentum.
  • This chart is telling you to either sell or pay close attention in the coming months, if you aren’t already. That being said, one could still sell out at prices well over $1.00.

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.

RHT Oct 17 to Oct 18.PNG

While there is a short recovery in late June / early July, the bulk of this chart communicates the following:

  • Price has been trending down, and has been firmly below both moving averages since August 2018.
  • The 10 week moving average is clearly pointing down, and the 30 week moving average, having come off its peak, is starting to do the same.

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:

  • How risk tolerant you are. If this meltdown has cost you a lot of sleep, then it may make sense to unload the shares.
  • Your time horizon. Are you trying to make a profit in a week, a month, a year, or 10 years ? It is always harder to be right in the very short term.
  • Are you working with a lot of capital ?  If you have a lot, then this loss shouldn’t impact you severely and you could continue to hold – and hope.

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: greyswan2@gmail.com

 

 

 

 

 

Reliq Health, Part 1: Bad vital signs…

RHT image

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:

 

RHT chart

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:

RHT tech 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.

RHT Mar 31 2017 balance sheet

 

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.

RHT Mar 31 2017 cash flow

 

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 analystsGiven 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.

BNN coverage of RHT

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.

RHT press

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:

  • Revenue: I had no idea what revenue might look like, so I projected various scenarios ranging from $1.0 MM to $15.0 MM.
  • COGS and Gross Margin: I decided to use the 2016 COGS% (58%) instead of the 2017 COGS% (80%), as using the 2017 COGS% would have required an astronomical jump in revenue.

RHT cogs

  • No growth in other expense items: I took total expenses for 2017 ($2,836127) and backed out amortization ($2,047), share based expenses ($243,305), and finance charges ($14,480) to arrive at an adjusted value of $2,576,295. I made the very optimistic assumption that Reliq could maintain expenses at this level, and used this value to calculate a go forward EBITDA value.
  • Total shares outstanding: I used the shares outstanding as of June 30 2017 (approximately 76 million shares) to calculate market cap and enterprise value.
  • Share price: I used the average price of the shares from November 01 to November 15 2017 (~ $0.65), as it was during this period that I was considering selling. The actual prices during this time ranged from $0.475 to $0.87.

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:

RHT ev to ebitda Oct 2017.PNG

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: greyswan2@gmail.com

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Titan Logix – revisited….

Titan Logix

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:

  • Attractive technical chart
  • Lots of cash & low debt
  • Reasonable cash burn
  • Clean earnings
  • High insider ownership
  • No institutional ownership & no analyst coverage
  • No self promotion
  • No share buyback
  • Out of favor sector
  • Business is easily understood
  • Potentially disruptive technology

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.

prod vs cons eia

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:

EIA WTI price 2013-2017

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.

