HWO.to Q1 2017 – quick update

I picked up some shares of High Arctic Energy Services post Q1 earnings and after the AGM. I like the risk/reward of this company given where I think we are in the cycle.

The company has a strong position in PNG and recent acquisition in Canada should ensure that earnings stay at least flat through the cycle.  Concord Well Servicing (came over with the Tervita assets acquisition) has a large fleet in the WCSB and the stabilization in oil should bring stronger utilization throughout 2017.

I believe there are other opportunities in Canada to pick up some assets on the cheap. Hopefully we will see more in 2017.

Management is conservative with leverage and has done a good job of taking advantage of the downturn.

Another nice tidbit is the board is going to limit the total dilution potential via stock options to management. The proposal passed at the AGM but 15-20% of shares voted against the option, DSU and RSU plan.

Valuation

HWO.to nearly net cash and trading at 5-6x ttm FCF. Shares trade quite cheap for a few reasons:

  • cyclical company during the worst downturn in oil and gas in many cycles
  • I don’t think the investment community appreciates their PNG operations
  • 42% of shares are held by Cyrus Capital making this company quite illiquid

Risks

  • the obvious is activity based on the price of oil
  • PNG may be lumpy given that the company operates a small amount of rigs and having 2 idle for a long duration will hurt revenue from PNG
  • short term volatility if Cyrus decides to liquidate their position in such an illiquid stock

Feel free to comment;

 

Dean

 

The author is long HWO.to at time of writing.

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High Arctic Energy Services – (HWO.to)

I started this post in late 2016. Since then the company has released Q4 2016 numbers. Though not 100% up to date, all the arguments are relative today.

I will be the first to admit that I have had mixed results investing in oil and gas related names. I think it’s pretty safe to say that we are closer to the bottom of the cycle than the top, but who knows.

I have owned HWO.to in the past and was lucky enough to sell mid 2014. Recently I have been sniffing around the O&G services companies in hopes of finding a company that will not only survive the current environment, but be bigger and better for the next cycle.

I believe HWO is a great example of a company taking advantage of the downturn by purchasing assets on the cheap in a non-dilutive manner.

PNG

The majority of their revenue comes from Papua New Guinea (see below for quarterly revenue).

geo_split

They own some high quality rigs in an environment where they have been able to keep several rigs utilized at any given time. PNG has been stable due to the large natural gas reserves and their LNG prospects. HWO has operated their for 9 years and built strong relationships with the major players. Admittedly, there is risk that the rigs in PNG are able to find work after their contracts are up.

Canadian Operations

For most part HWO’s Canadian operations have followed the overall business activity in Canada. Some decent Q’s, some lackluster and the typical spring break-up that’s associated with Western Canada.

This summer HWO acquired assets from TerVita. This including 85 rigs with various capabilities, rental equipment, engineering services, 5 owned locations, 300 employees and the right to use the legacy brand (which has a 30 year history in the marketplace). Apparently TerVita had too high of a debt load going into the downturn.

Thesis

The thesis is quite simple. The PNG operations I think are worth at least the current share price. They have a handful of high quality rigs, equipment rentals, and of course their existing presence.

The upside comes from two places:

  1. Increased activity in Western Canada. I’ll let the reader draw their own conclusions, but prices and activity seem to have stabilized in Alberta. Many service companies are recalling crews for the winter.
  2. Strong management team with several levers to pull to grow the business. I think the recent acquisitions show a patience and discipline in the current environment. Holding cash and waiting for the right opportunity takes time. I have seen several companies enter this downturn with excess cash only to wait too long to cut expenses and waste the opportunity. The chart below shows when HWO made major growth expenditures. (I did have to make some assumptions on what constitutes “growth”) As you can see the majority has been in the last quarter. The interim CEO was the former President and CEO of IROC Energy Services. He is interested in growing HWO given the current opportunity.

capex

Valuation

Market Cap and Enterprise Value are around $260mil. Using some assumptions, I think 40-50 mil in FCF is reasonable from operations. Making HWO trading at 5-7x FCF. Pretty cheap without having much contribution from Canadian operations.

I’ll be at the AGM in May.

hwo-investor-presentation-oct2016

Q4_Investor_Presentation_March_2017_03232017

Anyone else own HWO or finding value in the O&G market?

