President's Club: Various updates

IBI Group (IBG.TO) shares continue to deliver, having hit a number of new highs over the past month. We’re up nicely, to the tune of about 250% from first write up in 18 months. With infrastructure spending on the rise, particularly dollars directed at transit systems, IBI should deliver the revenues and earnings to justify its valuation. The company beat analysts’ expectations in the first quarter as well. The easy money has been made on this name. I’ve sold my shares and bought the 5.5% convertible debenture. If the stock goes above $8.30 I can convert the debt into shares for a gain. And with the interest coupon I'm paid to wait. The debenture are listed but aren’t very liquid. 

Colabor Group (GCL.TO) had a good run from our original recommendation but the stock took a drop after the release of Q4 earnings and then a harder drop after the release of Q1 results. While 2016 saw strong improvement     year-over-year with operating income of $19 million, a 73% increase, the fourth quarter tempered investor enthusiasm, with sales and EBITDA down slightly once you factor in that there were more days in the fourth quarter of 2016. The first-quarter was worse, with revenues down 16% and operating income down year about 50%. The last two quarters have brought to a halt the solid improvements we saw in the first three quarters of last year.

One problem is more competition in the distribution business in Quebec which led to lower revenue and margins. This was partly offset by cost cuts and better results from the seafood division. But that’s largely noise - competition comes and goes and is a fact of life in all industries. Deflation in beef prices also hurt (because food distributors charge a margin over the cost of the inventory they sell, falling prices hurt them. Even if the margin stays the same it falls in absolute dollars.) Again, cyclical noise, but damaging in the short term. 

There is some good news. The table below examines Colabor’s cash flows for the year 2016 and the most recent quarter. As you can see, the company generated significant cash in 2016. Operating cash flow, which is essentially net income plus non-cash items, was up slightly. But the company was able to wring an extra $10 million from working capital, a big improvement (falling net working capital is a good thing as it means the company is liberating cash form the balance sheet): 

The first quarter saw that trend reverse, with the balance sheet sucking in money. Cash from operations (before working capital items) was a big improvement, although still a loss as Q1 is the weakest quarter. But working capital went up as well. Because of this debt increased in the first quarter after being slashed last year:

So all in all it’s been a mixed bag. We saw great improvement in the balance sheet into the start of the year but that momentum has stalled for now, revenues are down as are earnings (this is a volatile business, it needs to be noted.)  This would be a bad sign but for one thing: the insiders keep buying. The most recent purchase was by the CEO, of 30,000 shares at $1.20 on March 3. In fact, all of the insiders, but for one notable exception, have been nothing but buyers for more than two years, often at higher prices than the current quote. And the CEO bought made that recent purchase pretty much knowing what the first quarter looked like. All in all insiders have been net buyers of millions of shares over the past 28 months. 

You’ll recall that the new executive vice-chairman, food distribution veteran Robert Briscoe, bought $5.5 million of stock last fall in the rights issue. 

Now, as mentioned, there is one notable exception: the late Jerry Zucker’s trust, which is an insider by virtue of being a +10% owner and having a representative on the board and which was one of the investors that backstopped the rights issue last fall. Up until February of 2016 it had been a relentless buyer, accumulating a position of 3.3 million shares. It was also buying convertible debentures.  It then started to sell a little, bringing its holdings down 3.2 million shares by October.

In the rights issue, it acquired 12.2 million shares to bring its holdings to close to 16 million shares, and then started selling again, in drips and drabs, until by year-end it was down to 14.4 million shares. In March, one last sale shed 1.5 million shares. 

Why would the trust sell? Possibly because it found itself owning more stock than it wanted to after the rights issue. The selling appears to be over, at least for now, the last sale having taken place March 30, 2017, and the trust  and related entities remain very large shareholders. 

Even with this selling, the trust has been a big net buyer of stock, as have insiders as a whole. That keeps us hopeful that we’ll see the turnaround regain its momentum. Management seems upbeat. On the most recent conference call the CEO said the balance sheet should resume producing cash this year, which bodes well for debt reduction. It’s also likely that the second half of the year will show much more progress, with the closure of the Vaughan distribution centre bringing big savings, on top of other cost cuts. The company is also hiring more sales people to diversify and grow organically. 

Plus, with suppliers now more reassured that the company isn’t going under any time soon, we should see debt continue to fall as the company is able to buy inventory on better credit terms. We need another six months to see if this turnaround has legs. It’s hard to bet against massive insider buying. 

If you need proof that part of a management team’s job is marketing its stock, look no further than Ceapro (CZO.TO), which is a serious disappointment. There are marijuana companies with zero revenues, no license and even less hope with bigger market caps than Ceapro, which, despite Q1 earnings that were disappointing, nonetheless has revenue, earnings, big and credible upside and $8 million of cash in the bank. 

The difference? It’s all about marketing your story, and Ceapro is asleep at the switch in that regard. 