Phases of price cycle.PNG

  • During the “low, flat price” part of the cycle: 
    • Producers are keeping a lid on costs, as price signals aren’t so strong that they are clearly signalling boom times. They are likely trying to keep service costs as low as possible, because price can’t cover up poor fiscal discipline. Additionally, because producers are so cost conscious, they are hesitant to spend to bring on new supply. At the same time, demand continues to grow, setting the stage for a demand-supply imbalance, and sowing the seeds for higher prices.
    • Service companies are reasonably busy. However, because prices are relatively flat, there are likely no new entrants into the marketplace. The number of competitors is probably fairly static. Anyone considering entering the market to compete is either well capitalized or has a strong business plan in place, as they know they will have to compete with existing service companies in an environment where producers are cost sensitive. Service companies are, for the most part, price takers.
  • During the “rising prices” part of the cycle:
    • Producers slowly start to see stronger price signals, and become more aggressive. Since they are always compared to their competitors, they are keenly aware of whether or not competitors are producing more than they are. Eventually, this combination of stronger pricing signals and “not wanting to be left behind” causes them to expand activity and bring on more production. In turn, their need for services increases, and they become less cost sensitive, as they can justify paying more given that the commodity price offsets increased service costs.
    • Service companies see their business increase. New service companies may enter the market, seeing increased activity and increased prices. Costs for services may go up, as the equipment of existing services companies is likely seeing higher utilization. New entrants may provide the incremental equipment required by producers, as existing companies may not be able to expand their fleets as quickly.
  • During the “rising & sustained high prices” part of the cycle:
    • Producers are all making money, as the sustained high prices hide all cost overruns. The most poorly capitalized/managed producers (usually chasing the highest cost projects) enter into the market, as with strong prices in hand, they can more easily sell their story in order to raise capital. With all producers running at “full tilt”, competition for services becomes fierce, and the most poorly managed producers drive up the price of services, as they likely lack fiscal discipline. The “produce at all costs” mentality sets the stage for oversupply.
    • Service companies likely have difficulty keeping up, and can therefore become price makers. Sensing the frenzied level of activity, they can effectively name their prices, knowing full well that producers have little choice. Like their producer brethren, even the most poorly managed service companies can turn a profit.
  • During the “low prices..again” part of the cycle:
    • Producers are likely stuck with high cost structure projects that were initiated during the high price environment. Saddled with the costs of these projects (that are not easily shed), they look for any costs they can easily and quickly reduce or eliminate. Negotiations with service companies become an exercise in “passing down the pain”, as they again become price makers out of necessity. New projects are either pushed off into the future or shelved entirely. Inventories of oversupplied commodity are slowly worked down.
    • Service companies see revenue declines and margin compression. Well capitalized service companies whose management (likely) have long tenures and anticipated the end of high prices are prepared, and can weather extended periods of low revenues. Poorly capitalized & poorly managed service companies exit via bankruptcy, or are swallowed by competitors. The pool of available companies shrinks, with only the strongest and best managed companies surviving. Once the cycle begins again, they are the ones that producers will turn to.

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:

  1. Titan is surviving because of its strong capital structure.
  2. Competitors are leaving (or have left) because they are poorly managed or have a weak capital structure, or both.
  3. When the sector starts to turn, there will be less companies to compete with, which means a higher concentration of business will fall into the hands of 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:  greyswan2@gmail.com

 

 

 

 

 

Titan Logix – a sleepy small cap wakes up.

Titan Logix.PNG

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:TLA chart Feb 2018

  • From mid-2016 through to February of 2017, the chart was almost flat, which told me interest in the company was low. Most investors that were in for a quick gain were long gone, so the shareholder base should be less flighty.
  • For the most part, volumes traded are also low, which is consistent with the idea that few investors are interested.
  • Low interest typically means low expectations. Low expectations mean that any positive news can potentially move the share price significantly higher. On the other hand, since most everybody has already given up on Titan, negative news probably won’t drive the share price much lower.
  • The moving average prices, in this case the 10 week and 30 week moving averages, had pretty much converged. However, there was no clear breakout to speak of. The share price was drifting along, neither moving up or down much.

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. Titan 3 months.PNG

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.

Titan cash flow.PNG

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: Titan 3 month Inc.PNG

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:

  • Directors and Officers do own shares, but not a large amount. Specifically Greg McGillis (CTO – 555,891 shares or ~ 2%) & Angela Schulz (CFO – 374,473 shares or 1.3%) hold shares. Alan Pyke (CEO) was hired as of February 23 2018, so he obviously held no shares at the time I made my first purchases.
  • Other significant individual shareholders on SEDI hold approximately 5.4 MM shares collectively, or about 19%. These are either shareholders that are identified on SEDI as directors, but are not identified as such on the Titan website, or persons who still hold shares but are flagged on SEDI as someone who has “Ceased to be Insider”.
  • The “Article 6 Marital Trust created under the First Amended and Restated Jerry Zucker Revocable Trust dated 4-2-07” holds 7.2 MM shares, or about 25%. This is what puts the insider picture firmly in the “neutral” camp. I could make no assertions about the motivations of this entity. Are they actively seeking to maximize the value of Titan ? I hope so, but I honestly can’t say, so the insider shareholder story flashes amber for now.