 

Thanks,

 

Dean

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BioSyent – RX.v

This post will be a short post as BioSyent is well known in the investment community and I have nothing material to add. Instead I will focus on how my view of a BioSyent type company has changed.

BioSyent almost perfectly embodies my maturity as investor. The company has grown rapidly, operates in a market that I am not well versed on, and is expensive.

In the past I would have overlooked BioSyent immediately. And to be honest I had initially overlooked it when it was first mentioned on twitter when shares where less than $1.00. As I was developing my qualitative skills as a microcap investor I wanted to get exposure to best in class management teams. A tagged along with a friend as was introduced to management of BioSyent. I was impressed and was willing to at the very least follow RX.v to see if there would ever be an opportunity to purchase shares at a more reasonable valuation.

I started formally tracking BioSyent in mid 2015. Shares were trading about where they are today after running all the way from under $1.00 to over $12.

I have seen a pattern with many high growth companies. The company usually is dramatically undervalued and shares trade extremely cheap. Then something changes the future of the business and the market is slow to react. The share price increases but not as quickly as the fundamentals of the business. As the company continues to execute the increase in valuation is higher than the increase in earnings. Suddenly, the company can do no wrong. Eventually the company’s momentum wanes and there is nothing to support the high valuation. Shares come back down to earth on the slightest stumble or pause in growth.

There are a few different likely outcomes:

  1. The rise in earnings was a temporary phenomenon and the shares will continue to trade lower.
  2. The rise is earnings is sustainable but the growth has disappeared as the share price needs to re-rate to the new reality.
  3. The rise in earnings is temporarily paused and the company enters transition mode. New products/services are being introduced, but do not drive enough revenue to have an impact to overall results. While the transition period drags on the shareholder base is slowly churned through. Many start to question whether or not they will see growth again. Short term investors are slowly replaced by longer term investors who believe in the story.

Being long RX.v I obviously believe we are in the middle of the 3rd outcome. The valuation of RX.v is high, but I am comfortable that my capital is being put to work wisely and management is aligned with shareholders.

The share price may be volatile in the short term, but looking out 2-5 years, I beleive $8/share will appear cheap. BioSyent may have fallen victim to tax loss selling and/or additional selling pressure as a Canadian investor’s shun all things pharma related after the blowup of Valeant.

Are there company’s that you are willing to pay a premium for?

Thanks,

Dean

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Pulse Seismic (PSD.to)

I recently purchased some shares in Pulse Seismic. I have been loosely following Pulse for several years but never in any detail. It has been profiled on a couple of blogs some time ago.

http://www.aboveaverageodds.com/2011/01/24/investment-analysis-pulse-data-inc-psd-to-it-doesnt-get-more-asymmetric-than-this/

http://www.punchcardresearch.com/pulse-seismic-a-wide-moat-company-drowning-in-cash/

I mentioned on twitter way back in August that I was looking at O&G service companies again.

og_twitter

Thankfully I didn’t have to look far. My thought process for investing in oil and gas companies in the current environment is:

  1. Must have the ability to cut expenses and run at or near break even (on a full year basis) at the current level of activity
  2. Must have a clean balance sheet so the company can use the downturn as an opportunity to expand the business
    1. The last thing I want is to have the company do a large dilutive share raise and multi-year lows in the share price
  3. Must have a capable management team with high integrity and spacial awareness to understand where the current opportunities are

The idea is to find a company that can ride out the downturn and be a larger business providing more value for all stakeholders during the eventual recovery. If I am able to find a company that meets all three of these, then I should theoretically be hoping for a long pronounced downturn as it will only expose more opportunities for the business to grow.

Brief description of Pulse

Pulse Seismic Inc. is a Canada-based seismic data library company. The Company is engaged in the acquisition, marketing and licensing of two-dimensional (2D) and three-dimensional (3D) seismic data for the energy sector in Western Canada. The Company has a seismic data library in Canada, which includes approximately 28,600 net square kilometers of 3D seismic and 447,000 net kilometers of 2D seismic. The Company’s library covers the Western Canada Sedimentary Basin (WCSB). The Company’s seismic data is used by oil and natural gas exploration and development companies to identify portions of geological formations that may to hold hydrocarbons. The Company’s seismic data is used in conjunction with well logging data, well core comparisons, geological mapping and surface outcrops to create a map of the Earth’s subsurface at various depths. It designs, markets and operates participation surveys and grants licenses to the seismic data acquired to parties that participate in the surveys.