Let’s start with the earnings. It’s no surprise that Ceapro’s business can be lumpy but no one likes to see revenues drop 15% and profits almost vanish year-over-year. The company says sales of beta glucan were lower, partly offset by higher sales of the other key ingredient it manufactures avenanthramides. Ceapro sells a lot of its product through a big German distributor names Symrise but it also gets the occasional large order from other buyers, hence the lumpiness in revenues. Last year there was a large order from a Chinese buyer. 

But investors were clearly spooked by lower margins and profits. They may have over-reacted somewhat. 

First, while gross margin dropped from 70% to 54%, a lot of that has to do with the fact that the company was running two plants, the old one and the new one. It had to do this to compare product from each plant in order to get customers to certify the new plant. That appears to be done now, so costs should drop. 

EBITDA margins were also sharply lower but that was partly due to higher stock-option expense and much higher research and development which, if done properly, is not an expense but rather an investment in the future. 

Foreign exchange volatility also weighed on results.

In other words, the company’s profitability didn’t deteriorate nearly as badly as it seems. Still, lower revenues are a disappointment. 

But they aren’t as disappointing as management’s apparent indifference to telling its story. Not a single analyst covers the stock. And the company doesn’t do much marketing, which is apparent in the stock price. At one point not long ago Ceapro had a premium valuation and could have done a financing to build a war chest for acquisitions. That premium has been squandered. 

I met with CEO Gilles Gagnon a couple of months ago and he said he had a couple of complementary acquisitions in his crosshairs. If he does them now and finances with equity the company will be paying a lot more given the much lower stock price.

Gilles also told me that Ceapro’s technology could be used to extract compounds from marijuana. He said they could do it “better than anyone.” Given the massive enthusiasm for marijuana stocks one might expect the company to talk about this and perhaps even pursue something. But it’s clear the company has no interest in doing this even though it would be good for shareholders and in keeping with its broad business plan.. 

So while this business has tremendous possibility, if no one hears about it the stock will languish, and it is. 

A little marketing will bring the stock back to life. It remains to be seen if that will be a focus.

I caught up with Marc Murnaghan, CEO of Polaris Infrastructure (PIF.TO), three weeks ago and found him very frustrated. Not because things aren’t going well at the company - things are going very well - but because no one wants to buy his stock, or at least wanted to at the time. Since then it’s bounced nicely. 

To recap our adventures in this name, we first recommended at $10, and it went straight to $7. We bought a lot more and pounded the table and it went to almost $19. Since then it drifted to close to $13 before recovering recently. And yet things at the company have improved. 

Polaris generates its income, and pays its dividend, in US dollars, and the greenback has gone up nicely against the loonie lately. This makes the company more valuable in Canadian dollar terms. The dividend, currently at  48 US cents/year, is worth a yield of 4.1%. The board will likely raise the dividend again this year. 

That’s a solid yield for a growth story. Remember that Polaris has $47 million US of cash (almost $65 million Canadian against a market cap of $225 million Canadian). Those funds are earmarked for some pretty exciting growth projects, including a drill campaign, which Marc said will likely be starting soon, and the binary unit. 

The company has a purchase agreement for up to 72 megawatts of power from its geothermal plant. It’s a generous contract given the 80% EBITDA margins Polaris has been generating. The contract runs to 2029 and provides for 3% price increases/year to 2021 and 1.5%/year thereafter. But the company is only producing about 60 MW, so there’s room to sell more into the contract. Production should climb this year to reach 70 MW. Each MW adds $1 million US of free cash flow (i.e. cash that can be applied to the dividend. There are only 16 million shares out.)

Besides the new drilling the company is evaluating the purchase of a binary unit (or heat exchanger) that can add another 8-10 MW. It sounds like the binary unit will be a go. Both the drilling program and the binary unit can be financed with cash on hand. The binary unit is largely an off-the-shelf piece of equipment and thee are many deployed in the world, so little execution risk. The drilling will have unknown results, but past programs have yielded strong returns. Finally, the company has a enough turbine capacity to use any additional steam to create electricity.

All in all there is significant potential growth, without even talking about the as-of-yet untouched Casita property, a second geothermal location, and potentially small acquisitions in the green-energy space, which the company is contemplating. This would diversify and likely improve the stock price. 

Despite all this, as Marc lamented, the stock goes unloved, which is perplexing considering how loved it was not long ago and that the five analysts who cover the stock an average price target of about $23.  

The closest company to PIF is U.S. Geothermal. It trades at an EBITDA/Enterprise value of 10 times against 2017 estimates, whereas Polaris is only at about 5.5x. 

Certainly some investors will view PIF as riskier given that it’s asset is in Nicaragua. But analysts are using a 7x multiple (a hefty 30% discount) to reach their targets for PIF so this risk appears built into the estimates. 