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:

  • I’m not expecting a 10x return on this. What I am expecting is that the oil & gas sector will recover, as cyclical sectors always do. When that happens, in 3-5 years, Titans revenues will increase, and their valuation and share price will follow.
  • I am expecting an annualized return of somewhere between 15% and 20% over a 3-5 year period. This means a recovery in the Titan share price of somewhere between $0.90 (20% annually over 3 years) and $1.05 (15% annually over 5 years).
  • I believe that this a relatively “low risk” opportunity. Professional money managers will beg to differ, citing the small market capitalization of Titan. However, this is what creates price inefficiency – the perception of “because it’s small, it must be risky” vs the fact that the company is debt free and cash rich, which mitigates a large degree of risk.
  • As of the writing of this (September 14th 2018), Titan has flirted with prices as high  as $0.65, and has closed fairly consistently above $0.60. While these both suggest returns north of 15% over a very short hold period, I believe the oil & gas sector is slowly on the mend, and am willing to hold given the limited downside.
  • Lastly, commodity sectors are cyclical, and the purchase of Titan occurred nearer to the bottom than the top. Energy demand tends to grow slowly and steadily, whereas energy production is driven by skittish producers who often shelve projects until market signals are as obvious as billboards. Although I don’t know when that time will come, I know it will, and in the meantime Titan can weather the storm.

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: greyswan2@gmail.com

 

 

 

 

 

 

 

 

Pioneering Technologies: Post Mortem?

PTE logo

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:

  • There is no debt on the balance sheet: No debt means that insolvency risk is about as close to zero as one can get.
  • G&A expenses have remained static: Total G&A expense for the 3 and 9  months ended June 2018 was $1.5 MM and $4.5 MM respectively. One of the things I was looking for in these statements was no further growth in G&A. The fact that both of these, when extrapolated over 1 year, end up at the same place ($6.0 MM) is a good thing. This suggests to me that the G&A structure is basically “in place”, and that we hopefully shouldn’t see further growth in overhead.
  • Cash + short term investments aren’t all gone: The company has $5.7 MM in cash and short term investments. For the 3 months ended June 2018, they burned $1.07 MM, and for the 9 months they burned $2.02 MM. If we assume they continue to burn cash (and essentially cannot sell significant product volumes) at the 3 month burn rate, then they will use up their entire cash position in about 16 months. If this does indeed occur, then I will be losing a significant amount of money, and I will be eating more than my share of humble pie. However, I believe management is highly incented to make sure this does not happen. Which brings me to my next point.
  • Management still owns a significant number of shares: If you add up the 5 largest holdings of individual insiders (Dueck, Paterson, Pavan, Callahan, & Shah) they total ~ 23 MM shares, or about 35% of the fully diluted share count of 64.5 MM shares.  While it is probably true that these guys are all (likely) wealthier than you or I, they too have “felt the pain”. Collectively, this group of insiders has “lost” a combined ~ $31 MM ($1.50 peak price – $0.15 price today). You can imagine that they are likely very interested in seeing the share price move back in the right direction.
  • UL 858 compliance isn’t sexy: When was the last time you were at a cocktail party and someone wanted to talk to you about “a safer stove”. My guess is never. The concept that PTE is selling (kitchen fire safety) and the niches that it is targeting (Seniors, University, Co-op housing) are boring. Consumer awareness of this issue is still close to zero, as “compliant” stoves likely won’t show up in showrooms till some time in 2019. This story is not blockchain or cannabis, and that being the case, many investors will not become re-engaged with it until the financial results start telling a different story. In the meantime, I would expect that we will see a flat-lined technical chart at best.
  • UL 858 compliance isn’t sexy, but someone is still noticing: There were three recent press releases regarding partnerships with HPN select (purchasing group for Co-op housing), Millers Mutual (insurance company providing insurance discounts), and Buyers Access (purchasing group for multi-family housing). I would imagine that large organizations such as these don’t sit around and draw straws to see “who should we  partner with” or “what should we provide an insurance discount for”.  These are decisions that have to pass through various levels of decision making before they get the green light, and only then after they determine that this will also be good for their organization, not just Pioneering.  When the purchasing group you deal with carries a product, you (as a multi-family landlord) are far more likely to buy it – which in the long run means more sales. 
  • The opportunity is still there: If you do a quick Google search on “how many multi-family housing units in the USA” you will get a number of different answers. If you believe the U.S. Energy Information Administration, the number is around 16.5 MM, and that was in 2005. If you think the National Multi Housing Council is right, then the number is 17.8 MM. For the sake of clarity, these number represent the number of buildings that house 5 or more units. If you are include all rental stock, then this number is closer to 40 MM. These units aren’t going anywhere anytime soon – they are still sitting there. Granted, everyone won’t want to buy a “Smart burner”, but it stands to reason that some will.
  • The company is priced for oblivion. Right now (Q4 2018), at a share price of $0.14, the company has a market cap (using basic shares outstanding) of $7.2 MM. Adjusting for cash on the balance sheet, this implies an Enterprise value of $1.5 MM. If the product that Pioneering is offering is truly useless, and nobody wants to buy it, then this valuation is correct. In turn, if that is correct, then organizations such as HPN Select, Buyers Access, and Millers Mutual have made some very poor decisions. However, my guess is that someone out there finds value in the concept of reduced risk of fire, and in turn, a reduction in related issues such as false alarms and property damage. Like a lot of other shareholders, I’m just going to have to wait.