Let’s take a closer look at Pulse to see if it ticks all the boxes.

  1. Ability to cut expenses to get to breakeven.

Given the nature of their product and the overall cost of the survey relative to the large expense of drilling for oil, they are able to maintain high margins regardless of activity. Their product is a very minor expense relative to the overall cost to drill. They are not interested in racing to the bottom in regards to pricing. That only damages their brand and will be very hard to claw back in the eventual upswing. Pulse has less than 20 employees and most costs for shooting the surveys are contracted out. As you can see below they have been able to maintain their margins with less business activity. The last chart shows that they have reduced opex to align with business activity. It’s reassuring that they are not sitting on their hands waiting for a recovery. They have also cut their dividend to preserve cash.

psd_ttm_s

psd_ttm_margin

psd_opex_ttm

2. Clean balance sheet to leverage as opportunities arise.

The company has paid back all the debt it took on from a large acquisition in 2010 and is now in a net cash position. They have also purchased shares and used to pay a dividend.

psd_bs

Given the ability to mirror opex with business activity, this company could take on a decent amount of debt without concern.

3. High integrity management team with ability to see opportunities.

This part of the due diligence process is subjective. The qualitative part of an investment is always the trickiest. The board is completely independent, experienced in the industry, versed on capital markets, and together own over 30% of the company. They also give a skill matrix in their MIC.

board_comp_psd

Management compensation is reasonable for a company this size. Their competition is global, were as they are not. So they need to know the geography inside and out. As well, the sales team needs to know the ins and outs of every project in the territory.

They have a couple of levers in regards to business growth.

  1. They can make a straight up purchase from E&Ps directly. The value of the contract may not be material to the overall costs associated with drilling for oil. Having said that, during a downturn all options are explored to be monetized.
  2. They could buy surveys from a competitor. Though not likely, it is always possible.
  3. They could conduct another participation survey. They help by doing some pre-funding but most initial costs are paid by end users.

Summing it all up

I think Pulse ticks all three boxes. In order to invest in this company you have to get comfortable to their exposure to oil and gas.

Pros

  • able to mirror expenses with activity quite easily
  • high value add product to customers
  • no debt

Cons

  • given how unique the business is, growth opportunities may not present themselves
  • they never really get expensive on a P/E or EV/EBITDA valuation
    • It’s likely from the fact that their revenues are not recurring and they have exposure to an industry which is extremely cyclical

Let me know if you are finding any value out there.

Thanks,

Dean

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Sangoma Technologies Corp (STC.v) – Update

I am going through my current portfolio and sharing thoughts on my holdings in hope of getting some feedback from readers. At the very least, it’s a therapeutic exercise for me. Please don’t expect clear succinct thoughts from these posts, it’s more of a mental dumping ground for my brain.

I originally wrote up Sangoma way back here and briefly mentioned it here. Since writing Sangoma has made some acquisitions (and integrated them), invested new products and services, and is seeking a larger share of wallet from customers. Since coming onboard, the CEO has stated that he wants to grow top line and move away from one time product sales towards having recurring revenue to remove lumpiness in the business.

All this has led to a shift in the financials as the new services, acquisitions, and legacy products all have different margin profiles. As with many analysts on the conference calls, I was somewhat skeptical of the desire for top line growth given how much cash was sitting idle. Most of the high cash net-nets sit on cash and do nothing with it. At least with Sangoma, management was acting.

All the hard work has led to a higher top line, less lumpiness through the year, and still have the combined gross margins above 60%. Operating margins have been challenged as this work was integrated and more expenses were required to market to new verticals and geographies. All this was done while maintaining positive net income over the last two years in a corner of the market that is not booming.

The tone from management has been consistent stable growth in top line will translate into a stronger bottom line eventually. Around 40% of revenue is now coming from services and the legacy products now make up about 30% of revenue.

Below is a look at their product vs. service revenue mix. Quite a change. And you can see the working capital required as a % of revenue has declined as well.

STC rev mixstc-wc

Here is a look at the new IP phones that bundle several of their products together. Demand has been strong according to the last two conference calls.