The problem now is that stock price and chart, as Marc says, becomes a self-fulfilling prophecy. Investors look at it and assume something is wrong when in fact the opposite is true. 

The solution, and Marc knows this and is acting on it, is to reach out to new, big investors and tell them the story. This is an institutional-quality story and a big player looking for a $10 million position would firm up this stock price nicely. Marc, a former investment banker with good connections, was talking to a couple. Eventually, investors are drawn to cash flow, and there’s plenty of that in this story, so we assume buyers will return. 

Since we spoke the stock has firmed up nicely, and there was a day of 450,000 share volume. Another couple of days like that and the stock could touch its 52-week high. 

After a year of doing nothing Martinrea (MRE.TO) shares have finally started to move in the past six weeks. There’s probably more to come now as the PE multiple is still under 10x. The auto-parts maker posted earnings of 45 cents/share in the first quarter, a record. This was despite slightly lower revenues (thanks to foreign exchange headwinds mainly), meaning margins expanded sharply. Lower revenues with higher margins aren’t a worry for us. It’s clear that management dropped some less profitable business to concentrate of margins. That’s always a good thing in a turnaround.

You can expect that revenues won’t rise or not much at least for a variety of reasons, some technical. We would concentrate of profits and margins, as this should propel the stock higher if management delivers.

While Martinrea doesn’t usually produce free cash flow in the first quarter, because it is building up working capital for the rest of the year, it did so this time, with almost $30 million of free cash flow before dividends. That’s a positive sign.

A clearer way of looking at things is return on capital. In 2014, the first year of the turnaround, the figure was about 7%. The current annualized rate is about 8%, and analysts expect that to climb to 9% or so in the next year. That is still low compared to peers, and may point to the potential for upside surprises.

The most exciting stock in my portfolio is Helius Medical Technologies (HSM.TO). As repeated ad nauseum, my trading system for riskier stocks is to sell a little as/if it goes up in order to get some or all of my capital back and still own some stock in case it keeps going up. 

I did that with Helius as it traded well north of $2, a 100% gain from first recommendation. But then I bought a lot more in the $1.90 financing because I think the risk-reward profile has improved. So my position is about as big as ever and I think I’ll be able to trim it at higher prices.

Here’s why:

Soon, we’ll get news that the last patient has been enrolled in the traumatic brain injury (TBI) program. This has taken longer than expected but for a very good reason. Like any medical device, Helius' PoNS system works better on some patients than others. The company’s scientists have, after years of research, a pretty good idea on whom it will work better on. Factors range from patient dedication (you have to do a lot of physio in conjunction to using the device) to more scientific reasons.

The point is that the company wants to make sure all patients enrolled in the FDA trial match the ideal candidate as closely as possible to improve the overall results and likelihood of an FDA approval. So they’ve been very selective, rejecting many candidates and accepting few. Nonetheless, they are very close to enrolling the last one. At that point, it’s about six weeks until the trial is over and soon after the data goes to the FDA.

But the company will already have the data. What that means is that management sees the patient results coming from the trial, it just doesn’t know whether it’s seeing placebo or active data. But when I last spoke to the CEO, Phil Deschamps, he said there was no bad data. There was a range of results, some excellent (although outliers are removed from the final data) but none awful. And since we already know the device is safe and that there is an unmet need for TBI (meaning there’s nothing on the market that works) the thinking is that the FDA has no down side approving it, and perhaps a lot benefit to bestow on victims of TBI.

On top of this we have the other trials, such as MS, which are at earlier stages but nonetheless promising. Plus, recent data has led some to believe that even without an FDA stamp, there is a business here as the device can be sold over-the-counter.

As you know, the stocks of companies about to release major clinical data announcements tend to trade sharply higher (buy on rumour). We’ve seen it before. 

The run-up in HSM could be spectacular. While still highly speculative, it has massive upside, and management appears very confident. Last month the company signed a five-year lease on a building in Pennsylvania to serve as corporate headquarters, a clinical research site and a physical therapy training centre of excellence. I doubt they’d sign a lease if they had major doubts. Of course, they could be wrong. 

But more important is that the company is eyeing a Nasdaq listing. The company has asked investors to approve a reverse stock split at the upcoming annual meeting. It says it wants to do so to improve liquidity and make the stock more attractive, adding that some brokers/institutional investors won’t buy shares trading for low prices.They’re referring to a Nasdaq listing. There are U.S. investors who want to own the stock today but find low prices unsavoury. There are a lot more U.S. investors who will be buyers once the data is available, which is a matter of weeks away.

So what happens when a Canadian company reverse splits its stock and lists on Nasdaq? Typically the price goes sharply higher. 

Here is the stock char of Tucows Inc., which split its stock on Dec. 31, 2013 and listed on the Nasdaq:

You can also look at Points International, Cynapsus (acquired) and others. The track record is pretty consistent.

I’m looking forward to the same for Helius, soon.

Warmest regards,

The President's Club Team