As always, these are only my thoughts and opinions. If you have questions or comments, I can be reached at: greyswan2@gmail.com

 

 

 

 

 

 

Pioneering Technologies: Part 4

PTE logo

  • Parts 1 through 3 reviewed recent activity, solvency and risk, and future potential.
  • In Part 3, we determined that regulation changes in 2019 could drive large sales.
  • In Part 4, we show how increased sales will impact the company and share price.

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):

 

Staples smartburner.png

Source: https://www.staples.com/Smart Burner/directory_Smart Burner

Wilmar smart burnerr.png

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%.”

Source: https://www.pros.com/blog/distributor-pricing-profit-margins-pricing-markups/

This is validated via another source, as shown below:

Reasonable markup to distributors.png

Source: http://www.tom-gray.com/2012/04/26/reasonable-markup-to-distributors/

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:

PTE 274000 units.png

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.

 

Pioneering Technologies: Part 3

PTE logo

  • Part 1 reviewed recent share price activity from 2016 to today.
  • Part 2 compared Pioneering financials today vs the those prior to latest financing.
  • Company is not at risk of going bankrupt, & balance sheet is solid.
  • However, the question of future sales volumes is still unanswered.

When we ended our discussion of Pioneering in Part 2, the key question we were trying to answer was one of sales: can Pioneering increase sales of the Smart Burner, and when. However, to understand the sales story, we should also understand the product, why it appeals to a particular market segment, and how large this market segment is.

The product is unique.   The Smart Burner is unique in that it prevents a fire from occurring, rather than setting off an alarm after the fact, or putting out the fire via an attached automated fire extinguisher or sprinkler. There are a number of safety devices on the market that do one (or perhaps even both), but one of the key points raised by end users is that prevention of combustion is far superior to an alarm or a product that extinguishes a fire after the fact. End users have highlighted that once an alarm is set off, the building may still need to be evacuated, and the local fire department may be on the way, regardless of whether or not the fire has been extinguished. When viewed in the context of an apartment building, this causes inconvenience for the residents, and may imply some cost to the building operator for each visit by the fire department. Additionally, residents & property are clearly less at risk from a situation where there is no combustion vs one where combustion occurs and is extinguished.

In addition to this, the Smart Burner is unique in that it meets the pending change to UL858 (Underwriter Laboratories) regulation, which will take effect in early 2019. The UL858 change will necessitate that all coil top stoves sold in the North American market must pass an ignition test. The test requires that an electric coil top stove, at it’s maximum setting, must be allowed to operate for 30 minutes with a pan of cooking oil on the element.  The stove must operate for 30 minutes or until such time that the cooking oil ignites. If ignition occurs, then the product cannot be sold North America.