Over the last two years there have been some angry investors attending the conference calls that were not supportive of management’s actions (I could only imagine how many emails and calls the company has gotten directly). From my vantage point, management has executed the plan that they have consistently communincated to investors.

Will 2017 be the year that we see the hard work bear fruit? I am betting on it.

STC.v was also mentioned on Investorfile.

Q1 2017 results should be out really soon.

 

*author is long shares at time of writing

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Why I Sold MUEL

I recently sold Paul Mueller Co. I thought I would go into a little detail on the decision. The decision relates to how I have evolved as an investor. For those who want the history, please read my previous post.

Paul Mueller Company is a provider of manufactured equipment and components for the food, dairy, beverage, transportation, chemical, pharmaceutical, and other industries, as well as the dairy farm market. Overall I think that the company has done a decent job running the business. Of the four segments (Dairy Farm Equipment, Industrial Equipment, Field Fabrication and Transportation); Dairy and Industrial make up the majority of the top line for the consolidated company.

MEUL_segment_split

Dairy has been stable  since the acquisitions post 2007-08. I was hoping for the Industrial segment to post some sort of turnaround in 2015. That has not happened.

MUEL_dairy_and_ind

The company’s valuation is still quite cheap without any contribution from the Industrial (or Field Fab and Transportation) segments.

MUEL_valuation

So there are a few questions to get comfortable with the company as an investment:

  1. Does the Dairy segment continue to do well?
  2. Does Industrial turn around?
  3. If yes to the first two, does the valuation of the company improve?
  4. And aside from all 3 of those, is this a business run by quality mgmt?
  5. Lastly, does the pension liability on the balance truly reflect reality?

I honestly can’t really answer any of the above. I never really could. My original thinking was that if I buy shares cheap enough, I don’t really need to answer any of these questions. That’s not a bad way to invest, it’s just not the way I have gotten the most comfortable with.

When you buy a business like MUEL, you are buying a business with low(ish) product differentiation, capital intensive, and the business is subject to shocks that are beyond the control of the current management team. As well, you aren’t getting a ton of communication with the outside investor world. When buying microcaps, you hope for a business that is somewhat nimble, you aren’t getting that with MUEL.

It should be mentioned that MUEL has recently announced a share buyback. With such low volume on the stock, it could really move the stock higher.

In order to properly accommodate all the specific risks with MUEL you would need a portfolio that has 20-30 names. As well the amount of churn in the portfolio would have to be high. Something I don’t have time nor the personality for.

You may think that I will shun commoditized businesses or a business with little product differentiation to end users, that is not entirely correct. I have been putting a lot of thought into whether or not you buy companies that are part of a market that is commoditized or with little barriers to entry, and the answer of course….it depends. I’ll try and get some thoughts down to encourage conversation.

Thanks,

Dean

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Life After Renting for 1.5 years

I feel bad sometimes for not posting more on the Petty Cash. The site has brought a ton of connections and ideas to me and sometimes I forget that. I heard somewhere that the key to any successful relationship is low expectations, I think that applies to anyone still following the site. Expect (next to) nothing and be happy when anything happens.

I want to take some dedicated mental energy and share how the transition from owning a home to renting has been. To be fair, I don’t know if owning is better than renting I just know it works for me. This won’t be me convincing you to rent or buy, but just me putting some thoughts, feelings and experiences out there. For my family owning vs. renting really came down to the math.

I know there are many home owners out there who are waiting for a crash and want to time the market. As well, there are many people who don’t own currently that feel the societal pressure to own a home.

First, the former is just a stupid idea. To think you can actually time when the market is going to crash (and presumably jump back in after the crash) is asinine. Your ability to time the market is likely no better than anyone else’s.

The latter is tough to quantify. Generally we have been taught as Canadians that anyone successful owns a home and learn to associate renting as someone who “is starting out” or “doesn’t get it”. People said congrats when I told them that I was approved for a mortgage. In fact, many people brag on how much they are approved for. When I tell people that I sold my house to rent I get this puzzled look. Most immediate dismiss anything that comes out of my mouth after that. “How can he know anything about investing (or anything else for that matter) if he isn’t even smart enough to buy a house.”  That’s what I imagine others are thinking of my decision. It takes more courage than you realize to act upon something that makes sense for your family when you know you will be scrutinized by your peers, friends, co-workers, etc.

For me and my family it came down to math. Simply removing emotion and letting actual facts make the decision.

Owning – pros and cons

Pros

  • capital appreciation in the house
    • one should note that unless you are able to pick the right house, capital appreciation expectations should be limited to annual inflation rate as housing costs make up a large portion of the annual inflation rate
  • likely inflation protection vs. holding cash in a bank account
  • stability (for the term) in mortgage payments
  • ability to pay off mortgage faster and get a guaranteed after tax way to build your net worth
  • Stability for the family – I can pretty much know where I will live for the foreseeable future
  • can borrow against the house (via HELOC) for anything I want
  • Tax free capital appreciation for your primary residence in Canada
  • It’s easier to fit in

Cons

  • Property tax goes up pretty much every year
  • Can be expensive
    • You buy a new(er) house and have big payments
      • Something to note is that many have had bad experiences with new homes still not being built with high quailty
    • Or you buy an older/fixer-upper and have to spend time/money maintaining it
  • Reduced mobility
    • it takes a lot of time and money to move (especially if you have a family)
  • Your Time required
    • cutting the lawn, painting, shovelling snow, raking leaves, etc

Renting – pros and cons

Pros

  • the biggest one for me is time
    • none of my time is dedicated to maintaining the house: no yard work, no snow shovelling, etc
  • usually you can lock in your expenses for a minimum of a year (likely longer)
  • no surprise breakdowns/repairs that you have to pay for
  • most people who rent have high mobility
    • they are able to pick yup and move quicker
    • that means less “things” which for me led to less mental clutter and more time/energy to focus on the things I truly value
  • If you have capital built in your house, you now have better access to it

Cons

  • You can have very little notice on when your house/condo/apartment can be sold and you have to move
  • You have to make rent payments as long as you rent
    • eventually when you own you stop making mortgage payments
    • I mean that’s the dream right?
    • You get to live in your house for free at some point
  • You could have a bad landlord
  • You aren’t able to “make it mine” by painting the rooms whatever color you want or knocking down a wall or renovating the kitchen

For us it was a matter of taking the capital that was tied up in the house and investing it in the public markets to (hopefully) get a higher return than if the capital was left in the house. This of course requires a ton of time.

You also have to consider ALL the expenses with home ownership. Property tax, utilities, sewer, additional fees from the city to upgrade streets, appliances, anything that breaks down.

Once we ran the numbers and realized that it makes sense for the family, we executed in pretty short order. It was actually quite therapeutic to downgrade the size of our living space. We got rid of a ton of things that we didn’t need. Without being forced to move, we likely would have kept many of those things.

Post Move Feels

Positive

  1. The largest thing that I noticed since we moved was how much extra time I have to do things I really want to do. I have been surprised with how much I’m into fitness. I spend a decent amount of time in the gym and wouldn’t be able to do that without sacrificing something else if I had a house to maintain. I also get more family time which is really appreciated in Edmonton’s short summer. Investing performance has improved as I spend more time understanding each business I purchase.
  2. Probably more important that the time is the reduction in mental clutter. I don’t worry about remembering to do or organize something related to the house.
  3. Going against the grain by renting has given me courage to challenge other societal norms. If I didn’t try renting then I wouldn’t have the courage to challenge other traditional beliefs.

Negatives

  1. We have less geographical security. Once in awhile you hear a horror story about someone renting and having to move with very short notice. This has crept into my thoughts a few times. We like to keep as nimble as possible so we are able to react to surprises.
  2. Even after almost 2 years, I still have friends and family think that I’m “wrong”. It’s funny how many people have it ingrained that you just own a home.

Not sure if it’s positive or negative, but many people want me to look stupid. Since they are so emotionally attached to rising house prices, they feel that anyone who doesn’t own a home is a bet against their fundamental beliefs and values. It’s hardened me as a person. In my 20s I would seek acceptance from people, in my 30s I really don’t care what others think of me.

Concluding Thoughts

The only thing I would encourage the reader of this article to do is to ask yourself what is right for you. Not what is easy. But what makes the most sense for you as a person. It wasn’t always easy and yes there is always times of doubt, but in the end renting has been a worthwhile endeavour.

If anyone has a similar experience, please share it.

Thanks,

Dean

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