The product is meeting a distinct need.   Statistics indicate that the vast majority of fires start in the kitchen, so the product has a clear application. The pie chart (below) shows quite clearly that over ½ of all residential fires start as a function of cooking. While this particular pie chart represents fires in Great Britain, data from the US National Fire Protection Association (NFPA)  is consistent with British statistics (NFPA data also shown below).

British kitchen fire stats.png

Source: https://www.ifsecglobal.com/innovation-at-ifsec-fire-safety-products-for-the-kitchen-by-innohome/

NFPA kitchen fire stats.png

Source: https://www.nfpa.org/Public-Education/By-topic/Top-causes-of-fire/Cooking

This data suggests that there is a very clear niche market that is currently not being addressed. However, while it is clear that a market exists, we have to ask how large this market is.

 

The size of the potential market is large.  Data sourced from the National Multi Family Housing Council provides the following snapshot of the US housing population:

US households by type.png

Source: https://www.nmhc.org/research-insight/quick-facts-figures/quick-facts-resident-demographics/

From this data, we can quickly see that there are 118 Million households in the US that could potentially install a Smart Burner. Of this total amount, we will ignore the Owner-Occupied segment. Home owners are far more likely to purchase a stove that is esthetically pleasing (glass top, gas, induction) vs one that is utilitarian. By comparison, the 43.8 MM rental units are owned by landlords, who are typically driven by cost and functionality. If we put ourselves in the shoes of a landlord, we can see that traditional coil top stoves are an easy choice for rental units based on the following criteria:

Landlords and stove type

While a landlord may ultimately put in whatever they want, for the various reasons shown above, coil top stoves are an easy choice. Coil top stoves are cheap, simple, pose no extra risk from a natural gas source, have no cooking surface (glass top) that can shatter, and do not require special pots or pans to be used. So from this data, we can say that out of the 118 Million households, the 43.8 Million rental households are the likely candidates for the installation of a Smart Burner.

With this data in hand, we then have to ask ourselves how many of these landlords will install a Smart Burner ? Again, the exact answer is difficult to pinpoint, but to answer this we will look at the implementation of another safety device – the home smoke alarm.

The first battery operated smoke alarm was available as far back as 1969. However, smoke alarms were not widely used, given that there was no law or regulation that required their use. In 1972, about 200,000 smoke alarms were sold in the United States. This changed significantly in 1976, when the NFPA (National Fire Protection Association) passed NFPA101, which was referred to as the “Life Safety Code”. This was the first document that stated “smoke alarms are required to be in every home”. By 1976, 8 Million units were sold, and in 1977, 12 Million units.

Source: http://www.mysmokealarmla.org/history-of-smoke-alarms/

This information highlights two important consumer trends. First, if consumers are left to their own devices, the majority tend not to implement safety improvements. This is not entirely surprising. Readers who live in jurisdictions where it snows have experienced this. While snow tires significantly improve stopping in winter conditions, many consumers prefer to use all season tires in order to save money.

Secondly, when regulation finally takes effect, the purchase of the device can experience a sharp increase. While the parallel between smoke alarms and the Smart Burner is not exactly the same, we are also not suggesting that the increase in Smart Burner purchases would be this significant. What we are saying is that the change in the UL858 standard will create awareness, and consumers (such as landlords) may be more likely to purchase a Smart Burner for their rental units.

This brings us back to our question, specifically, how many of these landlords will install a Smart Burner ?  Based on our smoke alarm example, we know that the introduction of regulation increased sales by a factor of 40 – but this was in 1976. To better understand what total sales of 8,000,000 smoke alarms in 1976 really means, we have to understand what the population of the US was in 1976, which (lucky for us) is relatively easy to do:

US population 1976

Source: https://www.google.ca/search?source=hp&ei=57YNW_WPOJr7jwTnkIqIAQ&q=Population+of+the+USA+in+1976&oq=Population+of+the+USA+in+1976&gs_l=psy-ab.12..0i22i10i30k1.370.6433.0.9649.30.21.0.0.0.0.283.3030.0j13j4.17.0….0…1c.1.64.psy-ab..13.17.3024.0..0j35i39k1j0i67k1j0i22i30k1.0.rgfatTHyJiY

Lastly, because we are comparing “households”, we have to adjust for the number of people per household, which has changed since 1976. Again, this is also easy to find:

US households size in 1976.png

Source: https://www.google.ca/search?ei=8rYNW8H7FqfojwT4_YBA&q=Average+household+size+in+USA+1976&oq=Average+household+size+in+USA+1976&gs_l=psy-ab.3…56520.64131.0.65177.34.23.0.10.10.0.257.2780.0j15j2.17.0….0…1c.1.64.psy-ab..8.25.2622…0j35i39k1j0i131i67k1j0i131k1j0i67k1j0i20i263k1j0i22i30k1j0i22i10i30k1.0.PVxKOQjp-hM

From all of this data, we can infer that in 1976 there were 75,432,526 total households (218,000,000 total population  / 2.89 persons per household), of which 8,000,000 purchased smoke detectors after the introduction of NFPA 101, or a total of 10.6% of all US households.

This answers our question as to what percentage of landlords might purchase a Smart Burner. However, we would suggest this 10.6% to be a “pie in the sky” type of figure. The UL858 change will require that any new coil top stove sold in North America is compliant – not that any homeowner or landlord (who already owns a stove) must be compliant with a stove they already own. We would suggest that once the UL858 change takes effect, and compliant products begin to show up at retailers, consumer awareness will increase, which in turn will spur sales of the Smart Burner. Landlords, seeing that  “safer” stoves are available, may want to achieve a similar level of safety with their existing coil top stoves. By reducing false alarms and potential fires, a Smart Burner may be able to save them money via reduced insurance rates, or simply decreases the risk profile of their housing units. So, some landlords may decide to purchase a Smart Burner to better equip & de-risk their housing portfolio. Like any new (or disruptive) technology, adoption does not occur “en masse”, and different people (and organizations) will take more or less time to decide to adopt a new product or methodology. This is consistent with what is known as “The Technology Adoption Curve”, which is shown below:

Tech adoption curve

Source: http://www.web-strategist.com/blog/2010/01/03/social-technology-adoption-curve-benefits-and-risks/

One can see that “Innovators”, who are early adopters of new technology, make up 2.5% of the potential marketplace. To be very clear, we are not suggesting that a safety device such as the Smart Burner is as sexy (or interesting) as an Iphone, we are simply highlighting what percentage of “innovative” landlords might be tempted to purchase a Smart Burner. In addition to this, it is unlikely that the entire 2.5% of the landlords that are “Innovators” will suddenly rush to order the product come 2019. Because of this, we would suggest that only a portion of this group will be interested in purchasing a Smart Burner in 2019. We would err on the side of conservatism, and in doing so, suggest that perhaps 25% of potential “Innovators” might purchase a Smart Burner in 2019, or 274,000 in total (43.8 MM x 2.5% x 25%).

In summary, our lengthy discussion of the potential market size (and the associated opportunity) highlights a few key points:

  • For various reasons, landlords likely favor coil top stoves for their units.
  • Because of this, landlords will be a very likely market for the Smart Burner.
  • Landlords control approximately 43.8 Million housing units in the US.
  • The UL858 standard change will create more awareness, and potentially more sales.
  • Increased sales of the Smart Burner would most likely happen in 2019 or later.
  • People (or companies) that are early innovators tend to make up 2.5% of the potential population, or approximately 1.1 MM of the potential 43.8 MM rental units.
  • Lastly, because people (and organizations) tend to move slowly, we would suggest that only 25% of the 2.5% of “Innovators” (approximately 274,000) would be initiating orders for the product once regulation changes in 2019.

This information provides a more definitive answer to the question we were left with at the end of Part 2. When we concluded Part 2 of our review, we had determined that the “million dollar question” was if Pioneering could actually sell increased volumes of the Smart Burner, and if so, when might we see these increased sales.  Having answered this question, Part 4 of our review will focus on how such increased sales might impact earnings & share price.